Real estate through the eyes of an investor

Bank of Marin sub-advisor tells how to diversify real estate assets

January 18, 2006

By DANE GOLDEN
ARGUS-COURIER STAFF

Question: How much real estate is too much?

Answer: It depends on the diversification of your portfolio.

"There's not a magic percentage of real estate in your investment portfolio." This is according to Charles Haynor, president of Rayner & Haynor Investment Counselors, a sub-advisor for Bank of Marin dealing with high net worth individuals and institutions.

Haynor was speaking at a Jan. 12 wealth management seminar at the Sheraton Sonoma County-Petaluma, hosted by Bank of Marin's Wealth Management Services Group. Bank of Marin has offered the services in Marin County since 1998 and recently added them to the downtown Petaluma branch when Bill Sullivan, a 20-year veteran of Charles Schwab, joined the bank as vice president and relationship manager.

Bank of Marin's Wealth Management Services currently manages approximately $200 million in client funds. The core of their business is personalized wealth management for individuals, families, and charitable organizations, as well as some businesses. They specialize in investments in stocks, bonds, mutual funds, cash and real estate.

For larger clients, Bank of Marin partners with third party investment advisors, such as Rayner & Haynor, a Mill Valley-based professional asset manager, which itself manages $250 million for individual and institutional investors.

Haynor spoke about the status of the real estate market and how real estate fits into an investment portfolio as a whole.

"It's important to take the portfolio approach for real estate, for debt, and for all the other assets -- stocks, bonds, etc.," he said.

Haynor's firm includes real estate as one type of investment in a properly diversified portfolio that, for his clients, includes large, mid and small cap U.S. equities, international and emerging market equities, real estate investment trusts, gold and fixed income investments.

Rayner & Haynor diversifies their clients' investments across each of these asset classes because investment return in each varies from year to year.

But it's residential real estate and a possible housing bubble that's on everyone's mind. So, is there a bubble? Haynor discussed arguments pro and con by noted experts.

Dr. David Lereah, chief economist at the National Association of Realtors, has a number of arguments in favor of a continued strong residential real estate market.

Lereah said that since people live in their homes, housing has a lower speculation rate than in other types of investments. In addition, Baby Boomers are buying second homes and people are living longer, further reducing the supply of homes. Also, interest rates are low and jobs are up.

And, of course, in the Bay Area, there is a severely limited supply of homes.

On the flip side, The Economist pointed out in a recent article that the real estate price to earnings ratio is a record 35 percent above the 30-year average. Price to earnings ratio is not commonly used when evaluating real estate, but it can be helpful if you are trying to compare real estate to stocks on a somewhat similar basis.

Additionally, The Economist said, low interest rates and creative financing structures have helped fuel the boom.

Haynor also shared his views on both sides of the argument.

"I think real estate, in general, is very prone to potential bubbles because of the building cycle and the lag that there is (in building)," he said. "When prices go up and builders build, build, build, then there's so much supply and people don't need it anymore" due to a year-long construction lag.

But Haynor said that he hasn't seen many examples of massive overbuilding yet.

That's not to say it can't happen. Although he said there hasn't been a year-to-year housing price downturn nationwide since the Depression, individual areas have seen them, including the Bay Area and San Diego at certain times, and Arizona during the S&L crisis.

But even within real estate, investors can diversify to spread out the risk, Haynor said. One way is by type of property. This means balancing between investments such as apartments and industrial buildings, leasing to a variety of tenants while maintaining as much property liquidity as possible.

Although individuals would most likely target investments in residential properties, vacation homes, condominiums, small retail stores or small apartment buildings, they can also form partnerships to spread out risk, investing with others in industrial properties, strip malls, or large apartment buildings. Individuals can also buy into real estate investment trusts (REITs).

Haynor said when it comes to real estate, it's easy for individuals to overlook some basic rules of investment, resulting in negative outcomes. These might include taking on too much risk, overestimating liquidity, excessive loss of capital, or a reduction in personal freedom due to the hands-on nature of managing real estate investments.

In determining how much real estate an individual should own, Haynor said that the investor should first understand their goals and then calculate both likely risks and returns.

But not all real estate investments, or all real estate investors, are alike. Haynor said that it's important to understand the levels of risk in each type of property. In increasing orders of risk, there are properties that are fully built and leased, those than are not leased or partially leased, land requiring redevelopment, undeveloped land, and unzoned land.

Other variables can be building quality, tenant risks, potential for natural disasters, and liquidity. Debt and tax issues must also be figured into the equation.

Haynor said the investor should create a basic cash flow model for real estate investments based on historical returns and expected future returns.

"For stocks, there are many sources of information, but with real estate, you have to do your own homework and know your own cash flow of your own property," Haynor said.

Haynor recommends that any real estate investment be viewed with a time period between five and 20 years in mind.

(Contact Dane Golden at dgolden@arguscourier.com)

KEY WORDS

Diversification: when portfolio assets offset each other to minimize risk

Asset classes: types of investment assets, such as large, mid and small cap U.S. equities, international and emerging market equities, real estate investment trusts, gold, and fixed income investments, such as bonds.

Liquidity: The degree to which an asset can be bought or sold in the market without affecting the asset's price.

Leverage: The amount of debt used to finance assets (using "other people's money" to buy properties)

BANK OF MARIN

www.bankofmarin.com

RAYNER & HAYNOR

www.raynerhaynor.com