By Adrian Colarusso, CFA, CFP®
March 5, 2023
I’ve talked to dozens of families about the role of real estate in their wealth pictures – from millennials grappling with the exploding cost of mortgages to Arm In Arm clients seeking help with back rent, to ultra-high-net-worth investors buying warehouses for their classic cars.
The Talmud Portfolio based on ancient Jewish law prescribes a one-third allocation to real estate: Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep by him in reserve. (Not investment advice!)
Here are seven ways real estate enters the conversation with our clients.
1. Buying a first home
Key consideration: Lifestyle fit
A rule of thumb is that housing costs should not exceed 30% of your gross income.
Housing might make up a smaller share of the pie for prosperous families avoiding lifestyle creep. A 15-year mortgage can govern them from splashing out too much.
Others stretch and put every dime into their first home. That’s not necessarily the wrong decision, but a risky and painful imbalance that a family can outgrow over time.
2. Upgrading from a starter home
Key consideration: Your current mortgage
Here’s a common scenario. The starter home is deliciously levered with that sweet, sweet, sub 4% debt we won’t see again for a while.
Do you have to sell to upgrade? For some, it’s unavoidable.
But others have enough income and wealth to buy their next home while making their current one an investment property. Of course, there are risks and responsibilities of landlordship that some don’t have the appetite for, and that’s fine, too.
Last thought – I’ve caught people pre-paying their sub 4% fixed mortgages. STOP! Consider investing the difference, even in short-term Treasury bills, which yield more than the mortgage rate! Not financial advice.
3. Embracing emptynesterhood
Key consideration: Evolving family
Our two boys are fortunate to have two sets of grandparents within 25 minutes. We see firsthand how people with grown children might re-orient their life around grandkids.
An evolving family dynamic raises questions about:
- sentimental attachments to the home
- travel distance to the homes of grown children and grandchildren
- the desire or need to lower upkeep costs
- progeny magnets like pools and playgrounds
- re-purposing home equity for other lifestyle enhancements
- if selling a home may affect Medicare premiums
- so much more, but my editor is capping me out
An empty nest is an exciting milestone filled with possibilities. We love helping our clients in this life stage grapple with how to evolve their real estate footprint.
4. Adding a vacation home
Key consideration: Opportunity cost
There are many emotional and financial factors to consider. The “Big Question” for families: do these dollars serve their highest purpose invested in a vacation home, or would they better serve us elsewhere?
Then the devil is in the details. How much of our net wealth should we dedicate? How much do we put down? Are we selling stocks or other assets to buy the home? What kind of loan should we take on? Will we rent it out? How will this affect our taxes?
Here’s a blog post I wrote with Summer, a company whose mission is to make vacation home ownership accessible to more families. No referral relationship.
5. Investing in a rental property
Key consideration: Your expertise
I called out “Touchy Feely Real Estate Moguls” in a past newsletter.
Beware the influencer luring you into a real estate side hustle. Directly investing in rental properties is risky and time-consuming.
I don’t mean to dismiss this strategy writ large.
It might be reasonable for those with the liquidity, expertise and spare time to cordon off a portion of their net wealth to invest directly in rental property (or those with the circumstance described in #2). Some will make it a lucrative career.
But for most people, unless real estate assets start getting puked up at low prices like in 2008, I don’t recommend trying your hand as a novice.
The successes are often exaggerated, and the risks and time commitment are downplayed.
6. Investing in a real estate fund
Key consideration: The right exposure
Most investors don’t have to worry about this. Between their primary residence, the starter home they now rent out, the vacation home they’ve added, not to mention the ~3% of the S&P 500 in the real estate sector, they’re good.
Those who want or need more exposure have many options. Before diving in, start with why. Is it to hedge against inflation, reduce portfolio risk, or enhance returns? Is it to make up a shortfall to your target allocation?
Real Estate Investment Trusts (REITs) come in all shapes and sizes, and trade publicly on exchanges. Some are bond-like, and some are stock-like. Some focus on office buildings, others multi-family residential.
There are also private real estate funds and single-project syndications available with investment minimums and lock-up periods to qualified investors.
What about direct-to-consumer platforms with low-minimum access to private real estate deals?
All interesting, but none can be recommended without the detailed context of your unique situation.
The key is to know what you’re buying and how it fits into your overall portfolio strategy through the lens of return, risk, and diversification.
7. Stewarding public land
Key consideration: Your community
This is a shameless plug for non-profit work I’ve been deeply involved in since 2020. The Friends of Herrontown Woods is a 501c3 organization that takes care of Princeton’s first and most whimsical nature preserve.
I’ve lived near this hundred-acre wood for much of my life, but first discovered it during the pandemic. Our family has since adopted it as an extension of our own backyard.
On my first visit, I came upon a hauntingly beautiful, abandoned house. A house on the private market in this section of Princeton with this much surrounding acreage would go for millions. “What an asset!” I surmised.
It was the former home of Oswald and Elizabeth Veblen. Oswald was a Princeton math professor and good friends with Albert Einstein, who visited often.
Oswald and Elizabeth donated most of the land in 1957 as the first preserved open space in Mercer County. They deeded the house and its surrounding acreage to the public in 1974 when Elizabeth died.
Now, after decades of neglect, the trails and house are in the hands of our small but mighty (and growing) non-profit. We’ve worked hard to clear invasive plants, open trails, and put the Veblen House on a path to restoration for use as a community gathering space nestled in nature.
We even have plans to add a sustainable solarium using wood milled on-site, which will host yoga classes and many other events.
Soon, our non-profit will seek nature-lovers with tax-efficient charitable giving war chests to help fund our construction efforts. Stay tuned.