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Many high net-worth individuals continue taking profits in real estate (an asset that has served them well since the 2009 bottom) and shift into defensive mode.

Getty Images/iStockphoto

Ask a financial adviser to tell you the key to investment success, and most will say diversification.

A well-balanced portfolio with a healthy mix of equities, fixed-income securities and cash – the proportion of which will vary based on factors such as the investor's age, lifestyle requirements and risk tolerance – is the gold standard for delivering long-term growth and wealth.

But what about real estate?

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The approximately two-thirds of Canadians who own their own homes are already real estate-rich, says Kevin Macleod, a financial planner with Calgary-based Money Advisor Wealth Management. That's especially true in hot property markets such as Toronto and Vancouver where home values have soared in recent years.

"People don't realize that real estate is already one of their biggest investments when they're a homeowner. And they don't recognize it's an asset class that they're overexposed to," he says. "There are a lot of people who are not financially wealthy but they are real estate wealthy."

That's why when advisers help clients develop an investment strategy, they shift the wealth from a primary residence into a separate category, then work with the investable assets that are left over. We all have to live somewhere, after all, so selling our homes isn't always an option.

Once that asset is removed from the mix, most Canadian investors are relatively underexposed to real estate-focused investment vehicles, says Brian Himmelman, president of Halifax-based Himmelman & Associates Financial Advisors Inc.

"Not a whole lot of advisers seem to be dialled in to real estate," he says. Even for investors who are house-rich, real estate investments can be another tool for strengthening a portfolio.

In fact, many financial planners argue that failing to diversify using real estate not only potentially sacrifices another chance to help mitigate risk, but it also forfeits an opportunity to accrue lucrative long-term gains in personal wealth.

Determining which type of real estate investment makes sense is often a personal decision.

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Some investors build wealth by owning hard assets such as rental properties. They find and purchase the right properties, attract and retain tenants, collect rents, maintain the properties, and more. Most of those tasks can be outsourced to a property management firm, but doing so will eat away at profits.

While well-maintained rental properties in the right areas can be cash cows, they can also be risky investments. As any landlord knows, all it takes are a few bad residential or commercial tenants – and a month or two of bounced rent cheques – to severely affect their financial standing.

Not sure whether owning and managing rental properties is right for you? Mr. Macleod suggests a simple stress test: Would you be able to survive a few months without income from your property and still carry any related mortgage or maintenance costs? For investors who answer "no," the best move is to park their money elsewhere.

"There are a lot of management issues that people don't necessarily contemplate before they make that type of investment," says Matthew Bacchiochi, portfolio manager at Toronto-based Gavin Management Group Inc.

"You have to look at the capitalization rates and rates of return [on investment properties], then compare that to what competing investments might provide," he says. If an apartment building offers a 4-per-cent return, but another investment, such as a mortgage investment fund, offers 10 per cent, then the investment looks better, he says. "And you don't have to worry about cashing cheques or getting a call that the plumbing has failed in the middle of the night."

That's why for most diversification-minded advisers, investing in vehicles such as REITs, or real estate investment trusts – organizations that own and manage income-producing properties such as commercial offices, apartments and factories – can be smart. These investments offer the opportunity to own shares in multiple types of income properties across a varied geographic area.

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REITs also historically deliver above-average income returns of 8 per cent to 12 per cent, Mr. Himmelman points out.

Those rewards can come with increased risk, however.

"We say that REITs are like pension money: It's not something that someone should be in for a shorter period of time than 5 years because they are highly speculative. For most long-term investors, a REIT fund of 10 to 20 years is most appropriate."

As with any investment, the best approach is the one customized to the individual investor. Mr. Himmelman typically recommends the share of real estate in his clients' balanced portfolios at between 10 per cent and 20 per cent.

It's a ratio that should always be up for review as market conditions change.

"It's like if you're eating a good diet," he says. "You don't necessarily have to take a multivitamin, but if it's missing then you want to supplement it to bring it up to a certain level."

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