Real estate offers greater potential upside and much better collateral protection.
In August 1982, the Dow Jones reached lows near 776 (close to 16,000 points lower than recent highs in 2014). Does the U.S. economy seem much healthier in 2014 compared to 1982? Didn’t the U.S. job market seem much stronger back in the early 1980s than today in 2014?
An improving U.S. job market historically has led to an improving Dow Jones Index. Yet, today’s job market still seems a bit weak in spite of all-time record high Dow Jones Index levels. If it weren’t for the continuing Quantitative Easing (QE) strategies (which included as much as $85 billion per month in Fed investments in stocks, bonds, and mortgages), would the Dow be significantly lower today?
What happens to the Dow if Quantitative Easing eventually goes back to zero?
Real estate investments seem relatively cheap compared to the rapidly skyrocketing gains seen in the U.S. stock market. As a parallel to the rapidly booming Dow Jones levels over the past 5 years:
If the median-priced home increased at the same 270%+ as the Dow Jones Index has increased over the past 5 years, the median-priced U.S. home sold in 2009 (approximately $160,000 per the S & P / Case-Schiller House Price Index) would be worth approximately $433,000 in 2014.
However, 2014’s median price (slightly over $200,000) is well below half of that projected $433,000. So, which investment class has a bigger upside potential in the near and long term – real estate or stocks?
Bonds vs. Real Estate
In the past few years, we’ve seen how home prices have begun to increase from the combination of record-low interest rates and absurdly low housing inventory levels. Real estate investors are still looking to earn decent yields–well over the negative net returns offered by local banks’ savings accounts or incredibly low Treasury Yields, and they may be a bit hesitant to jump into the rapidly changing stock markets.
Supposedly, the Federal Reserve continues to be one of, if not the largest, investor in the U.S. Bond Market. In recent years, fewer foreign investors or governments have been interested in purchasing U.S. Treasury Bonds in the 2%+ range.
As a result, U.S. investors and the Federal Reserve have allegedly increased the demand for these Bond Yields, which truly may offer investors negative net returns after factoring inflation, fees, and taxes. The Federal Reserve’s strategy of creating money “out of thin air” in order to try to boost prices has obviously increased both inflation rates and asset prices.
Investors in stocks or real estate may be quite happy with higher rates of inflation. But people who don’t own financial assets probably aren’t too happy about increasing consumer prices.
An increasing number of American investors are beginning to invest more in stocks and real estate for the potential much higher returns than with banks or bonds. The decreasing demand for U.S. Bonds is so concerning to Fed officials that they are openly discussing placing “exit fees” on bonds to keep investors from converting their bond funds into stock or real estate investments.
Will the potential of new “bond exit fees” actually rapidly increase the flow of money out of bonds and into stocks and real estate?
According to The Financial Times,
“Federal Reserve officials have discussed imposing exit fees on bond funds to avert a potential run by investors, underlining regulators’ concern about the vulnerability of the $10 trillion corporate bond market… Officials are concerned that bond-fund investors, as with bank depositors, can withdraw their money on demand even though the assets held by their funds are long-term debt and can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter.”
Stocks, Bonds, Real Estate: Which Has the Best Collateral Protection?
Stocks and bonds are effectively and literally pieces of paper backed by either a business or the “full faith of the U.S. Government.” In good or bad times, the collateral remains primarily that piece of paper. That stock investment may literally go to ZERO if the collateral business goes bankrupt.
With bonds, the risk of a U.S. government default may increase due to the record-setting deficits and political battles in Washington D.C. One or more missed payments may make those bond investments seem not so safe or profitable. Are the low return rates worth the risk anymore?
With real estate assets like multi-family, the collateral is a combination of the monthly rental income (from 50 to 1,000+ tenants per building) as well as the overall asset value of the building and land. Since we all need a place to live, apartment vacancy rates could continue to remain relatively low in both good and bad economic times.
As a result, real estate offers a better combination of 1.) potential higher upside with value gains, as well as 2.) much better collateral investment protection during sluggish economic times as compared to stocks, bonds, banks, or other investments. Leave your comments below.