Can real estate substitute for bonds in asset allocation?

[bingybear]

short answer, no
real estate is not a proxy for bonds. It is another asset altogether. That does not mean that it is not a good asset to hold.

I would suggest figuring what you want your asset allocation needs to be and not try to make assets fit match other categories.

 

[Doc0]

In the 2008 debacle the fed bought long term debt and issued short term debt. It was expected short term rates would go up but that didn't happen. That tells me we narrowly missed deflation IMHO. What would happen to your real estate cash flow including mortgages in deflation? Bonds esp LT bonds are deflation protection. They also reduce volatility in the overall portfolio through diversity.

See Harry Browne permanent portfolio

https://seekingalpha.com/article/3206326-kiss-retirement-portfolio-harry-brownes-permanent-portfolio

 

[pb4uski]

i have a lot of rental properties that are 76% of my nw.
i only have 7 mortgages now, it will be a couple more years until the next smallest one is paid off which will increase our cashflow nearly 8k / yr.
i am raising rents on 10 of them over the next few months which will give me almost 8k more cashflow next year to blow on my antique motorcycle addiction.
if our local economy tanks & housing values go down...who cares? i don't plan to sell, but will certainly buy more foreclosures. besides, when homeowners loose their houses to the banks i can buy them for a discount & rent them back to people that will always need a place to live.
rental real estate is paying for my living expenses as well as allowing me to "blow" (read: invest) at least 50-75k / year on "toys" (read: antique harley-davidsons).
while my 75% stock portfolio at vanguard is sharply up over the last couple years, my
25% bond portfolio at vanguard is basically as flat as keira knightley's chest.
on the other hand, my real estate has pretty much doubled over the last 4 years while also providing a seven figure gross cashflow....and fantastic tax deductions to boot!

Boy, you're really drinking the koolaid. Doubled in the last 4 years, huh? Values increased on average a little less than 50%/year for 4 consecutive years? Maybe in your mind but until you sell its only speculation.

And while a downturn may be a buying opportunity, if it is really severe then people just give up and move away and you have properties sitting there empty generating no or low income.... it happens... Detriot and Atlantic City come to mind. If you have a broad, geographically diversified portfolio of properties you can weather the storm... just like if you own individual stocks you can absorb some losers... but few property portfolios are sufficiently diversified to weather such an event.... luckily they are rare.

 

[Joylush]

Boy, you're really drinking the koolaid. Doubled in the last 4 years, huh? values increased on average a little less than 50%/year for 4 consecutive years? Maybe in your mind but until you sell its only speculation.

And while a downturn may be a buying opportunity, if it is really severe then people just give up and move away and you have properties sitting there empty generating no or low income.... it happens... Detriot and Atlantic City come to mind. If you have a broad, geographically diversified portfolio of properties you can weather the storm... just like if you own individual stocks you can absorb some losers... but few property portfolios are sufficiently diversified to weather such an event.... luckily they are rare.

I wouldn't be so quick to doubt. I'm in the same boat he's in. And exactly what he said about his portfolio I could completely relate to. Most of my portfolio is in real estate which completely funds my living expenses and then some. My stocks have done well but anything bond related is flat at best.
And I believe what he said about his increase in values. I have a house now purchased in June of 2014 for $95,000. I have it listed for sale and expect to get $215,000 for it.
Have one I picked up in 2008 for $108,000. If I sold today it would fetch $275,000 on a bad day. Another buy in 2011 for $115,000, today's value $225,000. Another 2011 purchase for $115,000 now worth $260,000. A 2009 purchase for $74,000 worth $150,000. A 2012 purchase for $87,500 worth $200,000. A 2010 purchase for $54,000 worth $120,000. Another 2011 purchase for $75,000 worth $160,000. A 2009 purchase for $95,000 worth $185,000. I even had two purchases in 2015 that have increased in value, one bought for $80,000 and now worth $140,000, another bought at $60,000 now worth $125,000. That's just a sample.

Real estate when bought right can reap a lot of benefits. Sure, I had to make repairs and improvements but the rent I've collected from them during ownership has more than covered those.
I even bought one as recently as a year ago. Paid $110,000. Did spend $25,000 in upgrades/repairs but it's rented for $1200 a month and I could sell it now for $165,000 easily in this market.

 

[pb4uski]

Let us know once you have sold.... until then it is wishful thinking.

 

[Another Reader]

Boy, you're really drinking the koolaid. Doubled in the last 4 years, huh? values increased on average a little less than 50%/year for 4 consecutive years? Maybe in your mind but until you sell its only speculation.

And while a downturn may be a buying opportunity, if it is really severe then people just give up and move away and you have properties sitting there empty generating no or low income.... it happens... Detriot and Atlantic City come to mind. If you have a broad, geographically diversified portfolio of properties you can weather the storm... just like if you own individual stocks you can absorb some losers... but few property portfolios are sufficiently diversified to weather such an event.... luckily they are rare.

I would never own rentals in Detroit, Atlantic City, or any other place with a depressed economy and an overreaching government. I own in growing markets with strong economies. If things start to change, I will sell and go where the money is.

Owning a "broad, geographically diversified portfolio of properties" is unnecessary and will actually depress your returns. In the Bay Area, every downturn since WWII has been a buying opportunity. Detroit has been visibly decaying since the 1960's. I like to think I'm perceptive enough to know the difference between the two markets, even 50 years ago.

The future is in cities with strong economies, good jobs, and and limited real estate close to those high paying jobs. Buy when the market is depressed, leverage responsibly, and your returns will likely exceed the paper asset markets substantially.

Speculation? People have to live somewhere and those with the high paying jobs will pay up to live close to those jobs, good schools, and other amenities. I bought properties in 2009-2012 that have tripled in value. They were depressed in price at that time. Buying at that time was no less "speculative" than any other time. The same thing can be said about the paper asset markets - it's only speculation until you sell.

In the end, it's how much income you can generate, not your net worth. If you decumulate paper assets for income, you are always looking over your shoulder to see what Mr. Market is up to. I would rather own a mix of real and paper assets that produce a fairly steady stream of income and worry less. That's true diversification.

 

[Joylush]

Let us know once you have sold.... until then it is wishful thinking.

Which technically is true with any asset that you own.

 

[pb4uski]

Perceptive glimpse of the obvious.

But... the values of widely traded stocks and bonds are very close to their published market values... whereas actual sales values for real estate quite frequently vary widely and are much more in the eye of the beholder.

 

[Joylush]

Perceptive glimpse of the obvious.

But... the values of widely traded stocks and bonds are very close to their published market values... whereas actual sales values for real estate quite frequently vary widely and are much more in the eye of the beholder.

I guess we'll just have to disagree. My real estate holdings aren't as volitile on a dail basis as my stock holdings. And even with fluctuations they continue to produce income. During the economic downturn there were stocks that took tremendous hits. Some lost 100% of their value (I know, ask my ex). Yet I still had my income producing houses. And still have them while the money invested in those stocks is gone forever. I have never lost money on a house, even on a few bought during the housing peak. Can't say the same about stocks. Stocks are a bigger gamble. I've found real estate to be a less riskier option. More work, but less risk. Of course this will vary depending on your market/location.

 

[pb4uski]

I suspect that we're talking about two different things.

I'm taking about the difference between bid and asked prices and saying that the difference is typically very wide for real estate and very narrow for widely traded securities. IOW, if a securities investor and a property investor each have portfolios that they believe is worth $1 million that the securities investor is more likely to be closer to $1 million after sale than the property investor.

I concede that the value of securities is more volatile, but as a long-term investor daily movements don't bother me much. While an individual stock might in rare instances might become worthless, it can't happen to a portfolio of stocks... that is why we invest in many tickers... to mitigate diversification risk.

Don't get me wrong... I'm not anti-real estate... I fact, I manage a very lucrative single-tenant commercial property for my mother... while the returns are great there are other risks that I would not want to assume, even for those returns. My dad was significantly invested in residental rental properties for years but ultimately decided that the return was not worth the hassles and sold them.

No matter how you spin it though it is not a bond substitute... just another asset class pari passu with stocks but with different risk/reward characteristics.

 

[harley]

Let us know once you have sold.... until then it is wishful thinking.

Have you ever looked into what it takes to sell a rental, with all the depreciation recapture and all that? My exit plan involves death and a stepped up basis for my DD.

 

[pb4uski]

Good point... a definite disadvantage. I was referring to posts saying my property is worth this or that and that property owners commonly have a wishful thinking view of what their properties are worth and that one doesn't really know until you have sold.

 

[Bruceski44]

It seems you're all talking about cap gains here, when the real question is more about reliable income.

My portfolio includes many professionally managed, triple-net, commercial properties diversified across sector and region, with long-term, investment-grade leases and long-term financing in place, which all provide reliable monthly income. I don't see how any real estate could be more secure than this and yet, I say only that they are "almost like bonds." It's a different asset class with different risks and rewards, but I find my portfolio to be a good bond-substitute with built-in inflation protection.

 

[Joylush]

I suspect that we're talking about two different things.

I'm taking about the difference between bid and asked prices and saying that the difference is typically very wide for real estate and very narrow for widely traded securities. IOW, if a securities investor and a property investor each have portfolios that they believe is worth $1 million that the securities investor is more likely to be closer to $1 million after sale than the property investor.

I concede that the value of securities is more volatile, but as a long-term investor daily movements don't bother me much. While an individual stock might in rare instances might become worthless, it can't happen to a portfolio of stocks... that is why we invest in many tickers... to mitigate diversification risk.

Don't get me wrong... I'm not anti-real estate... I fact, I manage a very lucrative single-tenant commercial property for my mother... while the returns are great there are other risks that I would not want to assume, even for those returns. My dad was significantly invested in residental rental properties for years but ultimately decided that the return was not worth the hassles and sold them.

No matter how you spin it though it is not a bond substitute... just another asset class pari passu with stocks but with different risk/reward characteristics.

I suspect we probably don't disagree as much as it seems. Of course a real estate investor would understand their are costs of selling. Where I disagreed is it doesn't mean, as you said, someone is drinking kook-aide, when they say their real estate investment has doubled in value in four years. I assume they meant give or take a few percentage points. Typical selling costs in my area are 8%. So if you bought a house three years ago (a personal example) for $95,000, put $10,000 into it, netted $20,000 while owning it, listed it for market value at $215,000 and ultimately sold it for $205,000, after paying for the costs of the sale you net about $190,000. So it cost you $110,000 but you earned $90,000 from your $110,000 investment in three years. Yes, this is before taxes but not an outrageous scenario.

Is it more work then investing in stocks? Yes. Riskier? Not necessarily. Just different. A substitute for bonds? I don't see a strong need for bonds if you have a well performing real estate portfolio, diversified stock portfolio and ample cash reserves. Although I would look to add to a bond portfolio with proceeds from a real estate sale to maintain diversification.

 

[pb4uski]

Actually, I found a error in my math... for something to double in 4 years it would be ~20% compounded... not 50%. Nonetheless, while it seems possible that there might be some selected opportunities out there to double in 4 years it is hard to believe there are oodles of them.... perhaps you guys are just outstanding anomalies.

 

[Another Reader]

Actually, I found a error in my math... for something to double in 4 years it would be ~20% compounded... not 50%. Nonetheless, while it seems possible that there might be some selected opportunities out there to double in 4 years it is hard to believe there are oodles of them.... perhaps you guys are just outstanding anomalies.

The real estate crash of 2008-2012 provided many such opportunities. The banks could not control the short sales and foreclosures, so the liquidation was not really orderly. Very few buyers stepped up until later in the cycle. I bought my last property in early 2012, as the cycle started to turn.

In 1991-92, the RTC was liquidating commercial properties all over the country. A bay area investor went down to Phoenix and picked up a boatload of half vacant shopping centers for $22-$35 per square foot in the period from then through 1994-95. That family company is now probably worth $100MM. You could buy small strip centers in secondary locations in Fremont and Milpitas then that were 40 to 60 percent vacant on 12-15 percent cap rates on the existing income - no value for the vacant space. Today they would sell on low single digit cap rates, including imputed rent for vacant space.

The real estate markets are dependent on a lot of factors outside the markets and are not efficient. You can have superior knowledge and a bit of skill and put it to good use in these inefficient markets.

 

[Texas Proud]

I know that a portfolio of residential is not like a REIT, but I thought I would compare Vanguards REIT with its total bond.... for some reason I cannot copy it, so here is a link... hope it works...

As you can see, the REIT is much more volatile than the bond... why? Because the asset value dropped... most people here talk income stream, but I look at total return... so if I invest in RE and the value goes down but I still get the same income I have lost money....


As to the people who talk about buying cheap... well, there were a good number of people who were renting those houses and lost them.... I could say 'if I bought at the bottom of the market in 2009 I would make out like a bandit'.... but that is pure 20-20 hindsight... people were buying RE to rent in 2007 prior to it crashing... and lost everything they invested... maybe YOU didn't, but that does not mean there were not a lot of people who did... people who had a balanced portfolio lost value, but the bonds provided a cushion for them... the lost value, but not everything...


edit to delete link that did not work... see pb4uki's post who fixed it for me... thanks...

 

[pb4uski]

link didn't work for me but perhaps this one will.

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

 

[pb4uski]

The real estate crash of 2008-2012 provided many such opportunities. .... In 1991-92, the RTC was liquidating commercial properties all over the country. ....

The real estate markets are dependent on a lot of factors outside the markets and are not efficient. You can have superior knowledge and a bit of skill and put it to good use in these inefficient markets.

No doubt that occasionally there are market dislocations that depress real estate prices and create opportunities for some... bonds are often inverse... during market dislocations they go up rather than down.... ergo... not a bond.

 

[Joylush]

It seems you're all talking about cap gains here, when the real question is more about reliable income.

My portfolio includes many professionally managed, triple-net, commercial properties diversified across sector and region, with long-term, investment-grade leases and long-term financing in place, which all provide reliable monthly income. I don't see how any real estate could be more secure than this and yet, I say only that they are "almost like bonds." It's a different asset class with different risks and rewards, but I find my portfolio to be a good bond-substitute with built-in inflation protection.

I look at each property as somewhat of a hands on personal annuity.

 

[Another Reader]

I look at each property as somewhat of a hands on personal annuity.

I consider the rental portfolio as a whole to have some characteristics of an annuity. The income is somewhat variable, but because of the number of properties, it can generally be relied on to produce a minimum income over the year. By having reserves, the income can be smoothed if necessary over the year.

 

[Doc0]

I consider the rental portfolio as a whole to have some characteristics of an annuity. The income is somewhat variable, but because of the number of properties, it can generally be relied on to produce a minimum income over the year. By having reserves, the income can be smoothed if necessary over the year.

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

 

[Another Reader]

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

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.

 

[Doc0]

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.

The bonds are in government debt you

 

[Another Reader]

Treasury notes and money market. If the Treasury quits paying, it's time for the preppers to say "I told you so."