Financial Advisors for Real Estate Investors: What To Look For
Real Estate Investors Have Specific Financial Needs (And Need an Advisor Who Understands Them)
If you’re a professional real estate investor or have a significant amount of your wealth in real estate, many financial advisors may not be a great fit. However, with the financial complexities of real estate investing, most real estate investors need a great advisor much more than the average investor. Most financial advisors generally focus on investing their clients in more traditional assets, like stocks and bonds, so they may not understand the complexities of real estate investing. They may not even want to work with real estate investors unless they have significant wealth in other assets, like retirement accounts.
A great financial advisor with real estate expertise can help you both navigate and improve your real estate investment process, help you ensure you’re not paying more taxes than you need, and make sure that your real estate investments help you work towards your major financial goals, all while helping provide you additional peace of mind.
What to Look For In A Real Estate-Focused Financial Advisor
If you’re a real estate investor looking for a financial advisor, there are a few things to consider, including:
General Experience: A good advisor will have experience working with various types of clients and ideally already serves clients with real estate as a significant portion of their investment portfolio.
Licenses and Certifications: Before choosing an advisor, you should ensure they’re properly licensed. In general, it's a good idea to choose an advisor who is also a fiduciary, meaning that they legally have to put your interests (not theirs) first. You should always use FINRA BrokerCheck to ensure that your advisor is currently licensed, is in good standing, and doesn’t have violations or complaints on their record.
Real Estate Experience: Since most advisors only have experience with traditional financial assets, like stocks and bonds, you’ll want to ensure that your advisor has specific expertise in the real estate industry. This could mean they’ve previously worked as an agent, broker, investment manager, or in some other capacity. Otherwise, they may overlook your real estate investments and simply attempt to push you towards investing in traditional assets, which may or may not be what you want.
Advisors Can Help You Safely Adding Real Estate To Your Portfolio
Whether you currently own real estate or you want to buy additional properties, a real estate-focused financial advisor can help you work through the investment process and, even more importantly, determine if adding real estate to your portfolio is a good idea. As most current real estate investors know, real estate has many benefits; primarily, as an alternative asset class, its value isn’t tied to the stock market, so it can provide portfolio stability during stock market downturns.
In addition, real estate can provide investors with a wide array of tax benefits and a stable income source. For example, even when both the stock market and real estate prices crashed in 2008, average rents remained stable-- meaning that, had you owned property during this time, you would have liked to receive the same amount of rental income (or even more), than you had in previous years.
However, real estate does have a variety of downsides. Buying and owning properties requires significantly more time and due diligence than holding more passive investments such as stocks and bonds. In addition, most people use loans to buy real estate, which can increase risk, particularly during real estate crashes. While rents did remain stable during 2008, many people who used mortgages to buy rental properties saw their property values fall so much that they owed more on their properties than they were worth. Going “underwater” on a rental property can be disastrous, as it often means that you’ll need to hand the keys back to the bank to avoid a default, leaving you with massive losses.
Therefore, a good real estate financial advisor can help you determine how much you should borrow on a property while still making sure you can keep it-- even if the real estate market crashes. While banks and other lenders may lend you 70-75% of a property’s value, this doesn’t mean this is a good idea. For example, in 2008, residential real estate prices fell by an average of 30%.
For instance, if you had a $750,000, 75% LTV loan on a $1 million rental property, and the property's market value dropped 30% to $700,000, you’d now owe more on the property than the property was worth, putting you underwater. This is why conservative real estate investors often borrow no more than 50% of the property’s value when investing. For instance, if you had used a $500,000 (50% LTV) loan on the same property, and the property’s price dropped to $700,000, you’d still have equity in that property, and, while your loan would now be at around 72% LTV, you’d likely be able to avoid default, and, if needed, refinance the property with another lender.
Understanding this is important both for potential and existing real estate investors. While it’s natural for real estate investors to want to keep expanding their portfolio, in some cases, it’s beneficial for some investors to get rid of some properties to reduce their overall debt load, ensuring that they can survive any real estate crash and get out unscathed.
Additional Real Estate Financing Options
While real estate investors may think they’re limited to banks and private lenders when financing investment properties, investors have various additional options, particularly for higher-net-worth individuals. For example, Fannie Mae and Freddie Mac offer extremely low-rate, long-term, non-recourse loans for multifamily real estate investors. Since they’re (indirectly) backed by the federal government, these programs often offer loans at significantly lower rates and better terms than what you can find at a bank, credit union, or private lender.
While these programs were initially only available to large real estate investors, both Fannie and Freddie now have smaller loan programs, with Freddie Mac Small Balance Loans (also known as Freddie SBL) starting at just $1 million and Fannie Mae Small Loans starting at just $750,000.
Tax Benefits for Real Estate Investors
While most real estate investors know that real estate has some incredible tax perks (like depreciation deductions and 1031 exchanges), they may only know some-- but a good advisor will know all of them. A few of the most significant tax benefits that real estate investors should be aware of include:
Depreciation Deductions: Depreciation deductions are one of the most effective tax benefits for real estate investors. Residential real estate can be depreciated over a 27.5-year schedule, while non-residential commercial real estate can be depreciated over a 39-year schedule. For example, if you purchased a $1 million residential property, such as a home or apartment building, you could take more than $36,000 in depreciation deductions per year. If you had a 22% effective tax rate, this would mean you’d pay approximately $8,000 less in taxes per year. However, as we’ll touch upon next, depreciation deductions can be accelerated through cost segregation, meaning that you may be able to take significantly higher deductions in earlier years.
Cost Segregation: If you want to take more depreciation deductions faster, you can also order a cost segregation study for your property. Since some parts of a property depreciate faster, such as roofs, you can take deductions for these parts of the property much quicker, for instance, over a ten or 15-year timeline. While the details can be complex and vary from property to property, if we follow the example above, this might allow you to take $50,000 or $60,000 in depreciation deductions per year in the first few years of owning a property, significantly reducing your taxable income. For instance, if you could take $60,000 in depreciation deductions for a few years at the same 22% effective tax rate, you’d be able to pay $13,000 less in income taxes for those years. Of course, this means that you’d take fewer deprecation deductions in later years. Still, money in your pocket now is significantly more valuable than money coming in later, which can greatly benefit your cash flow and overall net worth.
1031 Exchanges: 1031 exchanges allow an investor to exchange one investment property for a similar “like-kind” property of equal or greater value and avoid paying capital gains taxes until the “like-kind” property is sold. However, investors can do an unlimited number of 1031 exchanges, meaning they can continue to defer capital gains taxes as long as they keep exchanging properties indefinitely.
Mortgage Interest Deductions: The IRS also allows real estate investors to deduct mortgage interest costs from their taxable income, and since most properties are purchased with loans, this can provide another way to enhance the returns of any real estate investment.
Non-Interest Expense Deductions: In addition to mortgage interest expenses, real estate can deduct maintenance costs, certain property management expenses, some operating expenses, and even property repairs. In addition, they can also often deduct real estate investing-related travel expenses, 50% of food and beverage costs incurred during travel, and (sometimes) costs from seminars, conferences, and other real estate-related education expenses.
QBI Deductions: While the details can be complex, in many cases, real estate investors can claim a Qualified Business Income (QBI) tax deduction of up to 20% of the net rental income generated from their properties, subject to total taxable income limits.
Tax Credit Programs: If you develop or purchase low-income housing, such as properties, using the Section 8 program, you may be able to take advantage of the government’s Low-Income Housing Tax Credit (LIHTC) program. Around $9 billion worth of LIHTC credits are available for investors each year. For every dollar of tax credit received, investors and developers can reduce a dollar's worth of their federal income tax owed.
SDIRAs and Solo 401(k)s: In addition to the above benefits, real estate investors can utilize certain retirement accounts, such as Self Directed IRAs (SDIRAs) and Solo 401(k)s, to invest in real estate directly. Some even specialize in lending to investors who use these retirement accounts to purchase real estate. However, you typically can’t comingle funds from outside your retirement accounts to purchase real estate this way, so if you want to do this, you’ll likely need to amass a significant amount of funds in one of these accounts.
Additional Retirement Account Considerations for Real Estate Investors
We previously touched upon using SDIRAs or Solo 401(k)s to invest directly in real estate, but there are more benefits to these than might initially meet the eye, and a good advisor can walk you through your options.
For example, whether you’re a full-time real estate investor or generate additional income from real estate investing, as of 2024, you can contribute $23,000 to a Solo 401(k) as an employee. You can also make match contributions as an employer for a total contribution limit of $69,000 per year (though this match is capped at 25% of your income). You can use these funds any way you like-- whether to invest directly in more real estate or to diversify your portfolio by investing in assets like stocks and bonds. However, we should note that if you already have a 401(k) from a full-time employer, your total contributions from both 401(k)s are still limited to $69,000 per year with employee matches.
Retirement For Real Estate Investors
Some real estate investors may wish to own their properties for their entire life-- or even pass them on to their heirs. However, others may want to sell their properties-- slowly (or all at once) and reinvest the proceeds in more passive investments like stocks and bonds. Both of these can be great choices, depending on your individual goals and needs. If you don’t want the hassle of real estate investing, and your heirs don’t want it either, selling your properties and reorienting your portfolio to other investments can be a good idea-- though you’ll likely take a hefty haircut due to capital gains taxes.
Passing on Real Estate to Your Heirs
If you own real estate that you want to pass on to your heirs, there are additional things to consider. For example, you may want to place your property into a trust to help your heirs avoid probate. Perhaps more importantly, this can often prevent your heirs from having to pay estate taxes. A good financial advisor can help you understand the basics of trusts and will typically help you work with a good estate and trust attorney to help you pass on as much of your wealth as possible while limiting tax burdens for your beneficiaries.
Comprehensive Financial Plans for Real Estate Investors
Investing in real estate can be complex, even for experienced investors-- but a financial advisor experienced in real estate can help investors through the entire process, which generally involves creating a comprehensive financial plan. Some factors they may look at include:
Your Personal Financial Goals: Whether it’s generating extra income in your working years, planning a comfortable retirement, reducing your taxes, or leaving a legacy to your heirs, a good advisor can help you analyze what you want to get out of your real estate investments, and help you put together a plan that ensures that your real estate investments are working your you-- and not the other way around.
Total Portfolio Allocation: Real estate can be a fantastic way to build wealth, but it typically shouldn’t be 100% of an investor’s portfolio. For one, real estate is relatively illiquid since it often takes months to sell a property. Therefore, even hardcore real estate investors who don’t favor other assets, like stocks, should still keep some part of their portfolio in liquid assets, such as Treasury Bonds, cash, and CDs, so that they can fund life goals (like sending a child to college) or for emergency expenses-- such as expensive property repairs or personal medical costs. In addition, real estate markets can be volatile, so for most investors, keeping some part of their portfolio in stocks or ETFs can pay off. While these are also volatile, the stock and real estate markets often crash at different times, so diversifying your assets usually means your net worth won’t take a considerable hit should one of these markets crash. A good advisor can help you construct a balanced portfolio to help you sleep well at night while still achieving your highest financial goals.
Real Estate Risk Management: We’ve already touched upon the dangers of using too much debt to purchase real estate, but this isn’t the only risk real estate investors face. Other risks include natural disasters, general locational risks, and legal risks. An excellent real estate-focused financial advisor can help you reduce these risks as much as possible while getting a good investment return.
Real Estate Financial Modeling: While you may already use financial models to map out the profitability of potential investments, your advisor can help you improve upon and double-check these models to maximize the profitability of your investments.
In Conclusion: Real Estate Investors Don’t Need To Go It Alone
Successfully investing in real estate takes drive, ambition, and dedication, but you don’t need to (and shouldn’t necessarily) do it alone. By getting a great advisor on your team, you can have a second pair of eyes look at your real estate investing goals and strategies and ensure that they help best serve your needs. Better yet, you’ll be able to see how your real estate investments fit into your broader portfolio, better manage your risk, and plan for the future effectively and efficiently, increasing your profits and helping you gain more financial peace of mind.
