Tuesday, June 29, 2010
Question of the day: real estate or Roth IRAs?
We maintain an active presence on Twitter @family_finances, giving out a financial tip every day, and also taking questions from our followers. On Monday, we received a question from @therealbrandon1 who asked, "Curious what ur thoughts r...real estate vs roth ira?" Dan Danford's answer is below.
This is a question of apples and oranges. A Roth IRA is a type of account that can be invested multiple ways. Real estate is a broad investment option, much like stocks or bonds. Some real estate requires active management - rental properties, say, or construction - while others is more passive. The passive variety can be packaged into securities such as REITS or unit trusts. Actually, those securities could be purchased in a Roth or other IRA just like stocks, bonds, or mutual funds. Active real estate investors know that leverage (borrowing money to buy properties) is one of the appealing aspects of ownership. IRAs are prohibited from borrowing, so that's one reason why active real estate isn't a strong choice for IRA investing.
But I do think real estate can be one component of retirement investing. Many of the world's great fortunes were made in real estate. The two big factors to consider are liquidity and leverage. Liquidity simply means that it's tough to monetize your real estate investments when you need money. You must sell or borrow against them, and neither option is fast or assured. Leverage is what makes real estate so potentially profitable, but it's a double-edged sword. That same leverage makes it risky, and banks foreclose on real estate every single day. It's a high-risk, high reward business. For most people, owning their home is the only exposure they need to this sector of investing.