Real estate can add balance to an investment portfolio
By Neal Driscoll, for SBT
Commentary
Since the beginning of our “economic slowdown,” many investors have been the unfortunate recipients of a harsh lesson: Diversification is the key to wealth retention and growth.
Investment portfolios have been injured, and in numerous circumstances crippled, by the fall of the technology industry, corporate scandals and weak earnings reports across industry sectors.
As the Federal Reserve Board continues to scratch their heads in regard to long-term market stimuli, investors are gravitating toward real estate as an alternative investment.
Rest assured, there are many investment opportunities beyond the late night infomercials that guarantee million dollar earnings your first year selling homes (for the special offer price of just 3 monthly installments of $19.99).
The first and most passive of these real opportunities is investment in REIT stocks (real estate investment trusts). Public REITs are typically traded in the major exchanges, with no minimum requirement. Therefore, liquidity is an important benefit.
Private REITs exist as well. REITs typically specialize in a particular real estate property type and location. Since the mid-1980s, REITs total annual returns have outpaced the long-term government bond market.
In the past two years, overall REIT performance has outperformed the 10- and 15-year Treasury, the NASDAQ Composite and the S&P 500.
REITs must pay out 90% of their income in dividends each year, while many offer dividend reinvestment and stock purchase plans. Dividend tax relief has been a widely discussed topic of the Bush Administration’s recent stimulus package.
However, most REITs will not qualify for the reduction in corporate dividend tax because they generally do not pay tax at the corporate level.
Moving to more active investment in real estate, in turn, moves to greater risk and reward opportunities.
Today, a majority of income-producing real estate is traded based on a capitalization rate, directly affected by debt opportunities. You may apply for investment property loans if you need help financing your real estate investment.
Several basic investment opportunities exist for individual investment: the purchase of ground leases, single tenant net leased properties such as 2 bedroom townhomes and multi-tenant properties. If you want to be a cash buyer, there are real estate companies that can help you make your offer more enticing. You can look here for more info.
Real estate assets are typically purchased as an individual or through ownership structures such as limited partnerships, limited liability corporations, S-corporations or tenants in common (TIC).
The benefits of real estate investment include the security of well chosen investments, annual cash flow, Real estate can add balance to an investment portfolio the ability to capitalize on depreciation, interest deduction on debt against real estate, deferral of capital gains as assets are traded, and most importantly, overall portfolio diversification.
Today, investors are capitalizing on relatively inexpensive debt to maximize their leveraged position. As key rates decline, the spread between capitalization rates and debt create phenomenal cash flow opportunities.
As mentioned earlier, this year’s tax relief plans have two major benefits to owners. Primarily, capital gain tax is reduced from 20% to 15%. (It should be noted, this reduction is on the capital gain only. The recapture rate remains at 25%. Consult your tax advisor for details.) Secondarily, the act allows for faster depreciation on tenant improvements and certain equipment, which directly affects cash flow.
The primary downfall of real estate investment is liquidity. In a soft market, investors rely on the quality of their tenants to continue to pay rent and maintain occupancy factors, as required by their lender.
Contrary to more liquid investment options that can be quickly exited when losses occur, when operating expenses exceed revenues, owners may need to fund shortfalls with reserves.
Many investors have been waiting on the sideline for vacancy problems to force owners with poor cash flows to consider sales at discounted values.
The abundance of debt opportunities has allowed owners to refinance their assets and weather the current market slump. Consequently, opportunity buyers (also known as value-added buyers) with a need to place funds are ready to pay owners a competitive market price for their real estate.
There are great benefits to including real estate as an investment vehicle in your overall portfolio. The key to real estate investment is sound decision-making.
Neal Driscoll is the investment sales specialist at Inland Cos., Milwaukee.
July 11, 2003 Small Business Times, Milwaukee
