How to clear up clients’ misconceptions about real estate
Real estate can present an enticing opportunity to diversify a portfolio, but advisors are quick to point out some of the unique challenges of investing in real property that clients might not readily appreciate.
Those misconceptions can arise from any number of sources, which is perhaps not surprising, given how unpredictable the real estate market can be.
“I think it's the most heterogeneous asset class and therefore subject to the most variability and also the most analysis,” said Doug Cohen, managing director of portfolio management at Athena Capital Advisors in Lincoln, Massachusetts.
Investors often underestimate how labor-intensive it can be to maintain a rental property, while at the same time they might overestimate the return on the investment, said Peter Lazaroff, a CFP and the co-chief investment officer and a wealth advisor at St. Louis-based Plancorp.
“The probability of success with a stock and bond portfolio is much higher; it's also way easier,” he said. “Real estate investing is way more work than most people realize.”
Both Cohen and Lazaroff subscribe to the notion that real estate is a valuable balancing tool in a portfolio, in large part because of a low correlation with other assets, though Lazaroff argues that that gap is narrowing. Whether that takes the form of real property, real estate investment trusts or other products, Cohen aims for real estate to comprise between 5% to 10% of a client's portfolio.
Lazaroff, who decidedly favors REITs over real property, tries to position those funds at about 5% of a client's equity holding.
“You can get the same diversification benefit from a low-cost REIT fund,” he said.
Lazaroff also takes aim at the myth of an inexorable increase in housing values and cites research showing that over a century and a quarter, housing prices have barely kept ahead of inflation.
“Generally speaking, getting rich from your home is very rare, and if you do it it's because you're lucky,” he said. “A lot of your success with real estate is going to boil down to timing and good luck.”
For those with an irrational belief to the contrary, “what you're really doing is speculating rather than investing,” Lazaroff said.
At Cohen's firm, where the typical client has assets under management of between $25 million and $500 million, some clients made their fortunes in real estate. Others, whose wealth derived from other fields, assume that they can enjoy the same success in the real estate game, where the professionals are at a decided advantage.
Cohen cautions against such “false bravado.”
“We deal with people who very often have been extremely successful in their chosen business. I think there is often, or at least occasionally, a degree of overconfidence that comes with that,” Cohen said.
“Without overdramatizing it, I would argue that real estate truly is a different ballgame,” he said. "You can be an all-pro running back, [but] that doesn't mean your football skills are going to make you an all-pro linebacker.”
This story is part of a 30-30 series on building a better portfolio.