Article 1 of 5: Real Estate As An Investment Option
This is the first in a series of five pieces to help investors understand the benefits of owning commercial real estate, then differentiate the dynamics and variety of ownership channels.
For centuries, the two asset classes creating the most wealth have been stocks and real estate. Today, most people’s first investments are in stocks or stock funds. Established investors should consider adding real estate investments to enhance their portfolio.
Real estate has a different return composition.
Over the long term, U.S. stocks (i.e., the S&P 500 Index) have averaged annual returns in the 11% range. This comes mostly from appreciation and a modest (around 2%) dividend. Established real estate investments have comparable total returns, but a different return composition, with about 70% of the return coming from income. There are also tax advantages that can improve after-tax return. Both stocks and real estate investments can benefit from long-term capital gain tax rates, but real estate can offer additional tax benefits from pass-through depreciation.
Real estate has a lower risk profile than stocks.
Stock prices can fluctuate dramatically with quarterly earnings surprises, broad stock market gyrations and investor emotions. Real estate prices are driven by demand, net operating income (NOI), and interest rates, which all move more slowly. Demand can be driven by sector (apartments or warehouses, e.g.) or by the growth or decline of a specific market. Rising borrowing costs can restrict net income, however this is often offset by price appreciation in an inflationary environment.
Real estate behaves differently than stocks during economic cycles.
Stock prices are driven by earnings expectations and rise or fall in anticipation of changes in corporate earnings and broader economic forces. Building values tend to be much more stable through cycles, as values are determined by consistent rental income rather than less predictable corporate profit expectations.
Geography and sector diversity are important considerations.
The types of buildings you invest in and their location are important. Population shifts, regional economies, state-specific tax and business climates all impact real estate.
To learn more about how real estate can be classified by sector, location, and risk/return characteristics, read the next blog in our real estate series, “All Real Estate Investments are Different”.
As machines become more intelligent, their role as “Robo-Advisors” is destined to become more widespread. It’s popular for being a cheaper way for big firms to invest your money, but it is based on only a limited set of facts, like your age, financial stability, and your appetite for risk. Sadly, no matter how good it may seem, computers will only follow instructions.
Your financial planning should be more personal and nimble than a computer program. Automatically rebalancing a portfolio is fine, but you deserve professional expertise, compassion, and human judgment to make decisions for your money.
Financial planners may cost a little more upfront but building a relationship and getting holistic advice that considers your circumstances could be invaluable.
We build real relationships with clients. We partner with you to determine when you’ll need money. We take low risk with the money you need soon, allowing the opportunity to capture greater returns with money invested for later.
We do this by segmenting your portfolio into timeframes, from next year all the way to 15+ years. Each segment employs one of our 5 strategies, which keeps risk (and emotions) aligned to your needs and goals.
Many people have unanswered questions about setting themselves up for a successful retirement. Below are the primary risks to consider and some general ideas for overcoming them. We help our clients with these strategies, which starts with identifying the amounts needed to fund goals. This conversation is different for everyone, so we invite you to connect.
Underfunding:
Try to maximize your employer’s retirement plan. Many Americans contribute only the amount that triggers an employer match, failing to adequately fund this primary channel for retirement savings. Since salary-deferral contributions are not taxed, the reduction to your take-home pay is less than any contribution increase.
Overspending:
You want to stay retired, so be modest in projecting the growth of your investments during retirement. If you overspend early in retirement, you put too much pressure on your portfolio to sustain lifetime income.
Longevity:
With increasing life expectancies, retirees should plan to spend 35 years in retirement. Life expectancies are a mid-point, not an end-point. What you don’t want to do is plan to live to age 88 and turn 87 without enough money for the next 15 years.
Investments too Conservative:
The refrain of maintaining your principal and living off the earnings is not a good strategy. Inflation compounds every year, so retirees need growth investments to maintain their lifestyle. Every retiree needs some growth investments, which do better over long periods and can offset the challenges of increased longevity and rising costs.
Inflation and Medical Costs:
Inflation occasionally spikes (like after COVID), but even a 4% rate doubles expenses in 18 years. It’s estimated that 80% of your lifetime medical expenses are in your last five years, and the medical cost inflation rate averages 8%. Be sure to factor rising healthcare and living costs into your retirement planning.
It is widely recommended that you work with a financial advisor. We employ cash flow analysis and forecasting to model spending and investment strategies. The “4% Rule” is outdated and can compromise a peaceful retirement if markets decline early in your retirement. We created time-layered strategies to grow investments with appropriate risk throughout your retirement.
Broad asset allocation based on “risk scores” assumes more risk than aligning investments to fund specific goals. So, we take little risk with money you need soon, allowing the benefits of increased risk to mature over extended horizons. The longer investments have the greater the certainty of expected returns. Plus, you don’t have to worry about short-term market gyrations.
Set an appointment if you want to speak with us about how we might help you.
Typically, selling an investment property like a rental home or an office building will trigger taxes on the amount of gain. This may stop people unaware there is a way to defer these taxes.
The IRS allows a property seller who reinvests all the proceeds into one or more new properties (known as replacement properties) to defer taxes on the gain. This process is called a 1031 exchange, named for the section of tax code that allows it. This process is currently repeatable and you can also quit being a landlord!
The IRS allows reinvestment into passive investment vehicles known as Delaware Statutory Trusts (DSTs) which can also reduce risk versus owning individual buildings and provide monthly income.
There are several reasons investors consider a DST for their 1031 exchanges.
Because DSTs are professionally managed, you can quit dealing with tenants, maintenance, etc. These passive vehicles may also provide diversification across property types and regions of the country. The investor may also consider their heirs, who may inherit these investments tax-free. It is also easier for heirs to receive interests in a DST than negotiating to liquidate a physical property.
The 1031 exchange rules are complex. We recommend speaking with a knowledgeable financial advisor and tax professional well before an investment property is sold.
Enjoy today and tomorrow, and let us do the worrying!
We strive to add value to all aspects of your financial wellness. This includes your financial security – protecting yourself from theft of your personal data and financial information. Below are some tips we hope are useful.
Learn How to Spot a Phishing E-mail
A phishing e-mail is when a scammer sends a fraudulent e-mail hoping to trick you into revealing sensitive information or downloading / clicking on something that will give them access to your information. The sender may pose as a company or even someone you know. Scammers are getting more sophisticated and may learn how a friend or family member speaks via e-mail to impersonate them.
Here are some common red flags that can be spotted in a phishing e-mail:
Think Before You Click
Think before you click applies not only to e-mails but to text messages and messages/posts through social media as well. Scammers can even spoof a phone number to make it look like a text message comes from a number you recognize. A scammer may ask for your personal information, ask you to click on a link that could install malware on your phone, or direct you to a fraudulent website asking for credentials that they can then steal.
Legitimate companies won’t ask you for personal information via text. Watch out for texts saying things like:
We’ve noticed suspicious activity on your account
There’s a problem with your payment information
A payment has been made for XYZ. Contact us if you didn’t authorize this payment
A package (that you are not expecting) has been sent. Click for tracking information.
If you think a message might be real, contact the company using a phone number or website you know is real.
There are many helpful tips for secure passwords, including increasing password length and using a combination of upper and lower-case letters, numbers, and symbols. You may have seen a chart like this showing how difficult it is for a hacker to crack a long and complex password!
Enable Two-Factor Authentication
Two-factor authentication is a method that requires two credentials to be entered to access an account. For example, you may be prompted to enter your password, followed by a code received via text message. The password is the first factor, and the code is the second factor used to authenticate your identity. Some websites are beginning to require two-factor authentication. However, for those that don’t require it you may be able to turn it on yourself in your account settings.
Enjoy today and tomorrow, and let us do the worrying!
Watching your account balances shrink during down markets is never easy. Behavioral economists tell us that the pain people feel watching their investments decline is twice as powerful as the joy of gains. A period of market volatility like we have been experiencing recently is a gut check for even the most experienced investors.
Not too long ago, do-it-yourself investors were reaping the benefits of a rising market.
Notably, 2021 was quite abnormal with the S&P 500 rising approximately 27%. The index returned greater than 20% in only 4 of the 20 years prior.
What’s occurring today is a natural part of markets, but that doesn’t mean that it is comfortable. DIY investors may have simply stopped looking at their investments, which is a perfectly understandable reaction.
Professional managers are always looking and may be first to recognize buying opportunities. DIY investors have a tendency to wait for positive momentum before investing and may miss a significant portion of a recovery.
Some sectors are harder hit than others and professional managers make tactical shifts between them based on their research. We saw that stocks were overvalued last Fall and moved a portion of client assets to private real estate. We have since seen markets break technical support levels and further reduced equities exposure.
We only take meaningful market risk with the assets that can truly stay invested for the long term.
To accomplish this, we keep money that may be needed in shorter timeframes in safer, less volatile investments. We also have direct access to alternative investments that can complement stock risks.
One of the beauties of this paradigm is the reassurance that comes from knowing you’re not going to be forced to sell into down markets.
Speaking with a financial advisor may help alleviate the natural feelings of discomfort that occur during volatile periods.
If you would like to speak with us about your personal financial situation, click here.
So, enjoy today and tomorrow, and let us do the worrying!
We are among a select group of advisors who directly trade with Dimensional Fund Advisors (DFA). This mutual fund family was started in 1981 by alumni of the Booth School of Finance at The University of Chicago with the idea that stock markets are efficient and reward long-term investors.
Most investors have never heard of them because DFA limits the advisors who can offer their funds to groups who are willing to go through education, trading restriction, and reporting requirements.
We manage Dimensional Fund portfolios for long-term client accounts because of their scientific approach of applying academic research to practical investing works. They have a long history of strategies that have successfully delivered higher returns with minimal fees.
To ensure that their use of academic research was thorough, they first reached out to Professor Eugene Fama, known as “one of the fathers of modern finance”. He became a charter shareholder and was later awarded the Nobel Prize for Economics in 2013. Next, they asked Merton Miller (also a Booth School professor) to join the board. Miller won the Nobel Prize in 1990. The next office over was Myron Scholes, who also agreed to join them and received his Nobel in 1997.
The Science of Investing
As an example of their research, they show that $1 invested 95 years ago in U.S. Large Cap stocks would now be worth almost $11,000. The same $1 invested in U.S. small company stocks would be worth $32,800. So, the portfolios are overweighted to small-cap stocks!
The same is true for Value, that more often outperforms Growth, and International Stocks adding additional returns without a lot more risk. So, these portfolios are overweighted to Small Caps, Value and International. They tend to outperform more evenly balanced strategies, especially in times of economic expansion like we have now.
Each Integras Partners client has a custom blend of our strategies intended to align appropriate risk to each timeframe. By securing short-term needs in lower-risk investments, we can insulate the remainder and employ strategies including DFA funds to seek truly long-term growth.
Meet Paul, age 56, whose employer of almost three decades offered him early retirement. He’s afraid that if he doesn’t take it, the offer will be smaller next time. His wife, Maria (age 57) has a consulting practice, and would like to see Paul slow down for his health and sanity. They came to us for clarity on their retirement readiness and advice on strategies for moving forward.
In our Discovery Meeting, we learned that the couple has two grown children, who appreciate some financial help on occasion. Their parents are financially stable today but likely will need assistance as elder care needs increase. Eventually, they will downsize their home and dream of a small lake house, if possible. Their only debt is their home mortgage with eleven years remaining. Maria will need a new car soon and hopefully there’s a daughter’s wedding on the horizon.
Paul consistently contributed to his 401(k) and is eligible to receive a pension starting as early as age 60. His offer is for six months of severance pay with health coverage. Maria has some retirement savings from previous employers and the couple has accumulated some non-retirement investments and savings. They agreed that Paul could find work he enjoys and does not need the stress that goes with a six-figure income. Since he wants to see an endgame, we started by exploring strategies for taking Social Security.
Paul’s Social Security check will be the largest, which we suggest deferring, while feasible, so the surviving spouse continues receiving a higher income. (Social Security income goes up about 8% for every year delayed and maxes out at age 70.) We recommend Maria taking a reduced benefit immediately upon retirement, as early as age 62. We also suggested a small business health plan for Maria’s consulting business, which can be replaced by Medicare and Supplemental Policies after age 65.
In facilitating a conversation with his pension administrator, we learned that Paul has a “lump-sum” option, to take an immediate payout in lieu of a lifetime pension. He liked this idea and wants to invest the proceeds in an IRA. This can provide multiple benefits: potential increase in value, flexibility to use the funds when he likes, and protects any remainder for his heirs. These funds won’t be available without penalty until Paul turns 59 ½, which is fine because employees attaining the age of 55 before the end of their last year of employment are eligible to take 401(k) distributions without penalty.
Paul did elect to leave his company, and after a few months accepted some consulting work, which paired with Maria’s income to meet their monthly expenses. They have flexibility to draw moderate 401(k) distributions, as needed for extraordinary expenses. Their goal is to let retirement plans grow for now and eventually take a distribution and use some savings for the down-payment on a lake house, which they might even rent occasionally.
Paul and Maria are more careful about spending for now but are happy and see a comfortable retirement when they downsize. We will help them realize that dream when they have only the lake home mortgage, supported by income from the retirement accounts and two social security checks. We also introduced them to Generational Conversations, our initiative to support adult children and parents explore plans for senior housing options, elder care, financial continuity, and legal strategies.
When faced with a layoff or early retirement, this can be the most difficult decision. We’ve helped hundreds of clients weigh the options, so here are some questions that may be of help to you.
Is my former employer financially stable and is the pension well-funded? When companies have major layoffs, they’re trying to stop bleeding cash. Pensions are rarely completely funded and rely on the continued profitability of the company.
Do I take a reduced benefit to provide for my spouse? Consider your family longevity and personal health habits. If you take the larger amount upfront for the retiree, will you save any of the monthly payments? Women typically live longer and in 25% of couples aged 65, one spouse will live to 95.
How Do I Evaluate the Lump-Sum Option? Many employers offer a Lump-Sum Benefit to “buy-out” their pension obligation. Factors to consider include your personal health status & family longevity, interest rates and inflation, your current situation, the number of years until benefit eligibility, and your feelings about leaving assets to your heirs.
Could I generate more income by investing the money?
