When most people think about real estate, they picture a home or maybe that dream beach house. However, from an investment perspective, real estate can serve a different purpose in helping to diversify your portfolio and potentially smooth out the ride during retirement. So, how exactly can real estate fit into your financial picture? Let’s break it down.
The Many Faces of Real Estate Investing
Real estate can serve as a valuable piece of your investment puzzle, but it comes in many forms. The type of real estate exposure you choose depends on your goals, time commitment, and risk tolerance. The question isn’t just “Should I invest in real estate?” It’s more, “What role do I want it to play, and how involved do I want to be?”
Here are a few common options:
- Direct ownership: Buying and managing a rental property. Think of this as the “hands-on” version of real estate investing. It can offer both rental income and the potential for the property to appreciate over time, but it’s not exactly passive. You’ll be handling everything from repairs to tenants, unless you outsource it. Even with a property manager, there are still decisions to make, bills to pay, and repairs to address. It can be rewarding, but calling it passive income might be a bit of a stretch. For some, it feels more like a part-time job. If that’s not how you want to spend your retirement, it’s worth exploring more hands-off alternatives.
- Publicly traded REITs (Real Estate Investment Trusts): These are like mutual funds for real estate, offering exposure to commercial or residential properties without the hassle of being a landlord. They pool money from investors to buy properties—ranging from apartment complexes to office buildings to warehouses—and distribute most of their earnings in the form of dividends. This structure makes REITs a reliable income-generating tool, and because they’re required to distribute 90% of their taxable income to shareholders, the yields can be appealing. Plus, they’re much easier to buy and sell than physical property. Because REITs generate a lot of income, holding them in a taxable brokerage account can increase your tax bill. Consider using a tax-advantaged account, such as an IRA, for these types of investments to minimize the tax impact.
- Private and non-traded REITs: These are less liquid than public REITs and often require longer holding periods, but they may provide access to specialized or higher-yielding real estate opportunities.
- Crowdfunding platforms: Sites like Fundrise or CrowdStreet let you invest in fractional shares of real estate properties. These can be a way to dip your toes into real estate with lower minimums, but they also come with varying levels of risk and liquidity.
The Pros (and a Few Cons) of Real Estate in Your Portfolio
Real estate tends to move differently than traditional stocks and bonds, which means it can potentially help reduce the overall volatility of your portfolio. And because real estate rents and values often rise with inflation, it can offer a helpful hedge against rising prices. That said, not all real estate is created equal. A single rental property in one location is very different from a diversified REIT that owns hundreds of properties across multiple regions and sectors. Additionally, depending on market cycles or the structure of your investment, your funds could face liquidity challenges for years.
And let’s not forget taxes. Real estate income and gains are subject to unique tax rules. If you hold it in a taxable account or structure, you will pay taxes on any income earned each year. When it’s time to sell, you may face a variety of taxes, including depreciation recapture tax, along with capital gains. Some investors opt to defer taxes using more complex tax strategies with the help of a qualified tax professional if they’re facing a significant tax hit on a property sale.
Is Real Estate Right for You?
Real estate can be a powerful tool in a diversified portfolio, but it’s not a “must-have” for everyone. As with any investment, the key question is whether it enhances your overall portfolio in line with your goals, time horizon, and risk tolerance. In other words, just because you can invest in real estate doesn’t mean you should.
A well-constructed retirement plan should improve your return per unit of risk. If adding real estate helps do that, great. If not, there’s no need to complicate things.
Real Estate and Retirement Income Styles
Depending on your approach to retirement income planning, real estate can play different roles:
- If you’re in the “probability-based” camp (think total return investors), you might view property appreciation and variable rental income as useful components of your long-term strategy.
- Those with a “safety-first” mindset may be more skeptical. Rental income isn’t guaranteed. Tenants come and go, and unexpected expenses can pop up.
- For the “commitment”-oriented or “optional” income styles, it depends on whether you’re ready to lock up capital in less liquid investments or prefer flexibility and ease of access.
You can take our Retirement Income Style Awareness (RISA®) questionnaire now to discover your RISA® Profile. It’s a great first step, aligning implementation strategies with your individual preferences as you continue to explore if real estate should play a role in your portfolio.
Want to learn more? Listen to Ep. 181 of the Retire With Style Podcast.
