Why doesn't the Permanent Portfolio has real estate?

[helpme]

Given that real estate is a popular asset class which provides income and growth, I am surprised it is absent from the Permanent Portfolio. Will it be a good idea to have REITs in the permanent portfolio? Why is this so?

[craigr]

Given that real estate is a popular asset class which provides income and growth, I am surprised it is absent from the Permanent Portfolio. Will it be a good idea to have REITs in the permanent portfolio? Why is this so?

Consider that most companies in the stock portion are heavily involved in real estate in terms of the building and infrastructure they own and manage. So most investors do have real estate exposure, even if they think they don't.

With that said, some REITs in a variable portfolio are perfectly fine if you want to speculate in that area. Just be careful of the tax impacts as REITs tend to be pretty tax inefficient. I'd tend to keep them in tax-deferred if possible.

[Tyler]

Many homeowners have a large percentage of their net worth tied up in real estate with their home equity as well.  It's not a true investment, but people are exposed to the RE market more than they think.  Adding more actually reduces diversification for many people. 

That said, if there's one asset that interests me the most from a VP perspective it's real estate (specifically REITs).  I like how it's another relatively uncorrelated asset (most closely correlated to stocks at 0.59) to add to the mix.  Like Craig mentioned, I'd probably isolate them in a tax deferred account to keep things simple. 

Disclaimer: I own no REITs myself.  Just sharing a few passing thoughts. 

[ngcpa]

The mutual fund contains REIT's in it.  Currently almost 10%.  I think generally at around  7 and 1/2%.  A large part of the stock allocation (generally 15 % of the total portfolio) consists of stocks of natural resources and REIT's.

[craigr]

The mutual fund contains REIT's in it.  Currently almost 10%.  I think generally at around  7 and 1/2%.  A large part of the stock allocation (generally 15 % of the total portfolio) consists of stocks of natural resources and REIT's.

Yep. I should have been clearer. People think they don't own real estate, but the stocks they own, own real estate by the heaps.

Also as Tyler said, many people are up to their eyeballs in real estate exposure in their own homes. In some ways, people may own too much real estate if you add it all up.

REITs are an interesting asset. Not really stock, not really gold. They kind of straddle both. International REITs are also something of interest as a diversifier against the local currency to augment gold.

[sophie]

As I remember, Harry Browne didn't include REITs in his mix because he felt they added no diversification beyond the basic assets he chose.  In the original, early conceptions of the PP he did in fact include real estate in the stock allocation, which you can still see in PRPFX.  I assume that he was able to show that they essentially can be represented by some linear combination of stocks, gold, and bonds.

An REIT might be appropriate if you had a bunch of cash that you were thinking of using to buy an investment property for income.  I had thought about turning the apartment I just sold into an investment property, since my building allowed for such things.  But since rents in NYC are only about twice the maintenance charges, my returns would have been only ~3-4% after expenses.  Not worth it for the headache of managing an investment property, when you could get that kind of return by just buying a fund.

[ngcpa]

Hi Sophie:
        Part of the benefit of rental property is being able to offset ordinary income from paper losses (mainly from depreciation).  Since 1987 these losses are limited to $25K/year and even could be partially or totally postponed  if you have adjusted gross income > $ 100K.  In the past I have had clients who had rental property and were able to save a lot in taxes year after year by deducting rental losses even though they made more than they spent.  Even though you get to deduct depreciation, it is not an out of pocket expense.  They later sold their main residence and moved Into the rental property themselves.  This was not a hardship as it was a beach house and they had planned to retire there anyway.  They later sold it,after being there about 6 years,and excluded all the gain as it was now their personal residence.  For them it was a pretty good deal.  I'm with you though,I wouldn't want to have to deal with the management of rental properties.  For rental property to be worthwhile, it generally pays to have more than one.  It is not 3 times the work or risk to have 3 rather than 1.  It would also help to be in a situation where the house prices are rising.

[sophie]

Yes, I was aware of the depreciation writeoff.  That's included in the 4% (max) return estimate.  You would think that renting out an NYC apartment would be an awesome investment, but it just isn't.  Not only does maintenance take half the rent off the top, you don't get to exclude the portion of it that's deductible as taxes or mortgage interest, you lose the coop tax abatement, and there are substantial extra fees.

Your clients' arrangement sounds like it worked out perfectly for them.  Not to say that an REIT is always better than an investment property, just that it probably is in some situations and you have to do the math.