By: Scott Yang, FPA SV President

Have your clients, neighbors, and family members been asking you; “is it time to buy real estate?” I’m going to make some comments on this subject with information I received from Kent Noard’s brown bag presentation on real estate and Rich Arzaga’s real estate presentation to the East Bay FPA. Kent says that clients primarily buy real estate when they are looking at creating losses or deductions and typically do a poor job of picking good real estate investments. The clients that can afford to buy real estate typically make too much money to take advantage of the current year tax losses since they are phased out when the modified adjusted income exceeds $100,000. The suspended losses will be recognized at the sale of the property. But clients are hesitant to sell a piece of property when there is a taxable gain, even if the investment property has reached its full appreciation potential.

At Rich Arzaga’s presentation to the East Bay FPA, he says that many investments are purchased based on a paper napkin calculation that shows a break even or slightly positive cash flow. Forgotten are expenses that burden performance, such as capital/maintenance reserve, professional property management or opportunity costs, entity costs, etc. A piece of real estate is a living asset that requires maintenance. He also discussed repositioning poorly performing real estate near retirement age to enhance tax advantaged cash flow for retirement. A single family home gets a very low yield even when the debt is fully paid off. Net income of $24,000 per year on a house worth $750,000 is only a 3% yield on investment. A diversified bond portfolio performing at 5% gets you more income ($37,500 of interest on $750,000) with less risk to income (cost of repairs, vacancies, and liability issues). A diversified portfolio consisting of bonds and stocks have the potential to do even better.  The single family house is purchased with the hope of appreciation and is not an investment that can easily be valued like a commercial (core) real estate which is based on the cash flow it creates.

Where am I going with all of this? I suppose I’m asking you to tread carefully when advising in the real estate area. Those of you who thought real estate investments always go up in value may have been unpleasantly surprised over the past few years. Real estate has historically tracked with inflation over the long term. The reduction of interest rates coupled with loose underwriting standards has made real estate affordable to investors and speculators in the past. The longer term prospect of interest rates rising will be unfavorable toward the performance of the real estate, and the tighter underwriting standards will hamper investors trying to get into the market. Review with your client the goals they have for purchasing the real estate which will help evaluate whether it makes sense to make a purchase. The perception that the market is cheap is not a valid reason for purchasing until you consider all of the factors including current and future cash flow, the demographics of the area you are purchasing, and the strategy for exiting the investment considering the tax ramifications and selling costs (commissions and fix up expenses). REITs and non public REITS are another way to invest in real estate without the hands on management headaches associated with active management. It also may provide greater diversification as a pooled investment and offer more liquidity.

For the advisors who are looking for education on real estate investing, I highly recommend that you enroll in Rich Arzaga’s real estate investment class at UC Berkeley Extension. This class really opened my eyes on how to evaluate real estate and the pros and cons of making a purchase of various real estate investments by form (direct purchase, non public REIT, Tenants in Common) and by type (land, commercial, apartments, and single family homes).

Please join us at our May 14th chapter meeting with Kristen Luke, marketing consultant and owner of Wealth Management Marketing, who will discuss how planners can use social networking tools in their practice to develop business and make connections in the new world. If you are interested in integrating social networking into your marketing plan, and your compliance department has given you permission, you'll want to start with Facebook, LinkedIn or Twitter. Each one has its own unique style and purpose. Choose the site that best fits your business strategy or a combination of sites to achieve different purposes. You will learn more about this in her presentation.