Guide clients to take high costs and rental property risks

The founder of Real Estate Whisperer Financial Plan said that if a financial adviser asks clients for a rate of return on a leased real estate investment property, they should expect to hear a point of at least 5 percentage points higher than the actual return.

This is due to calculations based on “optimistic assumptions, untracked costs and lack of formal benchmarks”. Rich Arzagafounder of the Monument in Colorado, in a speech this week Financial Planning Association Retreat Oak Creek in Illinois.

“This is where ownership bias fits in the reality of reward,” Arzaga added. “Whatever they say, at least 5% will be eliminated.”

although Fortune Real EstateAssets may sometimes be overlooked by planners who leave behind a frequently emotional decision that is critical to the retirement of clients, which is crucial to the retirement of professionals from other fields who work more closely on investment properties.

Read more: Tax benefits for real estate investment

Instead, more planners should maximize their value to their customers by bringing it into realistic cash flow estimates and including it in all the expenses they can make for their long-term forecasts of their assets in retirement, Arzaga said. Even for high-net-worth clients, tens of thousands of dollars in rental income are generated each year, and the risks and costs of properties that do not meet their investment expectations can consume their holdings over time.

“I want to come up with that, here’s the idea you can use, that expands your thinking about the way we use this business,” Arzaga said. “I think the way we use it now is great, but I still don’t see it in any course – whether it’s a licensing, without a name, there’s no direct focus on real estate investment.”

Arzaga shares a case study of two 58-year-old clients from San Francisco, known as Kevin and Lynn, whose net worth is $3.6 million and rental income is $75,000 a year through property separated from their residence. However, through debt payments and other expenses, its property costs are $76,000. Arzaga estimates that if the couple followed their plans to retire at age 65 while maintaining the same quality of life, spending $312,000 a year, they would run out of assets by age 84.

“Someone has a net worth of $3.6 million, which is not what they expect, right?” he said. “That's why they came to us. Luckily, they came to us.”

Read more: Ask the consultant: When will real estate invest in?

If the couple were to sell the property on a 1031 tax exchange in exchange for better performing assets, or simply reduce rent holdings, absorb taxes and reinvest shares into their long-term portfolio strategy, their assets could accumulate hundreds of thousands of dollars worth of value, even higher than they are currently in the process.

According to Arzaga, one of the main misunderstandings stems from the cost of maintaining a leased property. In his example, the client mentioned their income and told him that the number included their expenses. He saw that when he checked their itemized deductions under Schedule A of his tax return, they had calculated them incorrectly.

Operating expenses include taxes and preparations, insurance premiums, legal expenses related to physical archives and other matters and two main areas – maintenance of reserves and property management. When it comes to maintenance, owners should spend about $30,000 to $40,000 per decade for concrete, foundation work, roof replacement or similar maintenance, Arzaga said. Property management also poses difficulties.

“Most people like to do it themselves. Most people don't have the ability,” he said. “It's important, it's a big asset. Some of the decisions they make are because they're not professionals in the field.”

Read more: Top 20 real estate funds in ten years

These realities may be hard to hear for clients, but they usually arise after planners have formulated the costs and risks involved in many small-scale rental properties. Arzaga said assisting clients to make smarter choices about real estate is “more important than beating the S&P 500” and “a nobler cause”.

“I think it’s crucial to know how real estate affects the financial situation of a family to be a comprehensive consultant,” he said. “You have to be willing to talk about these things. You don’t have to be an expert, you want to serve your clients.