If there is one thing I’ve learned as an advisor to physicians, it’s that most doctors either own investment real estate or plan to in the future. In our discussions, it’s not usually even a question of “Should I?” but “How soon can I?”
While owning real estate may be a great fit for your financial plan, I believe there is no one-size-fits-all solution for any client. What matters is your personal needs, goals, and resources. I happen to believe most every investor needs some real estate. One benefit of owning realty, for example, is that you can borrow to leverage your investment and take a tax deduction for the mortgage interest.
Where we may differ is in how you own it –physical property or through REITs (Real Estate Investment Trusts) owned through mutual funds. I often recommend a REIT mutual fund or ETF over physical property for the following reasons:
- Physical real estate is an illiquid investment. To get your principal, you must arrange for a sale.
- You have to deal with tenants, maintenance, insurance, property taxes, etc.
- Physical real estate is highly non-diversified. You are betting that the specific property you purchase is going to have better returns over the long term than you could get with your money elsewhere.
- You are usually buying a piece of property from a seller who knows much more about it than you do.
- You will need to arrange for a property manager if you do not live near your investment. Long-distance real estate management can be a real hassle!
- In summary, investing in physical real estate may give you a heady rush because you can actually touch, feel, and smell the property, but it can be quite time-consuming and risky if you aren’t an experienced real estate investor.
REIT funds, on the other hand, allow you to own real estate while diversifying among properties and giving you liquidity for such activities as rebalancing your portfolio and tax harvesting. The downside of REIT funds is the same as with investing in individual equities – you’ll have less opportunity to make a “killing” by finding that overlooked diamond in the rough. Not trying to make a killing, you say? Then REIT funds may very well be a superior alternative to physical real estate.
As I was doing a bit of research for this post, I ran across some surprising stats. While average 20-year returns in commercial and residential real estate have averaged 9.5% to 10.6% on an annual basis, REITs have outpaced both with average annual returns of 11.8%.
Am I advising that you don’t ever invest in physical real estate? Absolutely not. We work with many clients, physicians and non-physicians, who own real estate for the long term. One of the more common holdings is the buildings in which your practices are located in, which I heartily endorse. I’m simply recommending you think through the advantages and disadvantages and be aware that there are other options to fill that real estate space in your portfolio.
Those who approach real estate investing as a serious business and put in the due diligence tend to do just fine. But you shouldn’t measure results based upon whether you’re charging enough rent to pay the mortgage and property expenses. The only way to gauge your degree of success is to objectively track long-term results versus and compare them to the investment choices you bypassed. Include the value of your time, if appropriate.
If you have decided to make real estate one of the core holdings in your portfolio, our recommendation is to limit ownership to 10% – 15% of your overall portfolio’s value, including the amount of your mortgage. And if you own physical real estate, I recommend reducing the amount of REIT funds in your investment portfolio accordingly.