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Is Real Estate Investment Safe to Add to Your Retirement Portfolio?

MB Daily News, Raleigh, NC: When choosing to add real estate investment to your retirement portfolio you should considered a blend of commercial, residential, and buy to sell for a short amount of time.

Whether it is a physical property, such as an apartment building, or an investment in a real-estate investment trust or mutual fund, many financial-planning professionals say that income-producing real estate is an essential part of a well-performing retirement portfolio. However, while 75% of retirees have their money parked in bank accounts or CDs, just 12% own real estate other than their primary residence for investment, according to a survey conducted by the Transamerica Center for Retirement Studies between November 2020 and December 2020.

“In our research, we found that portfolios that have a mixture of stocks, bonds and real estate outperform other portfolios,” said Ken. H. Johnson, Ph.D., a real-estate economist at Florida Atlantic University. “You get a better risk/return profile from owning real estate.”

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Dr. Johnson said the “optimal mix” in a portfolio is 50% real estate, 30% stocks and 20% bonds. This formula, he said, would be considered sufficiently diversified to provide stability in retirement. The real-estate component can include your personal dwelling, investment property or a mixture of both.

But what type of real estate? And should you invest directly in income-producing hard assets, like residential rental property or commercial property, or make more passive investments, such as a REIT, by purchasing publicly traded shares or investing in a mutual fund?

Joe Pelayo, a commercial real-estate broker in Fort Lauderdale who works with individual investors, recommends warehouse properties to his clients looking to invest for retirement because they usually require little active management. Similarly, medical-office buildings also have long-term tenants and often have triple-net leases, he said, where the tenants pay expenses and assume management responsibilities for the building. Residential investment takes more work.

“When you invest in residential property, you have to have some management skills,” said Mr. Pelayo. “But with commercial properties, the leases are long—five to 10 years—so you don’t have to be chasing a new tenant every year or two.”

Despite the challenges, many retirees invest in residential property, such as single-family rental homes.

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Jim Cheeks has been a builder in Atlanta for about 20 years, and he always sold what he built. But about five years ago, he realized that he wasn’t creating long-term retirement wealth that way. So, Mr. Cheeks, 53, now retains about 25% of what he builds as rental property. His goal is to have a portfolio of income-producing properties when he retires. That portfolio currently consists of eight homes that he rents, but within a year he expects to own 29. His investments vary, but a typical property, which includes three units—a duplex and an accessory dwelling unit—throws off about $8,000 a month in rental income, which, he said, yields a “better than average” return on his investment.

At 28, Josh Pankratz has the same investment strategy as Mr. Cheeks. Mr. Pankratz, a medical sales representative from Hattiesburg, Miss., purchased his first investment property in 2018 and currently owns two three-bedroom, two-bath homes that he rents out. Each provides rental revenue of approximately $1,500 a month.

“I didn’t want my money sitting in a bank account being stagnant and not growing,” he said. “I have a 401(k) and a Roth IRA, but real estate diversifies your risk since people need to have a place to live, even through times of crisis. And it not only provides cash flow but it’s an appreciating asset.”

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That annoyance can be avoided by hiring a property manager. Doing so cuts into your return on the property, for sure, but many investors consider the cost—which varies by market, but typically is the first month’s rent plus 10% of each month’s rent thereafter—to be well worth it, especially since the management company will also find and vet future tenants.

Here are some things to consider if you’re thinking about adding income-producing real estate to your retirement portfolio.

Consider secondary, less-expensive property markets. It might be tempting to purchase investment properties close to home so you can keep a close eye on them. But, depending on where you live, real estate may be so pricey that the returns are low. Mr. Pelayo said investors from New York, Chicago and California are flocking to South Florida and pushing prices up and returns down. He recommends looking in less-expensive markets to maximize returns. Jacqueline Ready, a broker at Berkshire Hathaway HomeServices Panoramic Properties in Biloxi, Miss., said that she frequently works with out-of-state investors seeking properties for their retirement portfolios. “They can take their portfolio in Arizona, liquidate it and purchase two or three times as much property in South Mississippi,” she said. “Your money stretches much further in the smaller markets, and not just on the property itself but on maintenance, improvements and management fees.”

Diversify both product type and geographic area. “A diversified portfolio will have a smoother ride through the ups and downs that occur through the economic cycle,” said Michael Silver, a certified financial planner in Boca Raton, Fla. “If you invest across all asset classes—stocks, bonds, real assets and cash or cash equivalents—some of them will zig, while others zag, and you’ll get a more consistent, stable and predictable return over time.” Investors should also diversify geographically and not concentrate assets in a single market. “Commercial real estate can be risky, especially if you are looking in just one geographical area,” said Jamie Hopkins, managing director, wealth solutions at Carson Group, a national wealth-management and coaching firm.

Learn the lingo. While investors should always rely on professionals to review their deals ahead of time—including attorneys and accountants, who can review the numbers and confirm that the return on the property is what was touted—realize that commercial real estate is all about the numbers. And, to understand the numbers, you need to know the lingo, so brush up on the formulas for NOI (net operating income), cap rates and other applicable finance terms.