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Crisis Investing 101: Real Estate Assets Provide Safety in Good Times and Bad

Friday, February 22, 2013 1:00 PM

Real estate used to be the bedrock of many investors' portfolios. It used to stand the test of time as a sensible, solid investment across most every economic situation. That was until 2007, when the entire real estate market experienced what was unthinkable only a few years earlier: It plunged in value.

The real estate bubble that led to a stock market crash and the subsequent Great Recession is a story most people know: Overzealous lenders were giving away too many bad loans, while builders with access to easy money were developing too many homes. Everyone was happy and home prices soared.

But as home prices went up, people needed to borrow a lot more money. And eventually, those lenders couldn't afford to keep up with all the defaulted loans from bad creditors. Meanwhile, the oversupply of homes started to punish prices lower, leaving many homebuyers stuck owing way more than their homes valued.

Despite the real estate crisis, many savvy investors used the downturn to buy properties at bargain basement prices that will likely create profits regardless of what happens with the overall market. And indeed, just recently this downtrend in prices started to stabilize. Statistics from around the country are indicating upticks in prices and demand.

If the rebound continues, then these bargain buyers will quickly multiply their wealth. If the market slips backward again, then the property owners will still have the opportunity to generate income through rent payments. It's no wonder now may be the best time in a generation to own real estate. Investors from Warren Buffett to Ken Fisher to income expert and editor of High-Yield Investing Carla Pasternak are all talking about the "Renter Nation," a trend that can potentially make many investors a lot of money.

In other words, if you buy right, then the macro economic situation won't have a huge effect on the success of your investment.

And this is precisely why real estate is such a great asset to hold in a crisis portfolio. People will always need a place to live and to conduct business.

There are two primary ways to invest in real estate -- hands-on or hands-off. Professional real estate investors refer to these choices as the "hard" or "soft" way to participate in the market.

Hands-on
The hard method of investing in real estate is when investors buy the physical properties themselves -- single-family homes, apartment buildings or commercial properties can be purchased as investments by individuals or groups of investors. These properties can be purchased at a discount and then be improved to quickly lift their value to match the neighboring properties.

This takes specialized knowledge of the real estate market, the ability to understand and price construction, and a keen eye for value. The property is then quickly sold to the end-user or another investor at a profit.

Another popular way to profit from the hands-on method of real estate investing is to purchase properties with the express purpose of renting them out. If the rent for a particular area exceeds the mortgage and other carrying costs of the property, then the landlord or investor has a positive cash flow. Many hands-on investors have become millionaires and even billionaires by using this method of investing in real estate.

Hands-off
The hands off or "soft" method of investing in real estate is through real estate investment trusts, or REITs. Investors can purchase shares in REITS just like buying shares in any public company. The advantage to REITs is that you are buying into professionally-managed properties that are already producing a profit. In short, you become a landlord without the hassles of managing a property yourself.

The best part of investing in REITs is that they often sport attractive high yields. Names like Colony Financial (NYSE: CLNY), a commercial property REIT yielding more than 6% and Associated Estates Realty (NYSE: AEC), a REIT focused on apartment buildings currently yielding roughly 4.5% are just the tip of the iceberg when it comes to REIT investing.

And if you are worried about the risk of investing in a single REIT, then you can diversify by owning a basket of REITs through exchange-traded funds (ETFs). The downside of the ETF REIT route is generally lower yields and higher book-to-value valuations. However, this is nothing unusual and just represents the typical risk/reward trade off.

If you are interested in the REIT ETFs to minimize your risk, two of the largest are Simon Property Group (NYSE: SPG) and Public Storage (NYSE: PSA), both with a dividend yield of about 3%.

Risks to Consider: If you decide to go the hands-on route, then it's easy to overpay for a property, get bad tenants who don't pay rent on time, have unexpected expenses and a host of other troubles can get in your way.

Going the hands-off route of REITs has the risk of bad decisions or even fraud by the REIT operators.

Action to Take --> Every portfolio designed to withstand crisis needs to have exposure to real estate. How you decide to get this exposure should be based on your goals, skills, risk acceptance and capital level.

But diversification is key in any crisis portfolio, even within the real estate niche. Diversification can be geographic, with different types of properties and even with a mix of hard and soft types of investing mentioned above.

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.