April 16, 2024

Individual investors own more than 14 million properties in the U.S., comprising almost 20 million units.* For advisers, these numbers indicate that direct real estate investments could figure into the current net worth and future financial health of a significant number of their clients.
Advisers owe it to these clients to form a strategy around their real estate assets as part of a long-term financial plan. Focusing on these three questions with clients who hold real estate can uncover important considerations for integrating investment property into their wealth plan.
“Too often, advisers don’t think to ask these questions because they don’t see real estate as an asset that they’re managing in a liquid or custodial account,” says Rob Johnson, head of wealth management for Realized, a platform that helps advisers and investors manage investment property wealth. “But for holistic planning, they need to understand the client’s asset locations across all their investments.”
To get the conversation started, advisers should use three questions to uncover what investment property their clients might hold and what they might have considered doing with it.
1. Where does real estate fit into your wealth management plan as a whole?
Advisers typically begin conversations with clients by assessing their current financial situation and how it plays into their short- and long-term goals. If a client owns one or more real estate properties, it’s important to gauge how these assets complement more traditional sources of income and the role they can play in building wealth over time.
Some clients may have a clear idea of the role their investment property plays in their financial situation, while others—often those who have inherited or received real estate in a settlement—may need support integrating into their holistic portfolio. Clients who are still decades away from retirement will likely think about their real estate holdings very differently from clients who are closer to or even in retirement.
For clients at any stage in their wealth management journey, it’s a good idea to talk through the benefits of real estate as an investment. For starters, real estate has the potential to deliver strong returns, especially given that some investors may qualify for related tax breaks and deductions. It can also be less volatile than many other assets, and, since demand for real estate is strongly correlated with expanding economies, it can be a good hedge against inflation over the long term. Toss in the benefits of diversification that come with adding another asset class to the investment mix, and real estate’s advantages are hard to dismiss.
2. What is the net income from your investment property?
That said, direct real estate ownership comes with challenges. Number one: managing the ongoing expenses of ownership, followed by staying on top of taxes and insurance. “Just having an investment property and knowing it’s generating some income isn’t enough,” Johnson says. “Ultimately, every investment property owner should be doing an analysis on their own or in concert with their financial adviser as to what their net income from that property is.”
This analysis can be complicated because of the irregular nature of income and expenses related to rental properties. For example, the loss of a tenant could result in a gap in rental income, or unexpected repairs could require a significant expenditure that puts a dent in long-term income. It’s important to talk through these possibilities with clients and account for them when discussing a property’s long-term income-generating potential.
Taxes, too, can reduce real estate income, with cash flow and revenue from direct real estate ownership taxed as regular income. And a client who plans to liquidate faces a significant tax burden. Profits from property sales are taxed as capital gains, which leads to the last important question:
3. Are you interested in holding the property, liquidating it or swapping it for another real estate investment?
Some clients may have no interest in getting rid of their direct real estate investment. The property may hold sentimental value or bring in enough consistent income that is worth holding. Of course, clients who opt for continued direct ownership of a property must face the time, effort and expense involved in maintaining it.
Liquidating a property brings one obvious benefit: the cash that comes from the sale. Many individuals opt to go this route as they approach retirement, with the aim of converting an illiquid asset into higher liquidity. Unfortunately, unfavorable market conditions, capital gains taxes incurred on profits or both can erode potential gains.
But not many advisers or clients are aware of a third option: swapping out direct real estate ownership for passive property ownership in managed portfolios using a 1031 exchange. These exchanges allow taxpayers to defer the payment of capital gains taxes from the sale of an investment property by replacing the sold property with a “like-kind” property of equal or greater value. This strategy can provide more predictable income from real estate with less risk, and carries the potential for intergenerational wealth preservation.
In coming articles in this series, we’ll explore the pros and cons of 1031 exchanges in more detail. For now, remember that real estate investments can be an excellent part of a diversified wealth management strategy—and an asset that no adviser should overlook when meeting with a client.
* United States Census Bureau. Rental Housing Finance Survey (RHFS) RHFS Table Creator 2018 Current Ownership Entity of Property https://www.census.gov/data-tools/demo/rhfs/#/?s_tableName=TABLE2
Full disclosure. The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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