It's long-held conventional wisdom that as high net worth individuals age they need more liquid investments. The reason is cash flow, which can pose a challenge for people in their late-60s and older who may no longer work and have a greater risk of a medical emergency that can require immediate access to cash. This has traditionally meant that advisors and clients avoid new investments in real estate as they near or enter retirement.

But that thinking is beginning to shift, especially for high net worth investors. Many advisors are realizing that there is value in investing in real estate, even at this life stage, for the same reasons that apply in all investment decisions—portfolio diversification and income goals.

"For someone in his or her late 60s, with $5 million in investable assets excluding residences, fine art or other valuable collections, investing a portion of these assets in real estate is practical," says Christopher Wolfe, chief investment officer of portfolio solutions in Merrill Lynch's private banking and investment group. "He or she can expect to live another 20 years and more, which is a relatively long investment horizon."

But once retired, investors still need to diversify their assets across multiple classes, and while that could include real estate, the obstacle for many retirees, beyond the general illiquidity of property, is the still-resonant memories of the real estate debacle.

"Had you invested in a REIT in 2007 at the market's peak and sold at the trough in 2008, you would have experienced a 70% loss, on average," notes Chris Butler, vice president of private client group investment products at Raymond James.

Although the real estate market in many regions of the country has rebounded, and in some locales returned to pre-2008 norms, the asset class has lost much of its cachet. For high net worth people in their older years, the bad memories, combined with its lack of liquidity, have made real estate investments less attractive.

Still, advisors argue there is a place for real estate in the portfolio of those in or near retirement. There are a range of real-estate oriented investment options available, Butler says, including private core real estate funds, opportunistic funds and even distressed real estate, all with some degree of illiquidity and varying degrees of risk. The trick to using these options successfully is diversifying within the real estate holdings. "Just like you would diversify the overall portfolio, you want to diversify the real estate within it," Butler says.

Determining Priorities
The real estate market recovery and the attendant increase in liquidity may at first blush appear to be a compelling reason to consider real estate for a diversified investment portfolio. But Butler maintains that this should not factor into an investment decision for those in or near retirement.

"I would not advise investing in real estate for market factors alone. If the economy tanks and real estate tanks with it, the risk for someone older is possibly having to pull out at the wrong time," Butler says. "As always, investors have to make long-term decisions, in which liquidity and their own cash flow needs are carefully considered."

Adds Merrill's Wolfe: "Assuming these investments are well-diversified, if the course of any one investment alters, in the aggregate it shouldn't damage overall income generation to meet client needs."

The final structure of a portfolio depends in large part on the client's age. A 65-year-old person today can expect to live into his or her 80s and even 90s. If he or she lives another 25 years, the client would still be around to endure three more "boom-bust" market cycles, based on historical trends. "That's a long time horizon not to invest in real estate," says Edward DiConza, senior vice president and financial advisor, international, at RBC Wealth Management.

Butler shares this view, noting that a well-diversified portfolio contains a spectrum of counter-balancing opportunities and risks. "Certainly, a person can opt for the extreme of not taking on much risk at all, investing in U.S. treasuries, cash, CDs and the like," he says. "If you're in your 70s or 80s and have no children and no long-time horizon for your investments, this might be the course to take. But if you have beneficiaries and a longer-term investment growth horizon, there is a place for real estate."

Diversification and Allocation
What percentage of a retired client's portfolio should be in real estate? Acknowledging that no two high net worth investor's circumstances are identical, Wolfe maintains that between 5% and 15% would provide appropriate diversification.

The caveat is not to invest in a single type of real estate, such as REITs. "If you diversify the real estate in the portfolio," says DiConza, "combining real property with certain REITs, as opposed to going full bore into one or the other, you can achieve a well-balanced portfolio providing steady income and cash flow," he says. "Were the person to have investable assets in excess of $10 million and more, I would add pure play shopping mall and hotel exposures to their real estate investments."

Complicating the issue is that many older individuals already own their own homes and other properties. "It is not uncommon for a high net worth person in his or her 60s and 70s to own a couple of residences and maybe even the office building in which they worked," Butler says. "Consequently, they already have real estate exposures that must be considered in the context of the overall portfolio."

Generally, Butler recommends that no more than 3% to 5% of the average person's net worth be committed to real estate. For older, high net worth individuals comfortable with the liquidity of their investments, however, 10% to 15% in real estate would provide greater diversification and, "if you're substantially wealthier than $5 million in investable assets and still have growth objectives," he argues, "then 20% or more in real estate should not be a problem."

DiConza is even more bullish. He insists that within a diversified portfolio as much as 25% invested in real estate would not be problematic for certain high net worth people in their 60s and beyond.

"We're big fans of real estate being part of the pie," DiConza says. "The challenge is getting the liquidity feature right. At this stage of life, it all comes down to income. But if that's covered by other portions of the portfolio, then 25% in real estate should not be overly risky. Obviously, this depends on what the remaining 75% of the portfolio is invested in, its liquidity and the returns it generates. And it depends on individual circumstances—the person's estate plan considerations, whether or not they fully own their current residence or still have a mortgage."

What to Ask
DiConza counsels advisors to ask questions of older, high net worth individuals to discern their appetite for real estate. Make sure you know the following information about their situation:

  • Do they already own a rental property and if so, where is it located?
  • What are their current debt loads and monthly income requirements?
  • How liquid are their other investments?
  • Do they have any big, upcoming life events that will require large cash outlays, such as a wedding or an elderly parent entering assisted living?

"All these factors play into the determinations for the individual's cash flow needs," DiConza says. Once you have learned what these are, you will be in a better position to see what the client can afford to put into real estate.