A similar folly can be seen with the way some people view real estate, which has many investment subcategories. Studies have shown that while residential realty values are immediately sensitive to interest rates and to recessions and booms, commercial real estate is less sensitive because of long-term leases. Experts agree, though, because of statistical studies, that real estate should be in nearly everyone’s portfolio because value changes are not perfectly in sync with either growth stocks or several bond categories. It helps with diversification and will be recommended by the models I urge you to use. Fortunately for small but growing investors, real estate can be purchased in the form of mutual funds, albeit less liquid funds than stock or bond funds. Many people manage their own real estate physically. Managing one’s own real estate is extremely demanding and has risks, from potentially violent tenants to zoning changes.
The irritations, collection duties, maintenance, excuses about who broke what, potential lawsuits ... endless. Own investment real estate through composite investments, such as mutual funds and exchange-traded REITs, and maybe as a way to cut college expenses for a child. If you must hold realty in kind, let a qualified property manager handle it.
Real Estate Investment Trusts (REITs), for “qualifying investors” (those with portfolios well over $100,000 and no reliance for income on the amount invested), are touted as more direct investing than mutual fund versions and, as such, provide a better likelihood of a strong return. History does bear this out. However, I caution against REITs altogether for several reasons.
First, one purchases discrete units of a REIT for prescribed amounts. Hence, there is no way for the market to directly determine a price. Traditionally, this lack of transparent or market pricing caused brokerages to show the investment at the purchase price for its entire period of ownership. The result was that clients falsely assumed it at least had the value they originally paid. In recent years, independent appraisals have been required annually in order to show the value more accurately; there was a shock for owners! Eventually, “exchange-traded” REITs were devised and marketed, and some of the private units were converted for public trading and more accurate valuation. But the biggest heartburn I have with these is in how they are described to buyers, the “distribution rate” versus “rate of return.”
A close cousin of the REIT is the limited partnership, with similar tax advantages; superior for the oil and gas equipment leasing versions. But all such products have one tax problem in common. They do have nice tax benefits, but these all are subject to recapture if you stop using them and roll them into like-kind exchange arrangements. You avoid liabilities for the venture, being a “limited partner,” but the biggest detriment is lack of transparency, which annual appraisals do not solve—especially at first sale.
Timeshares
The sales pitch makes sense, it’s affordable, and even inflation in the non-guaranteed association management fees looks fine. And the comparison between expensive trips and hotels against timeshare use all works out perfectly. Except that the assumptions are all wrong, and you have no idea whether this purchase is priced to “market” the way normal real estate and leasing is. Hmm ... same problem as new-issue REITs. In fact, there is a competitive market for timeshares! And it is online and has dramatically better deals! If you want a timeshare, especially because you love the area and the ability to trade or lease out, then get these used. It makes sense to enjoy your investment before passing it on or liquidating it. But go to the Internet and find bargains; they’re all from people who lost money and overpaid buying it new.
