Author Topic: Help me sort out my real estate investment options  (Read 3444 times)

madamwitty

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Help me sort out my real estate investment options
« on: June 08, 2016, 01:08:44 PM »
I have just taken a good hard look at my investment strategy and decided that my target allocation for real estate is ~20% of my portfolio. For tax purposes, I want to put my real estate investments into my tax-deferred accounts, but options there are limited and I am concerned about risk. What's the best course of action?

The Details:

My target real estate allocation is 20% of my portfolio = $92,000. I have ~$8,000 in traditional IRAs, in which I can invest in Vanguard REIT Index (VGSIX, ER = 0.26%). The rest ($84,000) would have to go into my 403(b), which has very limited options for real estate:

QREARX: TIAA Real Estate Account, ER = 0.89%
IGREX: Invesco Global Real Estate Fund R5 Class, ER = 0.88%

First of all, I don't feel comfortable investing so much of my portfolio in a single account/non-index fund (I feel it may not have enough diversification, but am not sure). Second, high fees!

My options as I see them are:
  • Split the $84,000 between the two options - I currently feel this is too risky, but am not very educated on the subject, that's why I'm asking you guys
  • Invest some VGSIX in my taxable account, damn the tax consequences (I am in the 15% tax bracket) - I don't have $84,000 space yet in my taxable but it is adding up fast.
  • Reduce my real estate allocation for now, bump it up after retirement in ~3-4 years, when I can roll my 403(b) to a Vanguard IRA
  • Some combination of the above
  • Something I haven't thought of yet?

Suggestions appreciated!

Mother Fussbudget

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Re: Help me sort out my real estate investment options
« Reply #1 on: June 13, 2016, 02:17:15 PM »
I've recently changed my portfolio balance to favor REIT's over VTSAX (60% REITs /30% VTSAX /10% bonds).
I'm short the SPY (S&P 500) through the rest of 2016 - primarily because bull markets typically reach new high's within a year of their previous highs, and the current market's last 'high' was in May 2015.  I think we're more likely to see the markets move sideways or down rather than up.  This regardless of which presidential candidate wins in Nov (IMHO, Trump will print money to pay for tax cuts, Hilary will print money to pay for military increases; neither of which we as investors have any control over, so I can't worry about it.)

Based on the real-estate market being really hot, (especially in Seattle) and not in the same way it was in 2007, but in a more sustainable but still constantly upward trend movement, I decided to move to REITS - and be a lazy landlord, taking advantage of the upward move in real-estate without buying more houses ( as MMM puts it).  People are still going to need places to live no matter what happens on the macro economic front, so from that perspective I think the real-estate market will be more reliable than the overall market this year (and possibly the next 4 years).

In Seattle, it's almost impossible to buy a home today - supply is low, and demand is very high, so prices are up, similar to the story in the CA-Bay-Area. I was researching ways to get more exposure in my own retirement accounts, did the math on several REIT's, and liked what I was seeing.  So I've moved to split my 60% into 3 different REIT's, 20% each (SNH, LADR, and NRZ).   So far, I'm up 15% in price+dividends since March (mostly SNH), and more dividends to come later in the year.

For more reading, read the contributor who has a similar viewpoint on the markets "The Fortune Teller" on Seeking Alpha - start here

From my perspective, I'd go with option 1 - split the difference between the two REIT products, but you should do more homework on  REIT's before you make any changes.

mousebandit

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Re: Help me sort out my real estate investment options
« Reply #2 on: June 15, 2016, 11:16:39 AM »
Thank you Mother Fussbudget!  That is some very helpful info!


Vagabond76

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Re: Help me sort out my real estate investment options
« Reply #3 on: June 15, 2016, 11:35:50 AM »
There are too many tax advantages associated with real estate, such as return of capital and depreciation, for me to even consider holding equity REITs or actual properties in a tax-deferred retirement fund. The thought of converting untaxed distributions and long term capital gains into ordinary income--even several years down the road--makes my stomach churn. Roths and taxable accounts are okay.

zephyr911

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Re: Help me sort out my real estate investment options
« Reply #4 on: June 15, 2016, 12:47:27 PM »
Real estate is inherently tax-deferred. If you're leveraged enough, your annual depreciation deduction can equal 20-30% of your equity... meaning you can earn annual returns of 20-30% without having any taxable profit. Even if you pay cash, you can still defer close to 4% in annual returns without owing taxes.
Risk goes up with leverage, obviously, but it's often worth it.

madamwitty

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Re: Help me sort out my real estate investment options
« Reply #5 on: June 15, 2016, 01:11:47 PM »
Real estate is inherently tax-deferred. If you're leveraged enough, your annual depreciation deduction can equal 20-30% of your equity... meaning you can earn annual returns of 20-30% without having any taxable profit. Even if you pay cash, you can still defer close to 4% in annual returns without owing taxes.
Risk goes up with leverage, obviously, but it's often worth it.

There are too many tax advantages associated with real estate, such as return of capital and depreciation, for me to even consider holding equity REITs or actual properties in a tax-deferred retirement fund. The thought of converting untaxed distributions and long term capital gains into ordinary income--even several years down the road--makes my stomach churn. Roths and taxable accounts are okay.

I am not interested in holding real estate directly, but I am interested in taking advantage of the decorrelation between stocks and real estate to manage risk. That's why I'm interested in REITs and such. I understand how direct RE (landlording) is tax deferred, but don't REITs have substantial dividends and capital gains?

zephyr911

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Re: Help me sort out my real estate investment options
« Reply #6 on: June 15, 2016, 01:18:05 PM »
I am not interested in holding real estate directly, but I am interested in taking advantage of the decorrelation between stocks and real estate to manage risk. That's why I'm interested in REITs and such. I understand how direct RE (landlording) is tax deferred, but don't REITs have substantial dividends and capital gains?
Oh, then yes. Disregard. :/
I wanna hold it directly myself, because of what I said above (mostly). It's kind of awesome.

Vagabond76

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Re: Help me sort out my real estate investment options
« Reply #7 on: June 15, 2016, 02:07:36 PM »
I am not interested in holding real estate directly, but I am interested in taking advantage of the decorrelation between stocks and real estate to manage risk. That's why I'm interested in REITs and such. I understand how direct RE (landlording) is tax deferred, but don't REITs have substantial dividends and capital gains?

Yes and no.  REITs are required to distribute 90% of their income to shareholders as a cash distribution.  This allows the company to avoid taxes at the company level, and requires the shareholder to report the distributed income as ordinary income.  However, a substantial portion of the distribution is nontaxed "return of capital."  The return of capital is subtracted from the cost basis and is reported as long term capital gain when sold.  Or hold the shares until death and the basis steps up to the current FMV--and never pay the capital gains tax.

madamwitty

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Re: Help me sort out my real estate investment options
« Reply #8 on: June 15, 2016, 09:57:12 PM »
I am not interested in holding real estate directly, but I am interested in taking advantage of the decorrelation between stocks and real estate to manage risk. That's why I'm interested in REITs and such. I understand how direct RE (landlording) is tax deferred, but don't REITs have substantial dividends and capital gains?

Yes and no.  REITs are required to distribute 90% of their income to shareholders as a cash distribution.  This allows the company to avoid taxes at the company level, and requires the shareholder to report the distributed income as ordinary income.  However, a substantial portion of the distribution is nontaxed "return of capital."  The return of capital is subtracted from the cost basis and is reported as long term capital gain when sold.  Or hold the shares until death and the basis steps up to the current FMV--and never pay the capital gains tax.

Interesting! I wasn't aware of the "return of capital" angle. Taking a quick look at the Vanguard REIT index distributions, it looks like dividends are approximately twice the amount of return of capital, but I could imagine an individual REIT having more return of capital and less dividends.

rpr

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Re: Help me sort out my real estate investment options
« Reply #9 on: June 15, 2016, 10:31:19 PM »
The TIAA Real Estate Funds is one of the most unique options that are available. My portfolio has about 10% in RE and I hold all of it in the TIAA Real Estate.

Vagabond76

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Re: Help me sort out my real estate investment options
« Reply #10 on: June 16, 2016, 05:15:17 AM »
The TIAA Real Estate Funds is one of the most unique options that are available. My portfolio has about 10% in RE and I hold all of it in the TIAA Real Estate.

Not sure what this means, but it sends up warning flags wherever I see it.

zephyr911

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Re: Help me sort out my real estate investment options
« Reply #11 on: June 16, 2016, 07:02:00 AM »
Interesting! I wasn't aware of the "return of capital" angle. Taking a quick look at the Vanguard REIT index distributions, it looks like dividends are approximately twice the amount of return of capital, but I could imagine an individual REIT having more return of capital and less dividends.
It can be as much as 100% of the payout, depending on their financials. The more leverage they have, the more depreciation they can claim relative to equity. Throw in various tax credits and a company can earn plenty of profit and still have no taxable income.
The longer your investment timeline, the less of an issue RoC is.