The real estate talk

It’s hard not to be impressed by the performance of the residential real estate market over the past several years, particularly in Western Canada, where prices seem to be going nowhere but up.

In the past 12 months, for example, the price of a detached bungalow has risen 47.4% in Edmonton, 23.9% in Calgary and 11.3% in Vancouver. Meanwhile, in Saskatchewan, growth has been even more spectacular, with Saskatoon homeowners enjoying a 56.0% rise and those in Regina seeing a 42.4% jump.

Given this backdrop, it’s natural that some of your clients may want to reallocate a portion of their portfolios from equities, bonds, and cash to real estate. To some extent, that’s understandable. After living through the dot-com bust, many clients have lost confidence in the stock market. Meanwhile, real estate has posted some of the best returns in a generation.

Over the long term, the story behind real estate is a little less impressive than current figures suggest. For example, over the past 30 years, detached housing in the Vancouver market has enjoyed an average annual return of 7.91%. The TSX Composite, on the other hand, has seen a 12.25% return (including dividends). We’re fairly certain that the story is roughly the same in other communities across the country.

So if equities are so superior to real estate, why do advisors have such difficulty convincing clients to put their money in the stock market instead of the real estate market? Perhaps the problem isn’t with the message, but the way it’s being delivered. With that in mind, allow us to share some of our thoughts on how to talk about real estate with your clients.

Present FACTS, not ideology As advisors, it’s our job to show clients that over the long term equities offer superior returns to real estate. However, we must say this with our heads, not our hearts: too much passion about stock market superiority and clients can see you as a salesperson with much to gain by steering them away from real estate and toward equities. We acknowledge that real estate has its place in the portfolio. We show clients the research, and point out the performance numbers that prove how stocks are a superior investment over the long term, taking care to use a casual or neutral tone. After that, we sit back and let clients reach their own conclusions. Not only is this approach very persuasive, it positions us as stewards of client wealth rather than salespeople.

Preach diversification Investing in real estate means holding a highly concentrated, rather illiquid portfolio. These are important points to bring up in any conversation about real estate. Speaking about diversification allows you to claim the “high ground” in your discussion: you’re not anti-real estate, you’re pro-diversification. We’re careful to point out that we are neither for nor against any investment — they all have their place given the right circumstances. What we are in favour of is diversification, and that’s why we’re less than enthusiastic about direct investment in real estate. Because clients know diversification is a guiding principle of our practice, they accept our opinion on real estate investing more fully.

Talk about the “other” real estate market A lot of clients talk about real estate in broad terms, without stopping to think how their handful of residential properties within a single community is not a fair representation of the overall real estate market. Clients need some education here. The next time you talk about real estate, mention that you believe real estate can be an excellent investment. Then explain exactly what you mean by “real estate.” Talk about the market for industrial and commercial properties in your community. Then discuss the benefits of holding real estate in other cities — cities that have different economies and market forces that influence housing prices. Hopefully, this will lead the client to understand that while real estate may make sense as a broad asset class, a poorly diversified real estate portfolio in a single community does not.

Suggest alternatives It’s our job as advisors to not only point out the flaws in a given investment, but to suggest alternatives. This is particularly important when talking about real estate, where there are several features the client could find attractive. For example, if it’s income that the client is focused on, then a laddered bond portfolio or a custom-designed principal protected note might offer the same or better level of income, with a lot more liquidity. If the client is attracted to the counter-cyclical performance or inflation-protection features of property, then alternative assets might be an option.

If the client is simply bullish on real estate and wants some exposure to a hot sector, suggest a REIT or other pooled investment, which will offer similar potential for profit, but in a more diversified and liquid package. Often merely pointing out these alternatives is enough to convince the client that there are better ways to build and secure wealth than by purchasing an overpriced residential property.

However you decide to talk about real estate, avoid getting into the standard “stocks good / real estate bad” argument. Not only is it untrue (every asset has its place, given the client’s personal circumstances), it does a grave disservice to you as a professional. Always remember: you are not a salesperson. You are an objective, principled steward of client wealth. Don’t try to persuade clients to sell property and invest the proceeds in the stock market. Instead, explain how holding a large, concentrated position in real estate conflicts with one of your core investment principles. In the long run, such an approach will serve both you and the client well.

This article first appeared in the August 2007 edition or Advisor’s Edge Report.

Thane Stenner, Rod Bower and Rory O’Connor are senior investment advisors with Stenner Investment Partners of GMP Private Client (www.stennerinvestmentpartners.com), a private family office group. The views of the authors do not necessarily reflect those of GMP Private Client. This article is for information only. GMP Private Client is an affiliate of GMP Securities and subsidiary of GMP Capital Trust and member of CIPF. Contact: stennerinvestmentpartners@gmppc.com.

(09/13/06)