Can real estate substitute for bonds in asset allocation?

[Joylush]

In your scenario, borrowers would default, the risk premium for the remaining bonds would skyrocket, and bonds would also be close to worthless. Meanwhile, I would collect the $500 a month on my unleveraged properties and be just fine.

ETA: Reserves are cash. Stored in FDIC insured accounts and US Treasuries. If they go under, I don't think the paper asset markets will be functioning any longer.

I have plenty of cash reserves as well. Even during the down turn I didn't have any problem finding quality renters so no loss in rent. Being as my area does get hurricane scares it's possible I could sustain damages at multiple homes but not likely all of them at one time. And they are of course insured. So there are risks but the stock market could crash significantly again too and that's not insured. I've had rental houses for going on 35 years now, several have paid for themselves several times over, so even if they were gone the land alone is worth what I originally paid for them. It is important to maintain adequate reserves to cover the what ifs of course.

 

[Senator]

Properties I purchased in 2008-2012, have doubled in value. If you buy right, it's easy to do.

A property I purchased in 2012 for $197K is worth $500K based on recent sales. I actually bought a foreclosed mortgage and continued the foreclosure. I then put $60K into it. That is basically double.

A property I purchased in 12/2015 for $38K is worth, according to Zillow, $145,528. I am rehabbing it and I will list it in the Spring for $160K. That is 400% in 2.5 years.

A flip I did in 2012 purchased for 128K sold for $200K after putting $15K into it six weeks later.

Real estate is a high risk, high reward venture. For those who know how to play the game, it is much less risk and much more reward.

Real estate provides the cash flow of a bond, the appreciation similar to a commodity. And a nearly always is a great hedge against a bear market.

Which asset class has performed as well as bonds during U.S. equity bear markets of the past 60 years?

The answer, perhaps surprisingly, is residential real estate. During the Great Recession, of course, the real estate market collapsed along with stocks. But residential real estate’s performance during the 2007-2009 bear market was anomalous, according to data from Yale University’s Robert Shiller, winner of last year’s Nobel Prize in economics and the co-creator of the Case-Shiller Home-Price Index.

In 14 of the 15 previous U.S. equity bear markets, going back to 1956, the home-price index rose. And in that lone bear market prior to 2007 in which home prices did fall, they did so by just 0.4%.

Besides bonds, no other asset class comes close to this good a track record during bear markets.

https://www.barrons.com/articles/as-stocks-fall-real-estate-may-be-the-best-defense-1441104699

 

[Senator]

And in what vehicle would you store reserves? Why bonds of course. Suppose the recovery didn't happen. Suppose unemployment was still 15% with 40% in particular communities (like those who rent) and going into the 10th year (as happened in the depression). Tell me now about how smart a real estate portfolio is. You bought all these mortgages but have renters with no jobs? What happens to your cash flow? You might be able to rent your $1200 a month property for $500. Suppose this scenario and you live in Houston and your 10 properties went literally under water meaning they are uninhabitable, now your cash flow is $0, but the mortgage is still due. So much for the annuity idea. In that scenario owning a bond might look pretty good. Bonds provide a different kind of diversity and risk profile

You can always increase demand by lowering price. Every time. I never worry about vacancy. I have had less than 1% vacancy for a long time. People need a place to live. When people lose their job, they move out and you get new people that have jobs. Or the people get government assistance and continue to pay rent.

I suppose that some downtrodden areas, like Detroit, might be bad. That is typical of class D neighborhoods. Expect many landlords to take Section 8 and other forms of government paid rent.

 

[Luck_Club]

Love Real Estate.

It is very similar to a zero coupon bond that isn't callable. When you buy the property, you have several pieces of information:
1) A rough free cash flow number (coupon rate).
2) Cash required estimate (repair costs, down payments, and reserves)
2A) Mortgage, Tax and Insurance costs.
3) Market rents

It is, in my opinion, the easiest to analyze and least risky investment option outside of simple interest rates, Which can and do change without notice.

 

[Texas Proud]

I just cannot get my head around all the RE investors who are trying to wrap their head around RE being 'similar' or 'the same as' or whatever word used to a bond... why? so you can say you are invested in bonds?

It is NOT a bond... period...

You keep trying to pound a square peg into a round hole and say it fits....

Live with the fact that it fits your needs and be done with it...

 

[harley]

I agree. It's a different asset class than bonds. I own equities (mostly in MFs), I own bonds (also mostly in MFs), I own RE, I hold cash. I don't have any commodities, unless some are held in one of my funds. RE estate is not a bond. If you want to hold RE and not bonds, fine. It would be the same as holding RE and bonds, but not equities. It just is.

 

[Luck_Club]

It is NOT a bond... period...

Your right. It is a continuous cash flow generating investment, with inflation protection, and can't be called.

Oh and also usually has a higher yield then a bond, when prudently purchased.

I can't understand why Asset Allocators insist that bonds should be a percentage of your holdings for safe cash flow when they have risk of losing principle.

 

[pb4uski]

....I can't understand why Asset Allocators insist that bonds should be a percentage of your holdings for safe cash flow when they have risk of losing principle.

I can 100% guarantee you that with a bond you will NEVER lose principle. It has never happened in the history of man.

 

[pb4uski]

On the other hand, it is possible, albeit unlikely to lose principal... aka credit risk... but you get compensated for it.

At least the asset allocators know the difference between principle and principal.

 

[harley]

I can 100% guarantee you that with a bond you will NEVER lose principle. It has never happened in the history of man.

Didn't Greece just default on it's debt/bonds a few years ago? And I'm pretty sure it has happened at least a few other times. So maybe in the history of the US, but not of man.

 

[Luck_Club]

What risk of losing principal? Credit risk?

Yes credit risk, and rising rate risk. The rising rates are the larger risk on the immediate horizon, and 1 which you can't diversify out.

If you think back to the late 70's and early 80's bonds have been a great investment. rates have been declining most of the past 30+ years to the paltry interest levels we now have. If you look at the performance of bonds, they have been lock step solid safe returns the entire time.

Everyone agrees that bond prices fall when rates rise. So as the fed begins to adjust rates up, what is happening to all those bond portfolios?

Bonds & Bond funds aren't an asset class I see as favorable for the foreseeable future. two things are going to happen as rates rise.

1) Get locked into sub-market rates if you hold to maturity.
2) Take principle loss to increase your returns.

 

[Senator]

I just cannot get my head around all the RE investors who are trying to wrap their head around RE being 'similar' or 'the same as' or whatever word used to a bond... why? so you can say you are invested in bonds?

It is NOT a bond... period...

You keep trying to pound a square peg into a round hole and say it fits....

Live with the fact that it fits your needs and be done with it...

Wouldn't a bond fund that invested in mortgage backed securities be a considered a bond?

And if I invested $100K to pay off a mortgage, and my cash flow increases by $1,000 a month, would that be just as good as a bond fund paying the same (or typically much less)?

Why do people invest in bonds? Cash flow? Tax free income? Low volatility/Stability? If real estate provides all of these things, isn't that like a bond?

Bonds & Bond funds aren't an asset class I see as favorable for the foreseeable future.

++1

 

[pb4uski]

Yes credit risk, and rising rate risk. The rising rates are the larger risk on the immediate horizon, and 1 which you can't diversify out.

If you think back to the late 70's and early 80's bonds have been a great investment. rates have been declining most of the past 30+ years to the paltry interest levels we now have. If you look at the performance of bonds, they have been lock step solid safe returns the entire time.

Everyone agrees that bond prices fall when rates rise. So as the fed begins to adjust rates up, what is happening to all those bond portfolios?

Bonds & Bond funds aren't an asset class I see as favorable for the foreseeable future. two things are going to happen as rates rise.

1) Get locked into sub-market rates if you hold to maturity.
2) Take principle loss to increase your returns.

It's called interest rate risk... not rising rate risk... but it is temporary and if you hold the bond to maturity like a good long term investor then you get your entire principal back so no need to diversify out... interest rate risk only affects you if you sell prior to maturity... but at least a bond investor can sell at any time if desired... its called liquidity and it is a good thing.

 

[Senator]

It's called interest rate risk... not rising rate risk... but it is temporary and if you hold the bond to maturity like a good long term investor then you get your entire principal back so no need to diversify out... interest rate risk only affects you if you sell prior to maturity... but at least a bond investor can sell at any time if desired... its called liquidity and it is a good thing.

Isn't one of the reasons to invest in bonds so that you can sell the bonds if the stock market is down? And if you have a set allocation formula, doesn't that also mean selling?

 

[Texas Proud]

Wouldn't a bond fund that invested in mortgage backed securities be a considered a bond?

And if I invested $100K to pay off a mortgage, and my cash flow increases by $1,000 a month, would that be just as good as a bond fund paying the same (or typically much less)?

Why do people invest in bonds? Cash flow? Tax free income? Low volatility/Stability? If real estate provides all of these things, isn't that like a bond?




++1

Still trying to pound that peg in place...

Just because something has a few traits in common does not make them the same...

Pigs and humans share a large amount of the same DNA, that does not make a pig a human....

 

[knucklehead 61]

question for the other rental property owners: what is the point of holding cash reserves?
personally, i haven't had cash reserves for the last 30 years.
all of my $ is invested & working for me at all times, either in the stock market, real estate, or antique motorcycles.
i have a couple home equity lines of credit (5% interest) that i can use if i need to replace a roof, or buy another house with, so i don't see the point of having cash which at the best looses value at the rate of inflation.

 

[calmloki]

We hold a fair amount of cash. Making a whole 1.3-1.5% now. The amount held goes up or down depending on the size & number of RE loans we have out. I don't trust a bank to honor a line of credit if things get sticky - per normal, I trust me a bunch, my gal a bunch, a few others - but if sh!t happens others will protect themselves first. Not casting aspersions on character, just human nature to take care of yourself first. RE pays us a goodly monthly income; we own without mortgages, except for a small one on our house that can be paid off any time. If we needed to come up with cash in a hurry selling the places wouldn't meet the hurry part. Selling stocks or bonds would probably work, unless it didn't. Plain old cash though? That oughta cover emergency or opportunity and no one can stop me from using it.

Our money isn't working as hard as it could, but it doesn't need to and gives a restful easy feeling.

 

[Luck_Club]

question for the other rental property owners: what is the point of holding cash reserves?
personally, i haven't had cash reserves for the last 30 years.
all of my $ is invested & working for me at all times, either in the stock market, real estate, or antique motorcycles.
i have a couple home equity lines of credit (5% interest) that i can use if i need to replace a roof, or buy another house with, so i don't see the point of having cash which at the best looses value at the rate of inflation.

I hold too much cash. One of the problems of having more coming in then going out every month.

In all seriousness, it is something I should spend more time on finding places to park cash. However, it isn't a static number, it is constantly going up and down every month, then suddenly you notice you have too much cash on hand.

Remember investing in real estate has a minimum investment of $25K+ usually. Not exactly ETF entry points is it?

In my brokerage accounts I hold very low cash reserves.

P.S. Did anyone hear 10 yr yields are rising overnight? How does that effect bond prices again?

 

[Joylush]

question for the other rental property owners: what is the point of holding cash reserves?
personally, i haven't had cash reserves for the last 30 years.
all of my $ is invested & working for me at all times, either in the stock market, real estate, or antique motorcycles.
i have a couple home equity lines of credit (5% interest) that i can use if i need to replace a roof, or buy another house with, so i don't see the point of having cash which at the best looses value at the rate of inflation.

Security, flexibility, emergencies. I don't want the hassle of dealing with banks/loans any more than necessary. Do I earn less that way? Yes, but the stress relief it provides is priceless.not to mention having ready cash is useful for taking advantage of unexpected opportunities that come along.

 

[pb4uski]

Isn't one of the reasons to invest in bonds so that you can sell the bonds if the stock market is down? And if you have a set allocation formula, doesn't that also mean selling?

It can, but rebalance impacts are slight... if one has a 60/40 AA and stocks go down 10% and bonds are steady then to rebalance you would only sell 6% of your bond portfolio... and besides, commonly, when stocks zig bonds zag and those bons gains help offset the stock losses. Also, if your're still working you can rebalance by changing new money purchases.

 

[Senator]

It can, but rebalance impacts are slight... if one has a 60/40 AA and stocks go down 10% and bonds are steady then to rebalance you would only sell 6% of your bond portfolio... and besides, commonly, when stocks zig bonds zag and those bond gains help offset the stock losses. Also, if your're still working you can rebalance by changing new money purchases.

So why do people buy bonds? And if an investment vehicle provides a similar function, why wouldn't it be a substitute? It is certainly not the same, but maybe just as good - or better. I have heard that if a pension and SS provides the majority of a households needs, the household can have a higher stock allocation. My real estate is safer than a pension.

It is not a bond, but it provides me similar features. And from what I see, it is likely safer. Especially if I am getting over ~12% return/$14K monthly on my original investment/equity. That 12% is extreme emerging market junk bond territory, yet very safe. If I would not have paid down my mortgages so much, it would be considerably higher.

From what I understand, my real estate provides me the same features as a bond. It has a stable income. The real estate values have a very low correlation to the stock market. The income very seldom gets cut. My gross rents will go up at least $6K this year, just under 2%. I could go even higher. Rents are up over $48K since Jan 2014 (as of Jan 2018).

Some people have stocks and bonds, and no real estate. That seems to be OK and considered a diversified portfolio. Some people have real estate and stocks, to me that is OK too. Some people have gold/silver, some do not. Some have international, some do not.

One thing for sure, with real estate, if you think you are going to blindly invest in it and come out ahead, you are taking a BIG risk.

 

[pb4uski]

So why do people buy bonds?....

See orange line on linked chart. Note green line.

VTSAX Vanguard Total Stock Market Index Fund Admiral Shares Fund VTSAX chart

 

[Another Reader]

This period is unique in that interest rates were falling as the stock market dropped. The flight to "safety" worked. In a rising interest rate environment, bond yields decline, and a stock market shock might have an entirely different effect on bonds, especially if rates increase dramatically and quickly at the same time.

VNQ is in my opinion irrelevant to a discussion of individually owned properties. REIT's act like stocks, not like individually owned properties. The index is comprised of all sorts of REIT's. The values of a lot of real estate asset classes declined in the downturn. Therefore the value of the stocks based on the value of the properties also declined.

Again, for most direct real estate investors, it's about income, not the value on any given day. The higher cash returns of properly purchased and efficiently managed real estate protect you from the worry of a forced decumulation paper portfolio.

 

[Texas Proud]

Some people have stocks and bonds, and no real estate. That seems to be OK and considered a diversified portfolio. Some people have real estate and stocks, to me that is OK too. Some people have gold/silver, some do not. Some have international, some do not.

One thing for sure, with real estate, if you think you are going to blindly invest in it and come out ahead, you are taking a BIG risk.

This is exactly what I have been saying... there is nothing wrong with having stocks and RE... nothing.... but it is NOT stocks and bonds....

And even in stocks and bonds there is a wide range of what people have... some have aggressive investments and some are conservative... so even if you say you are 70/30 stock/bond that does not tell the whole story...


Your last stmt is the big kicker IMO... If you blindly invest in RE and do not know what you are doing you can lose 100% (or even more) of you investment... if you buy bonds that is almost impossible to do (not talking one company bond).... just because you are successful in RE does not mean everybody will be.... but everybody who buys a particular bond fund will do the same no matter how smart or how dumb they are.... hence, safer for the avg investor...


I see you never responded to my pig analogy (just having a bit of fun, no harm intended)

 

[Texas Proud]

This period is unique in that interest rates were falling as the stock market dropped. The flight to "safety" worked. In a rising interest rate environment, bond yields decline, and a stock market shock might have an entirely different effect on bonds, especially if rates increase dramatically and quickly at the same time.

VNQ is in my opinion irrelevant to a discussion of individually owned properties. REIT's act like stocks, not like individually owned properties. The index is comprised of all sorts of REIT's. The values of a lot of real estate asset classes declined in the downturn. Therefore the value of the stocks based on the value of the properties also declined.

Again, for most direct real estate investors, it's about income, not the value on any given day. The higher cash returns of properly purchased and efficiently managed real estate protect you from the worry of a forced decumulation paper portfolio.

But it can be used for a proxy of RE prices.... and home prices all over the US dropped during the crisis, kinda like stock prices did....

But, if I did not sell my stocks and kept getting the same amount of dividends then is it all about income? Also, why keep talking about how the houses are worth so much more than what you paid for them? That sounds like it is similar to stock appreciation.... individual bonds do not 'appreciate' if they reach maturity.... you get back what you invested... so RE looks more like stocks than bonds in this case....