The big story for 2019 will be …

Bitcoin, gold, oil, stocks, real estate, and popcorn …

Intoxicating investments can be toxic …

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Lessons from Puerto Rico for real estate investors …

“Those who do not remember the past are condemned to repeat it.”

   – George Santayana

This is one of our favorite quotes.  It’s simple yet powerful wisdom … useful for individuals, businesses, governments … and certainly for investors!

We could take this theme in a thousand different directions, but this CNBC headline caught our attention this week …

Here’s how an obscure tax change sank Puerto Rico’s economy

With tax reform in today’s financial headlines … and our memories of what happened to real estate after the 1986 tax reform …

… we think it’s a good time to consider the impact of tax policy on the economy, jobs, and real estate.

As for Puerto Rico … it’s a huge mess after Hurricane Maria.  Lots of infrastructure and real estate have been destroyed.

Of course, the financial mess in Puerto Rico was in the news long before Maria showed up.  The natural disaster just made the financial disaster a whole lot worse.

Let’s dig in and look for lessons for real estate investors …

The CNBC article points out, “Even before a devastating hurricane … the government was struggling with an economy in shambles …”

And, “That fiscal mess has its roots in the repeal of a controversial corporate tax break that helped spark an exodus from the island that sent its economy into reverse.”

Yikes.  Will people and businesses really move just because of some “tiny” tax law?

Yes.  Yes, they will.  It turns out taxes (and avoiding them) are kind of a big deal to people and businesses.

In this case, a tax break, “enacted in 1976, allowed U.S. manufacturing companies to avoid corporate income taxes on profits made in U.S. territories, including Puerto Rico. Manufacturers … flocked to the island.”

This lead to an economic and employment boom in Puerto Rico.

Of course, when politicians see money they just can’t help themselves.  The Puerto Rican politicians started spending, and borrowing to spend even more.

Meanwhile, back in the U.S., the CNBC article says …

“But by the early 1990s, the provision faced growing opposition from critics who attacked the tax break as a form of corporate welfare.”

So in 1996, a ten-year phasing out of the tax break began and “plant closures and job losses followed.”

Which bring us to tax policy and real estate investors …

The law had nothing to do with real estate or investors … but then again, it had EVERYTHING to do with real estate investing …

… because real estate investments are highly dependent on JOBS.

And whether you think it’s fair or not, corporations make decisions about where to do business (or not) based partially on tax policy.

In this case, tax breaks attracted corporations to set up shop and were good for jobs and real estate.  The removal of those breaks had the opposite effect.

Of course, the law in question was passed and repealed at the federal level.  It wasn’t under Puerto Rico’s control.

But Puerto Rico got the lesson.

So in 2012, Puerto Rico passed Act 20 and 22 … effectively becoming an attractive tax haven for both businesses and individuals.

We first heard about this from Summit at Sea™ faculty member Peter Schiff … who moved his asset management company and himself to Puerto Rico to save taxes.

He’s not the only one.  We have several other friends who’ve done the same thing.

Right now, the tax law still exists … though much of Puerto Rico doesn’t.

We think there’s probably a way to combine those two circumstances to create an opportunity for real estate investors.

Of course, back in the U.S., tax reform is in the air again …and corporate tax breaks are in the mix.

Will corporate tax breaks bring businesses to the U.S. and create an employment boom? If so, where?  And will the breaks be permanent or temporary?

It’s too soon to tell, but it’s something we’ll be watching closely.

Meanwhile, there’s another lesson from the Puerto Rico story …

We know a tax break brought in a tide of corporate investment, and the removal of the tax break decades later took the tide back out.

But there was a lot of opportunity in between.

Of course, to catch a wave, you need to be watching the horizon.  And when you see the wave forming, you need to paddle quickly into position.

In Puerto Rico, as in Florida, Houston, and the several Caribbean islands all decimated in varying degrees by the back to back hurricanes …

… there’s going to be a big tide of capital flowing in to repair everything.

And because of the scope of the problems, the season of rebuilding could last quite a while.

Recently, we talked with our boots-on-the-ground turnkey property provider in Orlando, and he says he sees a lot of opportunity in his market right now …

Problem properties are popping up with pricing that leaves some meat on the bone for investors.

That’s good news … not just for investors, but for the community at large … because investment capital is needed to help with the recovery process.

The same is true in Houston, Puerto Rico and other areas ravaged by the storms.

Of course, conditions in each market are different.  Orlando is in far better shape than Houston which is far better shape than Puerto Rico.

All that to say there are different levels of distress, bargains, risk and reward in each market.

Unfortunately for the average individual part-time investor, the gap between seeing opportunity and being able to take advantage can be too big to bridge.

For most U.S. citizens, their “investment” into these disaster zones will be a de facto donation through their taxes, as federal relief funds pour into each area.

Of course, many kind-hearted individuals will make modest personal donations, which is admirable.

But to get LARGE amounts of private capital into each area to help rebuild, it’s going to take an investment opportunity.

And we think private syndicators have a role to play.

Motivated real estate entrepreneurs with skills and availability have an opportunity to start a private investment fund to aggegate private capital and make profitable investments in each of these areas.

Busy qualified investors who don’t have the time or skills, but see the opportunity, can make an investment in these private funds and earn a profit while helping heal ravaged markets.

This is the kind of capitalism that makes a positive difference in the world …  people helping themselves by helping others.

Or as our good friend Gene Guarino often says, “Do well, by doing good.”

Until next time … good investing!

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Tech, stocks, and real estate riches …

Imagine you’re the proud owner of a modest 50-year old, four-bedroom, two-bath home … less than 2,000 square feet.

You put it on the market and it sells FAST … for $728,000 MORE than the asking price!!!

That’s not the sales price … just the premium OVER what you listed it for!

You might think this happened in that mythical marketplace … Fantasyland … but according this report, it just happened in Sunnyvale, California.

This average home was listed at $1,688,000 … which is RIDICULOUS in and of itself … but the actual sales price was a WHOPPING $2,470,000!!!

WOW.  Equity happened BIG TIME for that lucky owner!

But HOW?  And more importantly, what does it mean … and is there a way to get in on the action?

Let’s break it down …

First, equity is always about the right mix of supply, demand, and capacity to pay.

When there’s too little of something that lots of people can afford to pay more for … prices get bid UP.

In this case, the San Francisco Bay Area has next-to-no capacity to increase the supply of homes.

There’s an ocean, a bay, mountains, a green belt … and most of the available land has already been developed … or can’t be.Next, there’s a robust tech industry, great weather, and other attractions bringing an influx of immigrants from around the country and around the world.

Next, there’s a robust tech industry, great weather, and other attractions bringing an influx of immigrants from around the country and around the world.

So there’s lots of demand for housing relative to supply.But … $2.4 million for a run-of-the-mill house in an average neighborhood … bid up to $728,000 over asking price???

But … $2.4 million for a run-of-the-mill house in an average neighborhood … bid up to $728,000 over asking price???

That’s ALL about “capacity to pay” … and not from cheap mortgages.

No home lender is going to finance a mortgage on a home for $728,000 above asking price … no matter HOW great your credit score is.

So this huge overbid didn’t happen because some high-tech earner levered a fat paycheck into a fatter mortgage payment into an obese mortgage.

Without knowing the details of the transaction, we think it’s a safe bet this was a CASH purchase.  But that doesn’t mean cheap debt wasn’t involved.

Here’s how the Fed, tech, the stock market, and real estate all intersect …

It’s no secret the stock market has been on an epic bull run for quite some time.  It’s a bubble that just keeps inflating.

Inside the stock bubble are the FAANGs …  Facebook, Amazon, Apple, Netflix, Google … the tech sector.

These have been the horses pulling the stock market higher and higher.

Another part of the story is the long-term crazy low interest rates provided by the Fed.

Big corporations (like the FAANGS) then borrow cheap money to buy back their stocks … pushing up stock prices (and executive bonuses).

Of course, if you’re a compulsive-obsessive financial news watcher like we are, we’re not telling you anything you don’t already know … but stick with us …

Because what many people outside the tech industry aren’t aware of is a very common compensation incentive tech companies offer employees … called stock options.

Simply stated, a tech worker takes a slightly lesser salary, which aids cash flow for a start-up, while accepting options to purchase the company’s stock at a future date at a fixed price.

The employee is now motivated to work hard and stay long to drive the company to profitability … and a higher stock price.

When those options eventually vest, they’re what options traders call “in the money”.

In some cases, it’s a LOT of money.

Long-term Silicon Valley residents are accustomed to spurts of fast real estate equity caused when a booming stock market creates tech stock-option millionaires … and fuels bidding wars for scarce housing.

Of course, you don’t have to be in the tech industry or have stock options to be the beneficiary of explosive real estate equity.

You just need to be in the right market.

After all, what do you think the home next door to this $2.47 million property is now worth?

Of course, all this is intellectually interesting … but is there real world opportunity here for real estate investors?

We think so.

Way back in 2012, Forbes put out a list of top tech cities.  Among them were Seattle, Washington DC, and San Jose.

Today, with the benefit of hindsight, we know those markets have all seen substantial appreciation.

But there were other markets on the list, which didn’t have the same pop. So simply being a tech town isn’t enough.

Take a look at the list, then go back to our initial set of required conditions … low supply, high demand, strong capacity to pay.
Not all those places have a supply problem.  It’s tight supply, high demand caused by population growth, and capacity to pay … a lot … through high pay and stock options.

Here’s a 2017 list of top tech hubs for you to peruse.  You’ll see some familiar names at the top of the list.

But here’s something to think about …

Several top-of-list cities have become so expensive, tech companies are looking for new, more affordable places to move.

So cities lower on the list could be the beneficiaries of migrating and expanding companies.

Your mission (and ours) is to identify those “goldilocks” markets where the conditions are “just right” …

The market needs to be affordable today … and make sense on a cash flow basis, because if the rest doesn’t happen, we need to be able to hold the property long term and grow equity the old fashioned way.

The market needs some limitation to supply expansion, which will manifest in bidding wars, as tech wealth provides capacity to pay beyond easy mortgages.

There needs to be a solid combination of established tech companies and start-ups.

That’s where competition for talent forces small companies to offer options, which the bigger companies then need to respond to.

There are a few markets on this list that we have our eyes on … and some we’ve already developed relationships with.  So stay tuned for updates.

Meanwhile, do your own homework.  As much as we love cash flow, sometimes a big shot of equity can just brighten your whole day … and portfolio.

Until next time … good investing!

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• Stay connected with The Real Estate Guys™ on Facebook and our Feedback page.

The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources to help real estate investors succeed.

Waiting for the next recession …

Like waves on the beach or the rising and setting of the sun … the ebb and flow of the infamous “business cycle” is something every entrepreneur and investor must navigate.

The marketplace is fluid and dynamic.  There are no lane lines or guard rails.

More importantly, there is no singular cycle because there is no singular market.  As Jim Rickards says … it’s a complex system.

At our last Investor Summit at Sea™, Fannie Mae’s chief economist Doug Duncan warned the current economic expansion is one of the longest on record.

The odds, Duncan says, are high another recession is around the corner.

And as we’ve noted before, 10 of the last 13 times the Fed embarked on a rate raising program … the result was recession.  So …

Should real estate investors wait for the next recession to add to their portfolio?

The answer is … it depends.

That’s because it’s probably not smart to apply a one-size-fits-all simple strategy to an investing question about a complex system.

And even trying to “narrow” the question down to “real estate” is still complex.

After all, “real estate” covers a lot of ground (sorry, couldn’t help it) … in terms of geographic markets, property types, teams, available financing, and specific deal terms.

Common sense says if you look at enough deals, you’ll probably find a good one … in any cycle … because every real estate deal is unique.

So macro conditions are interesting for deciding which markets to shop in, but less so for deciding whether or not you want to find a deal.

Because if you won’t even look because you’re waiting for a macro-sale, you might miss a micro-sale… and find yourself sitting out much longer than you planned.

Remember, you can’t profit on property you don’t own.

Markets get hot for a reason …

When a real estate market gets hot, it’s because buyers are bullish about the future.  Sometimes they’re wrong, but often they’re right.

Local real estate markets are driven by local factors … the local economy, local tax and business policies; local infrastructure, weather, amenities and population trends.

When LOCAL factors are positive, LOCAL real estate prices and rents rise.  Sometimes in sync.

But sometimes, prices get ahead of rents.  Cap rates (rent ratios) fall.  Investors are willing to pay more for the same income in that market … for a reason.

And in a recession, the problem can actually get worse.  In other words, it’s not unusual in hard times for quality markets to become even MORE expensive.

That’s because when clouds form … or it starts raining … money seeks shelter in quality.

So strong markets and property types often attract MORE capital in uncertain times … thereby raising the price to acquire safe haven assets.

As we discussed last time, Americans and foreigners have already shown a strong preference for U.S. real estate … housing in particular … even as stock markets are raging to record highs.

Royal flushes are rare …

When a macro-event comes and slaps down the national or global economy, sometimes great markets get caught in the downdraft.

This happened in 2008 and it created some of the best buying opportunities since the real estate bust of 1989.  For those who were in position when it happened and acted, it was awesome.

But think about that.

If you missed buying the bargains coming out of 1989 and sat out waiting for the next real estate recession, you’d have been on the sidelines for nearly two decades.

Meanwhile, lots of people made lots of money in real estate … without getting the bargain of the century on every deal.

Pigs get fed.  Hogs get slaughtered … or starve.

This variation on an old investing adage still rings true in today’s investing climate.

The idea is there’s danger in getting greedy.  It’s about being overexposed to a market top, and taking on a lot of downside risk trying to squeeze out a little more upside gain.

But it’s also true about waiting … and waiting … and waiting … for the BIG correction, so you can swoop in and gobble up distressed assets for pennies on the dollar.

Remember … you can also strike out by standing at the plate waiting for the perfect pitch.  It’s usually better to swing.

What are YOU waiting for?  

A PIG is a Passive Income Generator … like rental real estate.  It’s the kind of asset which actually attracts capital in a recession.

That’s because when asset prices are uncertain, income is reassuring.  And as prices of stocks, bonds, commodities, and currencies go up and down like a roller coaster …

… working-class people ride the merry-go-round of getting up and going to work every day to pay their rent.

And if they don’t, you can replace them with someone who will … IF you’re in a market and product type with solid supply and demand dynamics.

To be there, you may have to pay a premium for quality.  The deal still needs to make sense, but it doesn’t have to be cheap to be a bargain.

“Bargain” is a relative term … and price is only ONE component.  There’s more to value and desirability than just price.  Few people want the cheapest brain surgeon.

So long as the market, team, property, and deal make sense … meaning you’ve got staying power to ride out a recession if it comes …

… then you can sail through the business cycle riding a PIG.  It’s not sexy.  But it’s better than starving or getting slaughtered.  You can score a lot of points with base hits.

Until next time … good investing!

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• Sign up for The Real Estate Guys™ Free Newsletter and visit our Special Reports library.
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The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources to help real estate investors succeed.

Real estate wins …

Real estate investing can be lonely.  Very few financial conferences or commentators even talk about real estate … much less endorse it as a wealth building vehicle.

So real estate investors huddle together in obscure corners of the financial community … quietly making money and muttering about the trials and tribulations of tenants, toilets and 1031 tax-deferred exchanges.

But recently, mainstream financial headlines seem to be painting a rosier picture of real estate …

Several news outlets published articles referencing this Bankrate.com article and survey which says Americans prefer real estate over cash, stocks, gold and bonds …

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The article says …

“… for the third consecutive year real estate is the favorite way to invest money not needed for at least a decade …”

“… home prices have gone gangbusters recently, climbing back above their record pre-crisis levels … according to CoreLogic.”

Click Bait and Switch

But then the balance of the article is essentially dedicated to telling readers why the survey respondents are wrong for preferring real estate over stocks …

“Still, ‘it’s a rather poor investment,’ says [a] RBC Wealth Management financial advisor.  ‘It’s highly illiquid, and markets aren’t always rational.’”

“One study … found that housing only returned 1.3 percent per year after inflation from 1900 to 2011, while stocks tended to perform more than four times better.”

As you might guess, RBC Wealth Management deals in paper assets.

Their trite critiques of investment real estate reveal a lack of understanding at best … and a dishonest bias at worst.

Let’s break it down.  Because whether you’re raising private capital to invest in real estate …

… or just trying to convince your spouse or in-laws real estate is a viable alternative to stocks, bonds and mutual funds …

… it’s important to be able to rebut the financial fake news bias against real estate.

Liquidity – LOL

The flip side of liquidity is volatility.  When traders can move in and out of an asset quickly, it makes the asset price volatile.  So liquidity isn’t automatically a good thing.

The survey asked about money “not needed for at least a decade” … so liquidity isn’t what investors are looking for when they buy real estate.

Besides … to say housing is “illiquid” is inaccurate. 

“Illiquid” means “not easily converted into cash” and “of a market with few participants and a low volume of activity”. 

Sure, you can’t day trade houses … but we see that as a plus.  It keeps prices more stable.

And when you can usually sell a house at a fair market price in about two months, that’s hardly “illiquid”.   Drop the price, and you’ll sell it faster.

Market Rationality – ROFL

A paper asset promoter saying real estate “markets aren’t always rational” … are you KIDDING???  That seems a LOT like the pot calling the kettle black. 

Way back in the 90’s before the dot-com stock crash, Alan Greenspan famously accused stock market participants of “irrational exuberance”.

Of course, a few years later the stock market crashed … and scared investors flocked TO real estate in the early 2000’s.

With the stock market at nose-bleed levels today, we’re guessing that’s why people are preferring real estate over stocks again.

Only Returned 1.3 Percent – LMAO

The idea that “housing only returned 1.3 percent per year after inflation” is so off the mark it borders on absurd.

The argument is the PRICE of a home in 1900, adjusted for inflation to 2011, only grew on an annual basis of 1.3 percent …

… and that during that same period, stocks grew by “about four times that.”

This argument assumes the only financial benefit of real estate ownership is price appreciation, which is a false premise.

We won’t bore you with all the math, but you should grab a calculator and do it all so you can quickly blow-up this ridiculous idea that stocks beat real estate over the long haul.

Here it is in simple terms …

Leverage

When you put 25 percent down, you own property at 4:1 leverage.  So 1.3 percent appreciation is a 5.2 percent equity growth rate.

Right there, you’re even with “about four times that”.  But wait!  There’s more …

Cash Flow 

Also missing from the comparison of stocks versus real estate is the rental income.  

Even if you’re before tax positive cash flow is only two percent, with 4:1 leverage, your cash-on-cash rate is 8 percent. 

Amortization

A 30-year fully amortized loan at 5 percent reduces the loan balance (i.e., builds up equity) at a rate of over 2.6 percent per year.

Add 4:1 leverage, and you’re growing equity at over 13% per year.  Now you’re destroying stocks.

We’ll skip tax benefits, which make it even BETTER, and let you tally the total. Any ONE of the three beats “four times that” all by itself.  Together … it’s a wipe out.

People Aren’t Stupid

Main Street investors have common sense … and at this stage of the information age, they’re able to research and fact check quickly.

They know stock prices are being propped up by cheap money and corporate buybacks … and with the Fed raising interest rates, the party might be ending soon.

The Bankrate.com survey reinforced what our anecdotal conversations tell us … Main Street investors are nervous about the stock market. 

Their preference for cash over stocks for a ten year hold says a lot.  Main Street is looking for safety and surety.

And Main Street investors like real estate.  They understand real estate.  They TRUST real estate.

But it’s not just Americans seeking financial safety in real estate.  Foreign buyers just purchased a record amount of U.S. houses.

Real estate is where people park money for long term wealth development and preservation.

Go with the Flow …

Even though home ownership in the U.S. remains at decade lows, it’s actually a boon for real estate investors.  Less homeowners means more renters.

For flippers and syndicators, real estate is highly regarded and in demand.  Money wants to be in real estate … so there’s a big opportunity helping it get there.

And while anything can happen, it seems the appeal of real estate isn’t abating any time soon.

Until next time … good investing!

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 More From The Real Estate Guys™…

• Sign up for The Real Estate Guys™ Free Newsletter and visit our Special Reports library.
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• Stay connected with The Real Estate Guys™ on Facebook and our Feedback page.

The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources to help real estate investors succeed.

The future of growth …

Put on your thinking cap.  This one’s going to use some brainpower.  But if your investment plans involve money and the future, it’s probably worth the effort.

During our 2017 Investor Summit at Sea™, Chris Martenson warned that a financial system dependent on perpetual growth is unsustainable in a world of finite resources.

We’ll forego discussing “finite resources”, though there’s probably a lot of opportunity there.  The New Orleans Investment Conference is a great place to learn more.

For now, let’s consider “a financial system dependent on perpetual growth” … one of the most important, yet least understood, concepts about the eco-system we all operate in.

It’s simple, yet confusing.  Here it is in two sentences …

When dollars are borrowed into existence, the only way to service the debt is to issue more debt.  If the debt is paid off, the economy ends.

Imagine playing Monopoly and each player starts with $1,500.  With four players, the “economy” of the game is $6,000.  This “start” money comes from the banker.

New money is introduced two ways:

When a player passes Go and collects $200 from the banker … or when a player mortgages a property by borrowing from the banker.

Notice all the money to play comes from the banker.

So let’s MODIFY the game ever-so-slightly …

Let’s have the banker LOAN the start and payday money to each player at 10% interest per turn.

We still have four players starting with $1,500 each for an “economy” of $6,000.  But at the end of the first round, each player now owes the bank $150 of interest.

(We’ll forget about the additional payday loans … it just complicates the math and isn’t necessary to make the point)

But borrowing money into circulation creates three (hopefully) obvious problems …

First, there’s only $6,000 in circulation.  With total debt of $6,000 borrowed plus $600 of interest owed, it’s now IMPOSSIBLE to pay off the debt using only the money in the game so far.

And if the only way players get NEW money is borrowing, this creates a cycle of perpetually expanding debt.

Second, if each player paid ONLY the interest out of their $1,500 start money, after ten turns, they’ll have no money left at all.  But they still owe the original $1,500!

So you MUST GROW your asset base by more than the interest expense or you’re consumed by the debt.

Third, if all players try to free themselves from debt, they would take ALL the money in the game and give it to the banker, the game would end, and each player would still be in debt.

In this system, it’s physically impossible to extinguish the debt without extinguishing the economy and ending the game. 

Naturally, to keep the game going, the banker continually extends credit to the players.

It’s basically the way the global money system works and why people way smarter than us say it’s unsustainable.

It’s also like a Venus fly trap because any attempt to reduce overall systemic debt is deflationary, making existing debt even more burdensome.

Deflation means borrowers pay debt down with dollars worth more than those they originally borrowed.

Worse, any assets borrowed against have dropped in value.

Think of 2008 when the credit bubble deflated.  Property values fell, while the outstanding debt remained fixed.  Property owners were “underwater” (negative equity).

Meanwhile, the dollar was STRONG.  It took a whole lot LESS dollars to buy anything.

Everything was on sale and cash was king.  Lots of people got rich buying things with cash when others couldn’t borrow to buy.

Deflation is awesome when you’re sitting on cash.

You’d think lenders are happy to be paid back with better dollars.  And they are … IF they actually get paid.

But underwater borrowers often decide to default on the loan so they can keep their dollars.

So bankers HATE deflation.  No wonder the system they set up in 1913 demands perpetual expansion of debt and prices.

In fact, the Federal Reserve overtly targets 2% per year INFLATION:

“… inflation at the rate of 2 percent … is most consistent over the longer run with the Federal Reserve’s statutory mandate.”

Here’s the problem with perpetually expanding debt … it weakens an economy.

Sure, it drives inflation, but inflation weakens consumption.  When things cost more, people buy less.

Debt also requires interest.  Even at minimal rates, HUGE balances require big payments.

Interest on public and private debt take money away from production and consumption … causing both to shrink.  Just not at the beginning.

When first injected into an economy, debt gooses activity and provides a temporary high.

And as in our modified Monopoly game, once deployed, more NEW money is required just to keep the interest from consuming the economy. There’s a point where new injections produce diminishing returns.

Whew!  Thanks for staying with us.  Tape an aspirin to your forehead.

With that backdrop, consider this headline from Investor’s Business Daily

Here’s Why China’s Latest Growth Scare Should Worry You – May 30, 2017

“Credit has been growing twice as fast as nominal GDP for years. The diminishing returns suggest that many loans are going to unprofitable ventures. They also signal that sustainable economic growth is far less than current growth rates. Such a rapid deceleration from the world’s No. 2 economy would sap demand and prices for raw materials such as copper, exacerbate overcapacity issues and act as a drag on an already-sluggish worldwide economy.”

Uh oh.  “Diminishing returns” and “deceleration” in the face of rapid credit growth.

When a junkie can’t get high, they either increase the dosage to the point of toxicity … or they wean themselves from the drug.

“China is getting serious about weaning its economy off torrid credit growth, and data and financial markets already are showing early withdrawal symptoms.”

Hmmm… sounds like they’re leaning towards weaning.  We like the addiction metaphor.

China and the United States are the two biggest economies.  What either does affects the world.

Right now, headlines say China is slowing its use of debt, which in turns slows its economic growth, with a ripple effect on other economies.

Meanwhile, the Trump Administration is talking bigly about reducing the deficit and debt. Will he do it? Can he do it?

Who knows? But if the global economic system sustains itself on ever-increasing debt. and the two biggest borrowers are going on debt diets … who’s willing and able to take on a bigger share of global debt?

And if no one does, then what happens to asset values?  Is deflation on the horizon?

Last question … then you can take a nap …

Would the Fed and other central banks allow deflation … or do they roll out QE4ever (quantitative easing) in an attempt to stop it?

Meanwhile, now seems like a good time to consider repositioning equity from properties and stocks with high asset values into properties with sober valuations and strong cash-flows.

After all, stocks and even real estate values might be a roller-coaster ride, but rents are more of a merry-go-round. Boring, but a nice place to hide when feeling queasy.

Until next time … good investing!

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12/14/14: Stocks or Real Estate – Which is a Better Investment?

In a recent article published by CNBC, famed economist Robert Shiller (yes, that Robert Shiller of the oft-referenced Case-Shiller index) is quoted as saying he thinks stocks are a better investment than real estate over a lifetime.

REALLY???

That’s like kicking a sleeping dog.  

So we got up off the couch and decided to do a show on this topic.

Some might say we’re shills for real estate…but we’ll find out who’s a bigger shiller here.

In the broadcast doghouse for this episode of The Real Estate Guys™ radio show:

• Your big dog host, Robert Helms
• His little dog co-host, Russell Gray

So we’re hanging out in our broadcast briefs perusing the news for interesting subject matter…and we see an article by CNBC headlined, “Where to put your cash? A house or a stock?”

Hmmm…that sounds interesting…

The article opens up saying that even though the stock market is at record highs, the government is pushing home ownership to build wealth…and using easy credit to help all those poor, unqualified borrowers.

The author immediately questions the premise by reminding readers of the “catastrophic housing crash of the last decade“…while completely failing to mention the accompanying catastrophic crash of the stock market…but more on that in a moment…

Then the author invokes Nobel Prize-winning economist Robert Shiller who is quoted as saying, “It would be perhaps smarter, if wealth accumulation is your goal, to rent and put money in the stock market, which has historically show much higher returns than the housing market.”

Seriously? Okay, now our hackles are up…

So we keep reading…and discover those comments were made at a Standard & Poor’s conference.  Last time we looked, S&P is mostly about stocks and Wall Street.

Of course, we do a little speaking from time to time, so we know when you’re in someone else’s house, it’s smart to say nice things. We don’t begrudge Mr. Shiller for playing to his audience.

Side note: a few days later, CNBC put out a video where Shiller says, “Go back to buying houses.”  Wow, that was fast. But we know the stock market moves quickly. 😉

Back to our current article…

So the CNBC author says, “Shiller notes that the comparison between stock returns and home value returns is rough, given that stocks pay cash dividends and housing pays ‘in kind’, in the form of housing services; that is, you get to live in the house.”

That VERY important point is quickly set aside in the next paragraph, which compares ONLY the capital gains of the broad stock market since 1890…yes EIGHTEEN NINETY…and Shiller’s own secret recipe (that’s how you win a Nobel Prize) of the “real” U.S. home price index.

There’s SO much here…we’re starting to pant.

The bottom line says Shiller according to the CNBC article…is that the net real capital gains (presumably after being adjusted for inflation) are “smaller than one might expect” (we get that a lot…)

Really? How small?

The article quotes Shiller as saying for stocks it’s about 2.03 percent per year. And houses…only a paltry 33 basis points (about 1/3 of 1%).

Confused? If buying stocks and real estate sucks so badly, why would ANYONE do it?

The perhaps obvious answer is that NOT doing it sucks WORSE.

Think about it. The dollar has lost about 98% of it’s value since the Fed was created in 1913. If you simply stacked up paper dollars, you’d be at a negative 98%. So plus 2%…or even plus 1/3% sounds pretty good by comparison.

So now that we know investing…even spending… is better than cash under the mattress, we’re back to comparing stocks and real estate.

The CNBC article points out that “A house can offer greater returns if the owner chooses to rent it out and not to live in it.” Duh. Welcome to our world.

This highlights a bigger point, which is that when you’re reading a mainstream financial media article on real estate, they almost always are talking about the house you live in.

To the CNBC author’s credit, she mentions that “Shiller adds homes should not be seen as an investment vehicle, like a stock, but as a consumption good, like a car.”

We agree. But, isn’t the entire premise of the article a comparison of the investing in stocks versus real estate? You might want to lead with that next time…

Still, this is a VERY USEFUL exercise for anyone enticed by this record high stock market...and every real estate investor being chastised by their stock investing friends. And ESPECIALLY useful for any real estate entrepreneur who’s out raising money to syndicate real estate deals.

After all, we’re all hearing about how great the stock market is doing. In fact, here’s an amazing chart from the CNBC article:

This shows how the stock market (blue) is crushing housing (red).

Aren’t you impressed?

Do you see the real estate bubble of 2003-2007 and the “catastrophic crash” in 2008? (Pay no attention to those GIGANTIC blue line ups and downs…but since you are…what does the pattern say might be next for stocks???)

The CNBC article concludes with this:

“The happy compromise [between taking the risk of leaving equity in a house whose value might drop and putting the equity to “better” use by investing in the stock market]…would be to keep less equity in your home though a long-term, low-down payment mortgage; or…through an interest only loan, and keep more cash at the ready for investing in the stock market. It’s a riskier choice, given the current volatility in home prices, but it may be the best way to build wealth.”

So NOW we’re on the floor laughing out loud…

Open your eyes. You can now look at the blue line in the chart.

Who’s calling who volatile???

First, before we go ballistic…we must say we LOVE the idea of getting idle equity out of a property to shelter it from that ever-fickle Mr. Market.

And because mortgage interest rates are SO low…you don’t have to be Warren Buffet to out-earn the cost of borrowing…especially when you consider that the interest is tax-deductible.
But stocks? We don’t think so. That chart makes us dizzy…

So we need to do some math. We figure if you’ve read this far, you must be a SERIOUS reader, so you can probably handle it.

We’ll only do enough to help you understand why there’s NO CONTEST when it comes to risk-adjusted returns in real estate versus the stock market.

Ready?  Take a cleansing breath…and…here we go…

First, let’s just say that Shiller is right and the real average annual value increase (capital gain) on housing is 33 basis points per year. We could argue, but he’s a Noble Prize winner. We’re a couple of schmoes with microphones.

What his comments and the CNBC article don’t take into consideration is financing…or better stated…leverage.

So if you were to put 20% down, you’d control five 20% parts of an asset (the property) which is 100% of it. That is, your “capital stack” is 20% cash from you (down payment) and 80% cash from the bank (the loan).

But YOU get 100% of the 33 basis points appreciation. At 5:1 leverage (you have only 20% cash in), YOUR appreciation rate on your cash is 5 x .33 or 1.65%. Nothing to run naked through the streets bragging about, but 5 times better than 33 basis points and a WHOLE lot closer to the 2.03% that Shiller says is the stock market’s history.

Now let’s stop right there.

Go back and look at the roller coaster blue line in the chart. Do you notice that the last low was lower than the prior low? Do you see that the high before this one, was higher than the high before that one? Any guesses on where the next low might be?

Now look at the red line. Looks like a smoother ride.

Would you be willing to give up 38 basis points (that’s the difference between 2.03% and 1.65%) to avoid having your stomach come out your ears?

But we’re not done…

Remember that 80% loan? Well, this is a RENTAL property.

That means you have tenants who are paying enough every month to cover ALL the expenses, including the mortgage (and professional property management…because who wants to manage a property?), and a little bit more. If that’s not the case, then you shouldn’t own the property.

Assuming your loan rate is 5% fully amortized for 30 years, the very first loan payment includes a pay down of principal (that increases your net worth on your balance sheet because it reduces your liability…we call it amortized equity) is $96.12 and it goes UP each month from there.

So month 1 is the LOWEST profit rate of the entire 30 years. Make sense?

Math time!

$96.12 x 12 = $1153.44 minimum annual equity build up from amortization

$1153 on a $20,000 cash invested (remember, you only put 20% down) is a growth rate of 5.76% annualized. Add that to your 1.65% of new equity (previous calculation) and you’re up to 7.41%.

See? It’s starting to look better. And it smokes the actual return of the stock market (according to Shiller) and still doesn’t take into account tax breaks or positive cash flow from rents.

So just for fun…can you think of anything you’d rather be doing right now???…let’s add in some net operating income.

Suppose this rental property only provided a modest positive cash flow of about $70 a month net spendable after ALL expenses…including maintenance, turnover, vacancy and set-asides…plus property taxes, insurance, property management, etc.

Is that reasonable?

We think so…and here’s the math (don’t worry, it’s simple!)…

If this $100,000 property is renting for $1000 a month (our 1% rule…and there’s lots of those out there right now) and you budget 50% for all non-mortgage expenses and set-asides, you have $500 a month left for debt-service.

An $80,000 loan at 5% fully-amortized over 30 years gives you a payment of $430.

$1000 rental income less $500 for expenses = $500… less $430 for mortgage = $70.

See?

But $70 x 12 = $840

And $840 return on $20,000 down payment is a 4.7% cash on cash.

So when you put it all in your financial blender and hit puree…your 4.7% cash on cash together with your 5.76% amortized equity and your 1.65% from Shiller’s 33 basis points at 5:1 leverage, you have a total return of 8.11 %.   That sounds a LOT better than 2.03%.

Wow. Now we need a nap.

But take a listen as we take on the challenge of stocks versus real estate. We debate. You decide. Then we can all go have a pint.

Listen Now:

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The Real Estate Guys™ radio show and podcast provides real estate investing news, education, training and resources that help real estate investors succeed.

The Real Estate Guys will be at The New Orleans Investment Conference in November

What mysteries lurk behind the mask of this economic recovery?  Is it real or is it just a big tease?

Robert Helms and Russell Gray, the hosts of The Real Estate Guys™ radio show head to The New Orleans Investment Conference November 10-13, 2013 for find out!

In fact, rumor has it, we’re even going to get some stage time to share our own thoughts on the state of the real estate investment market as we wind down 2013.  Join us!

The New Orleans Investment Conference was founded in 1974 and is described as The World’s Greatest Investment Event. We covered it last year and it was great!

The 2013 New Orleans Investment Conference features a host of renowned commentators and experts on economics, policy and investing including Marc Faber, Charles Krauthammer, Ron Paul, Robert Prechter, Peter Schiff and Mark Skousen.

To be clear, the New Orleans Investment Conference isn’t necessarily about real estate. It’s about investing. And if we didn’t learn anything from the Great Recession, we certainly found that the various financial markets and investment vehicles all have an effect on each other.

So even if you don’t invest in stocks, bonds, precious metals or energy, these are important markets to understand.  In fact, many people view gold as the canary in the goldmine which will predict the demise of the dollar.

Of course, many people who invest in real estate also invest in many of these other vehicles as well.  The New Orleans Investment Conference is looking to add some quality real estate speakers to the agenda, so until they can find some, they’ve asked us to speak.  😉

So, The Real Estate Guys™ will be at The New Orleans Investment Conference in 2013.  And we look forward to re-connecting with our 2013 Summit at Sea™ buddies, Peter Schiff and Mark Skousen. And if you haven’t heard yet, Peter Schiff will be back on our Investor Summit at Sea™ faculty in 2014!

Register to join us for the 2013 New Orleans Investment Conference in New Orleans, November 10-13, 2013.

Come out and hear what Peter Schiff has to say, then make your reservations to come out of winter hibernation in March 2014 and spend a week with Peter on a luxurious cruise ship in the Caribbean.  After all, just one great investment idea acted upon is probably worth the entire cost of both events. 🙂

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