How should my real estate investment affect how I allocate my stock and bond investments?
When investing in real estate, it is important to keep your stock and bond investments in mind. Real estate is a relatively stable investment, while stocks and bonds can be more volatile. As such, it is important to have a diversified portfolio that includes both real estate and other types of investments.
Given the relative stability of real estate, some investors are able to dial up their allocation to stocks when compared to an investor that relies solely on stocks and bonds to reach their goals.
Since real estate investments have a low correlation to the stock and bond markets, investors can be strategic about when to shift capital between their real estate and stock portfolios. For example, an investor may use cash flow from a rental property to dollar-cost-average purchases of additional stock over time. Dollar cost averaging has proven to be an effective tool for building wealth over a long time period. Alternatively, an investor may want to sell stocks after periods of strong performance to book gains and rebalance by buying another rental property.
Real estate investors also generally should keep more cash available to be able to address unexpected repairs or vacancy in their properties. While this cash does not produce a significant return, cash reserves are an important risk management tool for the real estate investor.
How will my real estate investments affect my retirement planning?
Your real estate investments can have a significant impact on your retirement planning. Each rental property has the potential to act like a sort of pension, providing a regular income stream during retirement.
When retirement is still years away, an investor may focus on using smart leverage to add more properties to rely on growth in the value of the properties at the expense of current cash flow. As retirement approaches, investors can pay down debt within their real estate portfolio to increase cash flow and reduce risk during their retirement years.
Lastly, traditional retirement savings in an IRA or 401k can act as a great diversifier for the real estate investor. A portfolio of stocks and bonds within a retirement plan can provide tax advantages and returns that are uncorrelated to the real estate market. This diversification in uncorrelated investments is what smooths out returns over time in order to make retirement planning more predictable.
What are the unique tax planning opportunities I have as a real estate investor?
As a real estate investor, you have a few unique tax planning opportunities. One of these is the ability to use a self-directed IRA to invest in property. This can be a great way to save on taxes and grow your retirement savings. Additionally, you can take advantage of the 1031 exchange, which allows you to swap one property for another without paying taxes on the sale.
There are also tax advantages to owning real estate. Investors can take advantage of depreciation to reduce taxable income, and with certain limits mortgage interest can be deductible.
More financially sophisticated real estate investors can also use equity in property to provide additional capital by utilizing lines of credit secured by property as a source of tax-free capital. This money will eventually have to be paid back, so this option should only be pursued under the guidance of an advisor and in the context of an overall financial plan.
Is my real estate a good investment? What are some key metrics that I should use when monitoring my real estate investments or evaluating a new real estate investment opportunity?
That depends on a few factors, including the market you're investing in and your investment goals. It's important to do your research before investing in any property, to understand the risks and potential rewards involved.
Some key metrics to monitor when evaluating a real estate investment opportunity or monitoring your portfolio are vacancy rates, rental rates, mortgage rates, and capitalization rates.
The vacancy rate is the percentage of units in a property that are unoccupied. This rate should be monitored over time to get a more accurate picture of expected loss of income due to income. This vacancy rate can be converted into an expense for your capitalization rate calculation.
The rental rate is the amount of rent being charged per unit. Growth rates of rent in the local market are important to monitor as well.
And the capitalization rate, or cap rate, is the ratio of a property's current net operating income to its purchase price. This is the rate of return in income on the price of the property. The cap rate is an easy metric to use to evaluate multiple investment opportunities on a level playing field. A lower cap rate may still be a more attractive investment if a property is in a desirable location and capital appreciation is your objective.
Ultimately, a property should be at least cash flow neutral, and an investment in a property should be evaluated against the opportunity cost of not being able to invest that capital in a different investment. Remember, the opportunity cost applies to all available investments, not just another rental property.
I'm thinking of selling a rental property, what should I do with the proceeds and how do I defer my capital gains taxes?
If you're thinking of selling a rental property, you'll want to consult with a tax advisor to understand the best way to defer your capital gains taxes. One option is to reinvest the proceeds into another property within 180 days of sale. This will allow you to defer the taxes on your capital gains until you sell the new property. This is known as a Section 1031 exchange, and it can be a great way to defer your taxes while still growing your investment portfolio.
If you are interested in deferring your capital gains, but you no longer want to own an investment property directly, there are options available as well. A Delaware Statutory Trust allows you to be a passive investor in a property or portfolio of properties with professional management, and receive your share of income and growth from that investment.
There are complex rules governing 1031 exchanges, so it is helpful to work with financial, tax, and legal advisors to ensure you avoid any costly mistakes.
