BY Brian Hufford, CPA, CFP®
In spite of the challenging environment for real estate investments in the past five years, I can confirm that, among most dentists, real estate is still the preferred investment. In fact, my informal polling indicates that for most dentists' investment portfolios, the value of real estate represents approximately two-thirds of the total value.
Not only is real estate the dominant investment for most dentists, it is also the largest source of financial risk since real estate is typically highly leveraged with debt. The question for me has been "Why do dentists love real estate as an investment, and is this ardor justified?"
Why do dentists love real estate? The first hint of an answer was revealed to me in Michael Lewis' book, "Boomerang: Travels in the New Third World." In an interview with California Governor Arnold Schwarzenegger about the state's budget crisis, Lewis wanted to know how Schwarzenegger felt about the challenges of local citizens in communities, for example San Jose, with rapidly declining public services budgets for such things as police and fire protection.
Lewis states, "At some point in our talks I asked Schwarzenegger how much time he had spent, as governor, grappling with the on-the-ground local implications of the big state crisis. The question clearly bored him. 'I'm not into the local stuff,' he'd said. 'I was born for the world.'"
For the most part, dentists are very "local." They do not have a narcissistic made-for-the-world view of life. They are intensely loyal to their communities. Their profession is dedicated to the most sensitive human organ — the mouth. How much more local can it be?
All of these local-like factors seem to provide a cultural bias toward investing in real estate. Many dentists believe Wall Street is rigged. Their real estate investments, whether through office buildings or second homes, provide direct noninvestment benefits to hard-working dentists and their families. These benefits must be tangible and experiential to provide real value in most dentists' minds.
Is real estate the best investment for dentists? The dictionary definition of investing is "the commitment of money or capital to achieve income or returns." It is in this definition of investing as pursuing income or returns that dental real estate investments fail miserably, especially when viewed in conjunction with the tremendous debt incurred by dentists in owning real estate. To illustrate this failure, let me compare an investment strategy of investments in office buildings or second homes with an alternative investment strategy, a REIT (Real Estate Investment Trust).
According to Morningstar, equity REITs grew at 9.3% per year compounded for the 20 years ended Dec. 31, 2009. Publicly traded REITs are typically geographically diversified, professionally managed, contain many types of income-producing properties (apartments, shopping centers, self-storage facilities, etc.), and if owned via mutual funds, are fully liquid (convertible to cash) on any given day.
How do these investment characteristics compare with the single-property investments made by most dentists?
1. Dental real estate investments are illiquid.
One of the most basic characteristics of safe investing is the ability to convert the investment into cash. Single-property real estate is very illiquid and is dependent on finding a buyer and paying real estate commissions to convert the investment into cash. REIT mutual funds can be converted to cash at any time.
2. Dental real estate investments are not typically diversified geographically, and are not professionally managed.
Most dentists purchase the majority of real estate in their hometowns. They own office buildings, and in many cases, residential, commercial, or agricultural real estate in the same communities as their practices. If their communities face economic challenges, their economic eggs are in one basket. Conversely, REITS are typically geographically diversified and professionally managed.
3. Dental real estate investments are typically accompanied by a high proportion of debt.
My main concern for dentists who dabble in real estate is the high-risk nature of their investing. Most investment properties are leveraged between 60% to 100% with mortgage debt. There is the belief that, if tough economic times come, practice income can carry the debt. At least a REIT investment is easily convertible to cash.
In summary, I'm not touting REITs as a superior overall investment strategy. I'm simply trying to break through dentists' love affair with single-property real estate as the only "safe" investment, and pointing out the risks of dangerous liaisons with real estate to overall financial health.
Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064 or [email protected].