What Now for Real Estate?

To be fair, the foundation was already set. After the technology bubble popped in 2000, investors grew wary of the stock market and started considering real estate as an alternative investment. Then after 9/11, equities became even more volatile. The Federal Reserve aggressively dropped interest rates to historic lows. Lenders loosened lending guidelines. And folks were fearful of travel and stayed home to nest instead.

Indeed, nervous Americans took their travel budgets and money earmarked for the stock market and shifted it into either the purchase of larger homes or renovations, says Celia Chen, director of housing economics for Moody's Economy.com. As a result, real residential investment (both renovations and home purchases) increased as much as 40% over the past five years surpassing levels seen during the last real estate boom of the late 1980s, according to the Economic Policy Institute, a Washington, D.C.-based nonprofit think tank. Those who rode the real estate market were well rewarded. Home prices jumped 47% over the past five years while the S&P 500 increased nearly 19%.

But just as the memories from Sept. 11 are beginning to fade, so is the strength of the real estate boom. The National Association of Realtors reports that in July existing home sales decreased 11% compared with the prior year and existing home prices increased less than 1% during the same time frame. And anyone who isn't well diversified is likely to get hurt.

"Many of the drivers that had supported the housing market during the last five years have retreated," says Chen. "Now we are in the midst of a downturn and will be seeing more softening for at least the next year."

As real estate softens, financial planners like Stewart Welch of Birmingham, Ala., are reminding their clients that over time the stock market is a better investment than real estate. Over the past 30 years, the S&P 500 posted an annual return of 12% compared with just 6% for real estate, according to Schwab & Co. So if all your excess cash is going to real estate, now is the time to reallocate those funds back into equities and start following a more traditional retirement savings plan, says Welch. (For more on retirement, click here.)

Here's what you can do to reposition your portfolio and protect your nest egg:

Assess Your Portfolio
Not sure if you're too heavily invested in real estate? Use this as a guideline. Saving for that first down payment is notoriously difficult. So it's understandable that for most first-time home buyers a house will make up a large percent of one's total net worth. But as folks age and grow closer to retirement, they should have liquid assets that generate enough income so they don't need to downsize into a smaller condo to fund their golden years, says Patricia Powell, a certified financial planner based in Martinsville, N.J.