How Real Estate Can Fit Into A Client’s Financial Plan

Many financial advisors see real estate as their competition, often because of the simple fact that advisors cannot draw fees from property a client manages. This approach can be shortsighted, and advisors who adopt it can leave clients unaware of how investing in real estate can help them achieve their financial goals. Advisors who embrace real estate, on the other hand, can lead clients to previously unconsidered sources of income and financial confidence.

Why It Works

The home in which you live, even if you own it outright, is not a real estate investment. Primary residences are assets, and their value can have enormous importance in retirement or estate plans. But real estate investments are defined by their ability to produce passive income for their owners through rental leases.

The biggest benefit of real estate investment is safety. Rental income insures clients against market swings and generates regular income with which clients can invest. That insurance can be critical in recessions, and it’s important to remember that the housing and stock markets have not historically moved in tandem. The 2008 financial crisis was the exception, not the rule.

As with every other investment, real estate works best when it’s part of a diversified portfolio that also contains brokerage investments and insurance policies. In fact, rental properties come with regular costs in maintenance and taxes, and property owners may find advisor fees on brokerage accounts very low by comparison!

How It Works

The typical investor breaks into real estate like this: An investor purchases their first home, their primary residence that counts as an asset but does not generate income. Then, when the numbers add up, the investor takes out a home equity line of credit or a cash-out refinancing to buy a second home as a rental property. Rental income is the leftover profit after an investor covers the mortgage, maintenance and taxes on a rental property.

An investor’s first rental property is typically a single-family dwelling, as that’s the easiest property type to acquire for investors without a lot of extra capital. Duplexes and fourplexes offer more rental income but often require 25% down payments.

But why residential at all, instead of commercial? As the pandemic showed us, everyone needs a place to live. Not everyone needs a place to host a business — lots of businesses have learned how to operate remotely, and many other businesses went under. Even Section 8 housing is safer for real estate investors than commercial properties, as government subsides often make Section 8 residents very reliable tenants.

It’s important to note that overpaying a mortgage is typically a poor use of rental income. Overpayments reduce a client’s ability to use the mortgage interest tax deduction, and returns on market investments typically outpace mortgage interest rates anyway. Remember, real estate equity means nothing for a client’s financial security unless they sell or refinance. The only time overpayments might be worthwhile is when a client owns a home they intend to live in for the rest of their life.

Who It Works For

Real estate isn’t the right tool for everyone, and it’s usually best to wait until clients bring up the idea. Millennial or Generation X clients may want passive income, or they may want to provide for parents who didn’t save for retirement themselves. Sometimes, clients will also want additional dwelling units as a base of operations for retirement travels or as a home for an in-home caregiver. They can acquire that ADU early and use it as a rental property until they retire.

Most importantly, clients need a definitive reason for wanting real estate. “I feel like I should have it” isn’t a good enough reason.

Clients also must be able to afford ongoing real estate costs, even in times of financial crisis.

Mortgage payments, maintenance costs and taxes are standard, but clients should budget for private mortgage insurance and the occasional tenant who can’t make rent, too. Finally, clients should plan to hold real estate investments for at least five to seven years. Real estate can generate impressive rates of return, but those returns take time to accumulate.

Real estate may be the most popular “alternative investment” in the U.S. right now, and it will continue to be a worthwhile investment option for the foreseeable future. When making plans for clients’ financial futures, make sure to consider the potential that real estate can offer.

Charlene Quaresma is a wealth management advisor with Northwestern Mutual in Portland, Ore. She is a global speaker and four-year MDRT member. She may be contacted at charlene.quaresma@innfeedback.com.