The boom in residential and commercial real estate fattened a lot of portfolios in the past decade, but that appreciation may have created a portfolio imbalance that exposes some customers to more sector risk than they may realize.
Thanks to years of steadily rising prices in markets nationwide, real estate now represents more than one-third (37%) of the wealth for the nation's mass affluent, which we define as those with $100,000 to $1 million of investable assets.
For the 33 million mass affluent, real estate represents a larger share of their wealth than managed accounts, individual stocks and bonds, IRAs, deposits, mutual funds and alternative investments (22%); privately held businesses (16%); employer-sponsored retirement plans (16%); and insurance and annuities (9%).
Even without counting the value of their primary residences, the mass affluent still have 14% of their wealth invested in real estate, including vacation homes, rental properties, undeveloped land, and real estate investment trusts.
This concentration of wealth in a single asset class, even a top-performing one, is sure to raise some eyebrows in the financial services industry. Private bankers know such a focused approach to investing is not without peril, and some wonder whether these investors understand or appreciate fully the risks they are taking by not being more diversified.
We suspect some individuals have not considered these risks, because they never made a conscious decision to acquire such large stakes in real estate. They purchased small apartment buildings or other income-producing properties that appreciated significantly in value.
Private bankers may want to ensure that these customers understand that overexposure to this asset class could cost them higher returns on investment in other asset classes or, worse, put them at risk of outsized losses if the real estate bubble bursts. That is a very real concern for those in private banking, some of whom see signs of a cooling market.
Nonetheless, the mass affluent have their reasons for making real estate the foundation of their portfolios.
First, real estate has been perceived as a relatively low-risk investment, making it particularly attractive to investors with memories of significant losses in the 2000-2002 bear market in stocks. It also appeals to those who invest for income but are wary of bonds, because of the capital losses that accompany rate increases.
Second, real estate has been one of the best-performing asset classes in recent years. REITs, for instance, have returned more than 30% each of the past three years, outstripping returns on international and domestic stocks, bonds, mutual funds, commodities, and cash.
Other investment real estate has been generating equally impressive returns. Even primary residences have appreciated smartly, with the median value nationally increasing 50% between 2001 and 2005.
It is no surprise that interest in real estate has skyrocketed. It has a place in most portfolios, of course, particularly those of individuals who are building a stream of income on which to live. However, the mass affluent need to be aware that real estate, like any other investment, is not a sure thing.
Here, private bankers can shine by initiating conversations about asset allocation and helping the mass affluent think through their situations. This is a potentially valuable service, because many of these individuals probably have given little thought, if any, to their investment real estate and the possibility that those holdings could decline in value.
In talking to their private bankers, some individuals may find they are comfortable with their exposure. Others may need to mitigate risk by adding more conservative investments to their portfolios. All are likely to appreciate the interest and concern of their private bankers, strengthening relationships and possibly leading to more business in the future.
