Should you invest in Denver's hot real estate market?

We live in a time when fewer people can rely on a company pension or Social Security.

Many have turned to real estate investing as a popular and sometimes profitable alternative. And in Denver, real estate market value is a mile high. Many of my emerging affluent clients own a number of residential, commercial or multifamily properties. For these investors, the last few years have been exciting.

Denver is the hottest real estate market in America in 2016, according to Zillow. Strong personal incomes, low unemployment, rising prices and low interest rates are fueling the flames for would-be real estate investors. Zillow expects home prices to rise five percent in 2016.

The potential rewards may make Denver real estate difficult to resist – but be cautious. At some point, supply may catch up to demand, sales may slow and values may stabilize or potentially decline.  And without careful financial planning, an investor can be put into a complicated cash crunch.

I recommend these tips to investors before they buy their next property:

1) Acknowledge Risk     

The real estate investor would like to believe that you cannot lose money in real estate unless you sell at the wrong time. Everyone has reasons for selling real estate assets, but for many, a forced sale comes under two scenarios: market opportunity or market obstacle. If you need cash to fund a new purchase or pay a bill, you may be compelled to sell before you’re ready. That person, the distressed seller, is put in a difficult negotiating position.

No investor wants to be in this situation. That’s why I urge investors to have access to liquidity. Carry “dry powder” to ignite a big opportunity or offset a potential obstacle.

For many, liquidity is cash. Its value doesn’t rise and fall with the real estate market. In other words, it’s non-correlated to the market.  And it’s always accessible. However, there are some downsides to cash. It’s low yielding, especially in today’s low interest rate environment, and heavily taxed.  Interest earned is taxed at your ordinary tax rate.  Together, that’s an inefficient place to hold dry powder for long.

Many of our clients who own real estate use permanent life insurance cash value as a source of liquidity.  The policy provides a death benefit to help your family pay future estate taxes due to growth in your real estate investments. The cash value of the product is guaranteed to grow, grows tax deferred, and can be accessed at any time for any reason. Additionally, policyowners may earn a dividend annually, adding extra value. While dividends are subject to change and are not guaranteed, Northwestern Mutual has paid a dividend every year since 1872.

2) Diversify

Real estate may reap big rewards, but it’s risky. Investing in just one asset class, though potentially profitable, can be very volatile.

Many investors want certainty and stability alongside their high-risk investments like real estate. Diversification can help balance out the volatility of holding just one asset class.

For example, one of my clients is earning $1 million a year through his real estate endeavors.  We talked at length about his risk tolerance, and at almost age 40, married with kids, he was ready to take some chips off of the table. As part of a comprehensive financial plan, he decided to launch a Simplified Employee Pension Individual Retirement Account (SEP IRA), allowing him to deduct up to $53,000 from his income annually and diversify those dollars.  He simultaneously purchased a permanent life insurance policy to help protect what he’s yet to build.

By blending world-class insurance services and well-diversified investment products in a plan designed to reduce risk and build wealth, his family has a more balanced approach to his goals. His family can live life differently and more confidently than ever before.

3) Define Your Goal

Real estate investing can be exhilarating, but it can be risky if not done by design. Begin with the end in mind.  How many properties, or how much cash flow do you want this piece of your portfolio to provide?  Be mindful that going beyond that number may be exciting, but also could build a larger estate bill and more risk. 

Make sure that your investing strategy aligns with your needs today and desires tomorrow. If you haven’t designed a blueprint to create balance, consider hiring a financial professional to build a plan incorporating your real estate investments.