Real estate: an overlooked investment.

• Author: Longstaff, John

Discussion among investors and in the financia press on where to put one's money typically focus on stocks bonds, mutual funds, and cash or cash equivalents (Treasury bonds, money markets, certificates of deposit, etc.). Often over looked is real estate. That's not surprising, since it has been in slump since the mid 1980s, when overbuilding drove down price and changes in tax laws decimated tax shelters.

A recovery is under way, though, and some experts think real estate will do very well in the next few years. They recommend that even small investors consider devoting roughly five to 10% of their portfolio to real estate. The following are some ways to do so:

Your home. Many people already own real estate - their home. In fact, it often is their single most valuable financial asset. Yet, financial planners usually don't count a home as part of an investment portfolio because people normally don't use it as an investment - it is not intended to generate income. It is a place to live in. While they may hope to sell it for a profit if and when they move some day, they typically roll the profits over into a more expensive home.

Nonetheless, a home can become an important investment at retirement. That's when people are more apt to sell it and move into a smaller house, condominium, or apartment and use the profits to help fund their retirement. Moreover, second homes such as a condominium in the mountains or a bungalow on the beach may be used to generate investment income through rental or sale. If you do rent out a vacation home, be aware that the tax rules in this area are complex, so be sure to consult a tax advisor.

Investment property. Generally, a more direct way to invest in real estate is to buy individual commercial properties, such as apartment houses, rental homes, or office buildings. These generate income through leasing and by profits from the eventual sale of the property. Also popular are sweat equity" homes, where the investor buys a home, improves it, then sells the property quickly for a profit.

Certain tax advantages make investing in commercial real estate attractive. For example, you can depreciate investment property (buildings, not land) - that is, write off its full price on your taxes - over, 27.5 or 39 years. If you actively manage the property, such as interview prospective tenants, set rental rates, or do repairs, you can write off operating losses up to $25,000 a year against non-investment income (such as...