Yes, real estate is hot right now, and agents and investors are flush with cash. It’s time for real estate professionals to diversify their finances, or face the consequences when things finally cool down.
With a red-hot housing market, times are good for real estate professionals.
Demand for second homes more than doubled during the pandemic, according to economists at the national real estate brokerage Redfin. Home prices in many metropolitan areas around the country have jumped significantly, reaching record levels.
I witnessed the price rise first hand. I recently returned from a family vacation in the North Carolina mountains, where many homes now sell for double or triple the price compared to just a couple of years ago.
As a result, anyone working in real estate has likely seen their income balloon during the last 12 to 18 months. Agents are turning listings over more rapidly, receiving strong commissions and moving on to the next deal. For real estate investors, they are seeing price tags soar and homes selling at a premium.
The Danger to Real Estate Professionals
With all of this cash flying around, people making their living in real estate need to take action now to diversify their assets. And this means investing in assets other than property. Failing to do so can be costly.
I’ve seen this mistake before. Back in 2008 during The Great Recession, a family member of a client nearly went belly up after the real estate market crashed. She owned a real estate brokerage company and several properties.
Once the recession hit, it took her more than a decade to recover financially. She had no cash or other investments outside of real estate. Facing mounting expenses, she couldn’t break even on her properties.
Fortunately, she’s now making money again. Unfortunately, it’s too easy for her and others in real estate to simply reinvest their profits in what they know. But that’s not a sound strategy.
For older professionals nearing retirement, the importance of a diversified liquid portfolio is even greater. Having rental income is good, but consider how much equity you have tied up in these properties. You can’t buy groceries in retirement with the equity in your real estate unless you take out debt against the property, tying your hands even more.
We know that real estate has its business cycles and eventually will cool off. So, now is the time for real estate pros to diversify by making these four financial moves:
Set Up an Emergency Fund
Since real estate is cyclical and many real estate professionals have incomes that rise and fall quickly, they should set up an emergency fund that will cover approximately 12 months of expenses. Because income for a real estate agent or investor is less predictable than many other occupations, this 12-month reserve is roughly double the amount recommended for salaried jobs.
Sock Away Money in a Retirement Account
Self-employed individuals or small-business owners in the real estate profession who foresee another year or two of strong profits should consider saving some of that money into a tax-deferred retirement account.
This is the time to sock away thousands of dollars on a before-tax basis. At a minimum, these individuals could consider funding a 401(k) retirement plan by depositing money that allows their status as employee and employer to contribute up to $58,000 annually, or $64,500 for those 50 and over. Many types of retirement accounts exist, including solo 401(k)s, SIMPLE IRAs and SEP IRAs, so talk with a tax adviser before setting one up.
Open a Brokerage Account (or Bump Up the One You Already Have)
Real estate pros should also consider opening or making contributions to an existing taxable brokerage account. These accounts have no age or deposit restrictions, which allows a person to tap into this money when the economy starts to cool and their business slows. They can also make withdrawals in retirement that are taxed at lower capital gains tax rates compared to tax-deferred retirement accounts, which are taxed at higher ordinary income tax rates. Since this type of account might require withdrawals sooner than a tax-deferred retirement account, consider having more bonds or other conservative investments in the brokerage account.
Keep Your Lifestyle in Check
When the money is flowing, many real estate pros can be tempted to buy luxury items – a new car or a pool for the home. And once a person becomes comfortable with a bigger, more expensive lifestyle, the harder it is to scale back. Less spending on frills will make it easier to adjust your lifestyle when the market takes a turn.
Even with the market and the economy humming, take the time now to build a nest egg and plan for the future. While we all want the good times to last, it’s likely the economy will eventually slow down and the housing market’s torrid pace will stabilize. When that happens, it’s important to have enough income and savings to ride out any downturn.