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Make sure clients don’t romanticize real estate investing

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The prospect of real estate investing has an alluring pull for clients, but advisors caution that those romantic notions can obscure some of the pitfalls that arise when purchasing investment property.

“For all the millionaires and billionaires real estate has created over the years, there are also a lot of lost fortunes because of real estate,” said Doug Cohen, managing director of portfolio management at Athena Capital Advisors in Lincoln, Massachusetts. “You really need to understand how to enter and exit real estate.”

As a starting point, the message that advisers emphatically convey to clients looking to purchase an investment property is to do their homework and research the unique features of a given market.

“The real estate investment outlook in New York may be very different than the real estate investment outlook in North Dakota,” Cohen said. “There's probably more variability in real estate than any other asset class.”

Peter Lazaroff, a CFP and the co-chief investment officer and a wealth advisor at St. Louis-based Plancorp, takes a decidedly dim view of real property as an investment.

He is quick to point out an array of factors that can make real estate a less desirable asset class than a traditional package of stocks and bonds.

“Plancorp views real estate not as an investment but really as a place to live,” Lazaroff said.

At the same time, he firmly believes that real estate has a place in a balanced portfolio, but he prefers real estate investment trusts and other products that don't have the shortcomings of real property.

Lazaroff notes that an investment in a single piece of property is an illiquid and undiversified holding, and that, moreover, it is indivisible.

If a client needs cash, “you can't sell your kitchen,” he said.

Lazaroff also points out that the liquidity issue can cut both ways, and not always to the owner's advantage.

“The liquidity is asymmetric, so you can get a lot of money out of your house when housing prices are going up,” he said. “But when housing prices are going down, that liquidity is gone.”

Advisors recognize that real estate, probably more than most investments, has a strong emotional component to it, and if a client is bent on purchasing a piece of property, it can be hard to dissuade them.

Jody King, vice president and director of client services at Fiduciary Trust in Boston, said that the advisor's job is both to connect with a client on the "softer side of the conversation," as well as helping them see the property as a black and white investment.

So, if a client is planning to purchase and rent out a vacation property, she will try to talk to them about having “someone else in your home.”

“That's something that I always try to make sure clients understand,” she said.

King will also help clients spot other potential red flags, encouraging them to do an extra level of due diligence if a property has been sitting on the market for a long time.

Or if the client is looking at purchasing a condo, she advises that they research the condo association to evaluate whether it is "healthy, financially and otherwise."

“They don't always think to go to that level,” King said.

But even if some of the intangibles seem good, she will sometimes remind clients that they are making a financial move above anything else.

“There's always that personal side to it," she said. "[But] if you're going to make an investment decision, you have to stand back and separate a little bit ... separate the investment side to make sure it's a logical choice.”

This story is part of a 30-30 series on building a better portfolio.

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