Investing in Real Estate with Your 401(k): A Guide to the Potential Rule Changes

A recent executive order could soon allow 401(k) plans to offer direct real estate investments, providing a new path for retirement diversification. While this change aims to help savers tap into higher-growth assets, it introduces significant risks, including illiquidity and volatility, that are not suitable for all investors. Understanding your liquidity needs and risk tolerance is critical before considering these alternative options.

What Are the Proposed Changes to 401(k) Rules? Currently, 401(k) participants are largely limited to traditional investments like stocks, bonds, and mutual funds. While it has always been technically possible to include alternative assets like private real estate or cryptocurrency, the administrative complexity and high legal risks for plan fiduciaries have made them virtually inaccessible. The new executive order directs the Department of Labor to clarify rules and provide legal protections for plan providers, potentially making these investments available within the next 180 days. The stated goal is to help retirement savers achieve better diversification and potentially higher returns.

What Real Estate Investment Options Could Become Available? If the new guidelines take effect, your 401(k) menu could expand to include several real estate-focused vehicles. These may include:

• Private Real Estate Funds: These funds pool capital from multiple investors to acquire and manage properties, similar to how institutional investors operate.
• Real Estate Investment Trusts (REITs): While some plans already offer REITs—companies that own, operate, or finance income-producing real estate—the selection could become much broader.
• Direct Property Stakes: A more complex option could involve taking a direct ownership share in specific development projects.

Proponents argue that adding real estate can provide a hedge against inflation and reduce reliance on the stock market's performance. From 2019 to 2023, for example, median U.S. home prices climbed more than 37%, showcasing the asset class's potential for appreciation.

Table based on publicly available market data from 2019-2023. Past performance is not indicative of future results.

What Are the Key Risks of 401(k) Real Estate Investing? The same qualities that make real estate a potentially high-reward investment also introduce substantial risks that are not present with traditional 401(k) assets.

• Illiquidity: Many private real estate funds require investors to lock up their capital for several years. If you need to access your funds for a home purchase or an emergency, that money may be unavailable.
• Valuation Difficulty: Unlike publicly traded stocks, private real estate assets are not priced daily. You may not know the true value of your holding until it is sold, making retirement planning more challenging.
• Volatility and Fees: Real estate markets can experience sharp swings. Furthermore, these investments often carry high management and transaction fees, which can significantly erode your returns over time.

Is 401(k) Real Estate Investing Right for You? Based on our experience assessment, expanded access is best suited for specific types of investors.

• Younger Savers: Those with decades until retirement have time to weather market downturns and wait for properties to appreciate.
• Experienced Investors: Individuals who already understand real estate nuances may find value in adding it to a tax-advantaged account.

However, for investors nearing retirement or those who are not well-versed in alternative assets, the risks are significant. Experts generally recommend limiting real estate and other alternative investments to no more than 5% to 10% of a total retirement portfolio. It is crucial to work with a financial advisor to assess whether the long-term growth potential aligns with your short-term liquidity needs and overall financial strategy.

Before making any changes, consider all available avenues. A 401(k) is not the only way to gain real estate exposure. Real Estate ETFs and Self-Directed IRAs can offer diversification with greater liquidity, potentially providing a balanced approach without locking up a large portion of your retirement capital.