Can real estate substitute for bonds in asset allocation?

[Another Reader]

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....

What most retired people are worried about is meeting their living expenses, not their portfolio value, except to the extent the portfolio is converted to cash to pay those expenses. If you live off income, not decumulation, the relatively steady income from real estate mirrors the relatively steady income from bonds.

 

[Another Reader]

A more accurate way of looking at this is to say if you own a successful real estate investment "business," you can probably skip bonds as part of your overall asset allocation. You can live with the volatility of equities and reap the higher long term rewards because you have a solid base level income from the real estate. I believe that is what Senator does and it's what I do, although I have pensions and Social Security as well.

 

[Senator]

Great point.

That is exactly what I am trying to say. I also have social security at some point, and a pension whenever I am wanting to take it.

Real estate is definitely not a bond, but it does provide some of the same features. Assuming you are Savvy enough to acquire it and get a solid return out of it.

And as a bonus, you also get many of the same advantages of owning a business.

 

[Texas Proud]

What most retired people are worried about is meeting their living expenses, not their portfolio value, except to the extent the portfolio is converted to cash to pay those expenses. If you live off income, not decumulation, the relatively steady income from real estate mirrors the relatively steady income from bonds.

But that means you have saved more than you need to retire....

I could have a big enough portfolio where the income distributions more than covered all of my expenses.... I would not have to worry about the portfolio value, just like you say about RE.... but that is not efficient IMO...


And don't get me wrong, bonds have some huge risks.... one is that the income is not as steady over the long term.... IOW, my dad invested in CDs earning 15% back when I was young.... there was no way to invest that money when it matured to get close to that same income level... that is interest rate risk... but it is known as a risk with bonds...

RE has its own risks.... you seem to minimize them.... I do not.... I look at them and say that it is not for me.... I just do not want to deal with all the issues RE presents even if the return is 'great'....


SOOO, is owning RE a substitute for owning bonds? No... is RE income a substitute for bond income.... maybe so... then again I could say that EBay income is a substitute for bond income also.... but then you are back to doing work (which BTW I put managing RE into that bucket)...

 

[Another Reader]

"But that means you have saved more than you need to retire...."


Yes, my net worth without my house is more than I need to retire using a 4 percent SWR. However, I accumulated the necessary income much faster than most people accumulate the paper asset portfolio to decumulate using the four percent SWR. Buying smart, using leverage where it made sense, and managing the portfolio efficiently made that possible. And that includes making a number of good-sized mistakes along the way.

 

[pb4uski]

My bonds never call me in the middle of the night to let me know about a broken pipe that is making a mess and needs to be addressed immediately. I never have to chase down my bonds to get my monthly interest payment. I've never had an interest payment returned for non-sufficient funds. I never have a gap in my income because my bonds have moved and left the place a mess that I have to clean up before the next tenant.

You get the drift... there are a lot of plusses and minuses to real estate but it is w*rk.

 

[Another Reader]

My bonds never call me in the middle of the night to let me know about a broken pipe that is making a mess and needs to be addressed immediately. I never have to chase down my bonds to get my monthly interest payment. I've never had an interest payment returned for non-sufficient funds. I never have a gap in my income because my bonds have moved and left the place a mess that I have to clean up before the next tenant.

You get the drift... there are a lot of plusses and minuses to real estate but it is w*rk.

And that's why the return is higher. Add in the tax benefits, and you can get to FIRE a lot faster with real estate than you can with most paper asset portfolios.

 

[Texas Proud]

And that's why the return is higher. Add in the tax benefits, and you can get to FIRE a lot faster with real estate than you can with most paper asset portfolios.

All great points.... but those are statements in favor of RE not being a bond... you are making my point for me...

 

[Another Reader]

The question was not if real estate is a bond, but if real estate could be substituted for bonds. In many cases, mine included, it can be.

 

[Senator]

My bonds never call me in the middle of the night to let me know about a broken pipe that is making a mess and needs to be addressed immediately. I never have to chase down my bonds to get my monthly interest payment. I've never had an interest payment returned for non-sufficient funds. I never have a gap in my income because my bonds have moved and left the place a mess that I have to clean up before the next tenant.

You get the drift... there are a lot of plusses and minuses to real estate but it is w*rk.

There are plenty of RE investments that do not require hands on work. Even with my rentals, I just signed a contract with a property maintenance service to be able to handle any calls that I cannot handle while I snowbird.

The company would even manage them 100% if I wanted. In my case, I probably save $40K+ by doing my own work and management. As long as I am around the properties, I may as well do the maintenance.

 

[pb4uski]

You still have to manage the manager.... and wonder if or how he is screwing you.... lessens the hassle but still more than bonds.

 

[Another Reader]

You still have to manage the manager.... and wonder if or how he is screwing you.... lessens the hassle but still more than bonds.

The question was can real estate be substituted for bonds in your asset allocation. The answer is that it can in some cases.

The only bonds I own are in Wellington and some I-bonds. My father would never buy any bond except for treasuries. He believed the risk was mispriced and I tend to agree.

I think a lot of people have some recency bias with bonds, based on how they performed in 2008-2012. They look at that "orange line" you cited and think bonds are a safe hedge against stock market downturns. Let's see what attitudes are about bonds when interest rates take a steep jump and bond values drop dramatically in a short period of time.

 

[Texas Proud]

OH... one other thing... RE has tax advantages that are of no value to me anymore....

IOW, I pay zero income tax.... taking depreciation (required) would only mean I would have to pay recapture tax when sold... I do not have that problem with a bond..

BTW, DW has a rental that she owns.... her mother takes care of all the stuff and gets a good fee from it (we do not have to send money as this is a substitute, so that is good)... when I was working it was good as it cash flowed and we got to save on taxes.... the only thing now on taxes is it helps me get a bit more on ACA credits...

 

[Texas Proud]

The question was not if real estate is a bond, but if real estate could be substituted for bonds. In many cases, mine included, it can be.

That is being very specific... in general (the vast majority of people) it is not a bond substitute... so if it is not generally viewed as a bond substitute I will take that as the answer...

As an example.... would you recommend someone who is 70 and invested 50/50 to take all of their bond money and go buy RE? Even if they hired a manager to take care of all of the problems and all they got was a check? If you did I think you could be sued for that advice....

If you want to put it in as one that is fine.... but I still say square peg, round hole...

 

[Another Reader]

Those tax advantages are worth a lot to a committed investor. I write off six figures in depreciation every year. The heirs will get a step up in basis, so no capital gain, and that depreciation will never be recaptured. The benefits are generational in nature.

 

[hesperus]

Let's see what attitudes are about bonds when interest rates take a steep jump and bond values drop dramatically in a short period of time.

With an individual bond ladder holding to maturity, no change in my attitude toward bonds.
I'll simply put that principal into another set of bonds at the higher rates. Rinse and repeat.

 

[pb4uski]

....let's see what attitudes are about bonds [-]when[/-]if interest rates take a steep jump and bond values drop dramatically in a short period of time.

Fixed it for ya.

I would not matter to me.... just a paper loss and I just hold to maturity. No problem.

 

[Another Reader]

Fixed it for ya.

It's only a matter of time...

 

[pb4uski]

Those tax advantages are worth a lot to a committed investor. I write off six figures in depreciation every year. The heirs will get a step up in basis, so no capital gain, and that depreciation will never be recaptured. The benefits are generational in nature.

All true... as long as you never want or need your "principal" back.... to do what you describe locks up your capital for a long time... gets back to the liquidity advantage of bonds.

Will someone please start a "pay of the mortgage?" or "when should I claim SS?" thread?

 

[Senator]

That is being very specific... in general (the vast majority of people) it is not a bond substitute... so if it is not generally viewed as a bond substitute I will take that as the answer...

As an example.... would you recommend someone who is 70 and invested 50/50 to take all of their bond money and go buy RE? Even if they hired a manager to take care of all of the problems and all they got was a check? If you did I think you could be sued for that advice....

If you want to put it in as one that is fine.... but I still say square peg, round hole...

I would not recommend buying RE to anyone already retired. BUT, if the 70 year old was already invested in RE via a landlord or similar, I may advise against bonds.

 

[Another Reader]

All true... as long as you never want or need your "principal" back.... to do what you describe locks up your capital for a long time... gets back to the liquidity advantage of bonds.

Will someone please start a "pay of the mortgage?" or "when should I claim SS?" thread?

If I sold to get my principal back, I would pay selling expenses and taxes and reap the remaining appreciation. In the meantime, I pay very little in taxes and get the income stream. It's a tradeoff I am willing to accept, because I have other investments and income sources. I don't need the liquidity.

ETA: The real estate pays me far more than an annuity would, is somewhat inflation protected, and doesn't die with me like an annuity would. Sounds good to me!

 

[Luck_Club]

If I sold to get my principal back, I would pay selling expenses and taxes and reap the remaining appreciation. In the meantime, I pay very little in taxes and get the income stream. It's a tradeoff I am willing to accept, because I have other investments and income sources. I don't need the liquidity.

ETA: The real estate pays me far more than an annuity would, is somewhat inflation protected, and doesn't die with me like an annuity would. Sounds good to me!

+1 DO the . I think the first 20% of our retirement rental income just became tax free! Not as good as MUNI's though.

https://www.watsoncpagroup.com/SubS.pdf

 

[ILikeStarTrek]

This is the OP checking in again. This continues to be a very interesting discussion.

Throughout this topic, several posts just say, "real estate is not a bond". I'll quote a couple of these posts below (by no means the only posts saying this throughout the topic). However, I don't think that exactly answers my OP, which was phrased as a question about my Asset Allocation. To expand on this as I reply to some of these quotes...

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.

Figuring out what my AA needs to be is exactly what I'm trying to do. But one way to get there is to compare my current AA to what I perceive is the generally recommended one. Then I ask questions like, why is the recommended one recommended? Do I need to change from mine to the recommended one? These questions tend to lead to the comparisons of asset classes.

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...

In fairness to this quote, I believe it was in response to other specific replies in this topic. Some of these replies are extremely analytical in discussing the detailed characteristics of RE vs stocks vs bonds. But in doing all that analysis, I hope that the folks replying do not miss the point of my original question. To get back to what I said in my OP: I have been trying to get my head around AA as I will transition soon into retirement. There seems to be a widely recommended 60/35/5 split among monetary/liquid type assets. In my OP, I basically asked the question, do I need to move some of my assets into bond assets to match this recommended split? Or not?

My thinking is, I'm leaning towards "or not". I don't think I would want to keep a 90% stock portfolio in retirement if I didn't have any RE. But with RE in the mix, some of the reasons people own bonds (e.g. diversification from stocks and reliable income in a down stock market), are some of the same things I perceive RE giving me. It doesn't mean RE has all the exact same characteristics as bonds or that RE is a bond. But maybe RE has *enough* similar characteristics that it limits the risk I would otherwise have of keeping 90-95% stock portfolio in the monetary/liquid part of my portfolio.

The question was not if real estate is a bond, but if real estate could be substituted for bonds. In many cases, mine included, it can be.

That is being very specific... in general (the vast majority of people) it is not a bond substitute... so if it is not generally viewed as a bond substitute I will take that as the answer...

As an example.... would you recommend someone who is 70 and invested 50/50 to take all of their bond money and go buy RE? Even if they hired a manager to take care of all of the problems and all they got was a check? If you did I think you could be sued for that advice....

If you want to put it in as one that is fine.... but I still say square peg, round hole...

I think "Another Reader" came closer to the meaning of "substitute" I intended in my OP. I posed the question about my own AA, not someone else's. I wasn't suggesting for someone who is 70 and holds no RE to go out and buy some, but rather I was asking if I, who already hold more than 50% of my retirement assets in RE, need to sell either some of my RE or some of my stocks and buy bonds in order to fit the classically recommended 60/35/5 monetary asset split.

If the answer is, "Live with the fact that it fits your needs and be done with it" (as Texas Proud posted previously) - i.e. I do *not* need to transform my AA in order to hold a lot of bonds - then, that means that RE is in some sense a "substitute" for bonds, at least in my own portfolio (which is the portfolio I was asking about in my OP).

 

[traineeinvestor]

If I had to choose* between real estate or bonds, over the longer term, I would take real estate every time as the potential rewards outweigh the risks if you buy in the right market at the right time.

* of course, in the real world, it's not an either-or question - no reason no to hold a few short term bonds as a source of near term liquidity

 

[Texas Proud]

This is the OP checking in again. This continues to be a very interesting discussion.

Throughout this topic, several posts just say, "real estate is not a bond". I'll quote a couple of these posts below (by no means the only posts saying this throughout the topic). However, I don't think that exactly answers my OP, which was phrased as a question about my Asset Allocation. To expand on this as I reply to some of these quotes...



Figuring out what my AA needs to be is exactly what I'm trying to do. But one way to get there is to compare my current AA to what I perceive is the generally recommended one. Then I ask questions like, why is the recommended one recommended? Do I need to change from mine to the recommended one? These questions tend to lead to the comparisons of asset classes.



In fairness to this quote, I believe it was in response to other specific replies in this topic. Some of these replies are extremely analytical in discussing the detailed characteristics of RE vs stocks vs bonds. But in doing all that analysis, I hope that the folks replying do not miss the point of my original question. To get back to what I said in my OP: I have been trying to get my head around AA as I will transition soon into retirement. There seems to be a widely recommended 60/35/5 split among monetary/liquid type assets. In my OP, I basically asked the question, do I need to move some of my assets into bond assets to match this recommended split? Or not?

My thinking is, I'm leaning towards "or not". I don't think I would want to keep a 90% stock portfolio in retirement if I didn't have any RE. But with RE in the mix, some of the reasons people own bonds (e.g. diversification from stocks and reliable income in a down stock market), are some of the same things I perceive RE giving me. It doesn't mean RE has all the exact same characteristics as bonds or that RE is a bond. But maybe RE has *enough* similar characteristics that it limits the risk I would otherwise have of keeping 90-95% stock portfolio in the monetary/liquid part of my portfolio.



I think "Another Reader" came closer to the meaning of "substitute" I intended in my OP. I posed the question about my own AA, not someone else's. I wasn't suggesting for someone who is 70 and holds no RE to go out and buy some, but rather I was asking if I, who already hold more than 50% of my retirement assets in RE, need to sell either some of my RE or some of my stocks and buy bonds in order to fit the classically recommended 60/35/5 monetary asset split.

If the answer is, "Live with the fact that it fits your needs and be done with it" (as Texas Proud posted previously) - i.e. I do *not* need to transform my AA in order to hold a lot of bonds - then, that means that RE is in some sense a "substitute" for bonds, at least in my own portfolio (which is the portfolio I was asking about in my OP).

Why are you trying to fit your situation in what is 'widely recommended' Choose what allocation you want with the 5 classes of assets that I posted awhile back... that includes commodities and gold... some people have a good amount of gold but don't try to

And in each class there are many sub-classes that you also have to decide on...

But I will go with you last line... sure, you are substituting RE for bonds... IOW, if you think 35% bonds are correct and you instead have 35% RE, then you substituted RE for bonds... but RE does not ACT like bonds and it does not offer the same benefits as bonds... and your OP asked if RE was a substitute for bonds, not can I substitute RE for bonds... two very different questions even though they sound exactly the same... I have not see a study on how the portfolio performs on up and down markets, but some here that have a good amount of RE seem to say it performs very well... it would be better to see an actual study with this.....

Now, if you already own the RE and are doing well with it, I would not advise you to get rid of it... it can do much better than a bond in appreciation and as an inflation hedge...


Here are some articles I found when I was quickly looking for a study... have not found one though...


https://www.huffingtonpost.com/ryan-poelman/the-inflation-wildcard-in_b_7835004.html

https://www.sharestates.com/blog/the-ultimate-investment-comparison-stocks-vs-bonds-vs-real-estate

RE vs stocks...
https://www.financialsamurai.com/which-is-a-better-investment-real-estate-or-stocks/


https://www.equitymultiple.com/blog/learning-series/real-estate-vs-other-asset-classes/