Have You Invested Too Much in Real Estate?

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By Mark Jewell, AP Personal Finance Writer

BOSTON (AP) — Are you overexposed to real estate?

It's a question worth asking if you're among the legions of homebuyers contributing to a turnaround in home sales.

That's not to say that real estate prices are overvalued. There's still a long road to recovery.

A government index of home prices, released Thursday, declined 0.2% in February, the third straight monthly drop. Nationally, the median sales price in March of $170,700, was nearly unchanged from a year earlier, according to the National Association of Realtors.

Real estate can play an important role in your overall investment strategy whether you're a homeowner or a renter. That's because real estate investments tend to move up and down at different speeds, and at different times. Such diversification helps to limit the overall volatility of your portfolio.

HOW TO INVEST: There are three major ways investors can own a stake in real estate: direct ownership, real estate mutual funds, and real estate investment trusts.

Owning a home is important because it's a key component of household net worth. Home equity, the value of the home minus the mortgage amount, generally constitutes the largest share of a household's net worth. It's advisable not to view your primary residence as an investment in the strictest sense.

"A home is a totally undiversified and concentrated asset, and I wouldn't consider it in deciding the allocation in an investment portfolio," says Larry Swedroe, research director at Buckingham Asset Management, a St. Louis-based financial advisory firm.

If you're staying in your home long-term, a spike or dip in its value may not amount to much by the time you're ready to sell. Keep in mind that a home isn't liquid and its purchase is driven by many quality-of-life factors beyond a return on investment. What's more, you can no longer count on the double-digit annual price increases of a few years ago, when homes became ATMs for taking out home equity lines of credit.

"A home is my domicile — it's worth whatever it's worth, and I don't really think about it," says Cliff Caplan, a financial planner and president of Neponset Valley Financial Partners in Norwood, Mass.

Mutual fund investors, who got in early, have seen real estate funds bounce back in a big way. Over the last year the category has posted a return of 73.5%. That's the top domestic stock fund category tracked by Morningstar.

Yet real estate funds have lost an average 10.5% over the past three-year period. That's second only to the funds that focus on the badly beaten up financial sector.

Finally there are REITS, which trade on the stock market and are the lifeblood of mutual funds specializing in real estate. These companies own and often operate income-producing real estate. That's mainly commercial rather than residential real estate, and commercial property values often zig when home values zag.

HOW MUCH EXPOSURE?: Many advisers suggest keeping 5% to as much as 10% of stock holdings in real estate to buffer against downturns in the rest of a portfolio. That's because REITs frequently move in a different direction than stocks generally, like commodities and precious metals.

REITs also are attractive to retirees and others needing steady income, because they're mostly about dividends. To escape corporate taxes, REITs must distribute at least 90% of their taxable income to shareholders each year.

The real estate balancing act gets a little trickier if you own an investment property or two in addition to a primary home, or if you've got a second home. Might another real estate plunge gut the value of your properties and your stock portfolio at the same time?

An investment property stake may not be a reason to trim REIT holdings from a stock portfolio unless property represents a big piece of your overall savings, or if you rely on it for income. Be especially careful if you own a stake of a commercial property whose value might move in tandem with commercial REITs.

"If you own a second home, you should probably dial back your real estate stock exposure a bit," Swedroe says. "If you own lots of investment properties, you shouldn't be investing in REITs at all — you'd be double-dipping."

TIME TO JUMP IN?: There's plenty of room for REIT anxiety. Warnings have been long in coming that commercial real estate will hit bottom, and sink so low that it might jeopardize a broader economic recovery.

By some measures, the market still appears to be worsening. Delinquency rates on commercial mortgages rose to an all-time high in March, according to Fitch Ratings.

Yet REIT stocks continue to do well. The Dow Jones REIT Index, a broad measure of REIT performance, was up 9.3% year-to-date through the end of March. And recent REIT stock offerings have been successful, a further sign of investor confidence. Still, REIT stock prices broadly are down more than 30% from their early 2007 peak.

While commercial real estate's troubles are hardly over, "It's not the financial Armageddon many people were predicting," says Caplan, the Massachusetts financial planner.

"REITs only own about 10% of all commercial real estate in the country," Caplan says, "and they get the cream of the crop."

WHERE TO JUMP IN: Of course, not all REITs are alike, so you've got to be choosy. Steve Shigekawa, co-manager of the Neuberger Berman Real Estate (NBRFX) a REIT fund with a five-star Morningstar ranking, expects commercial real estate fundamentals to hit bottom sometime this fall. REIT stocks will continue rising, he predicts, but it won't be uniform. Office building REITs won't bounce back until unemployment drops significantly, he says. That's because occupancy rates are tied closely to the number of workers needing space in offices, where leases typically run several years.

The comeback will be speedier for hotel REITs, where revenues depend on travelers' one-day visits. Hotel REITs were hurt early in the recession as businesses cut back on employee travel. With the economy recovering, many of those business travelers will be coming back.

"The hotel recovery," Shigekawa says, "is just getting started."

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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