So the market is down and you’re worried about inflation. Maybe you got out of the market already, but now with inflationary pressure, are wondering where to put your money. Well look out your window and think ‘Real Assets.’ Nothing like Real Assets can protect your assets against inflation woes like a leveraged Real Estate Investment, though buying bonds related to the housing and building sectors is perhaps second best. As inflation goes up, real estate generally rise in a similar slope. Bonds that are sensitive to inflation-related sectors, or related to the housing market, are also a relatively safe hedge in a time of rising inflation.
Many investors will be instructed to include real assets, such as real estate and associated securities because these asset categories tend to hold up during inflationary climates like the one predicted ahead. Stocks, which rely on earnings, tend to underperform during an inflationary climate. This logic was true in one of the most major inflationary scare in the United States. Following the oil crisis of the 1970s consumer prices increased 10 percent per year between. 1979 to 1982. Real Estate delivered strong returns averaging 14 percent, while stocks at the time averaged just 9 percent, and bonds a mere 6 percent, meaning they lost ground on an inflation-adjusted basis.
Enhance Your Portfolio With Real Estate
So why is real estate a hedge against inflation? To put it simply, inflation increases the value of your property, and decreases the value of the money you borrowed to buy the appreciating asset. In this way if you buy a $1,000,000 home with just 10% down, 90% of your investment is keeping up with inflation, as the value of the home will appreciate even while your fixed rate mortgage does not. The new tax bill also allows you to write off what you pay in interest on a loan up to $1,000,000. So you win twice! Mortgages are often easier to acquire during inflationary times and that means it is possible to buy real estate (with a good credit score and income) with as little as 5% down. (Banker’s know that the value of the home is rising in these times and need to invest in Real Estate through their mortgage loans.) While borrowing is associated with risk, while home values are strong in a hot market like Santa Barbara, you can be relatively assured that a well maintained house will keep pace (or outpace) in a market where inflation is rising.
Pimco, a huge investment strategy firm, recommends real assets, saying they can “potentially enhance portfolio diversification, mitigate inflation risk and provide more stable real (after-inflation) returns.” The firm also notes that inflation is likely to pick up in the near future. So why do financial managers recommend a mix that is nearly twice as rich in Real Estate?
Advantages that Real Estate
1) Tangible asset: Real estate is, well real. It has utility even when its price fluctuates, and there are always renters seeking shelter. Stocks don’t contribute to the world on their way up or down, except monetarily. Shelter
2) Choice and Control: With Real Estate you are in a position to raise rents, improve or market your asset. Of course you are still at the mercy of the economic cycle, but overall you have much more leeway in making wealth optimizing decisions. When you invest in a public or private company, you have no management input. If you can calculate realistic expenses and rental income that’s all you really need when it comes down to valuing a piece of property. If you can borrow at 4% and rent out for a 6% yield, you’ve likely found yourself a winner. There’s not only the cash flow component, but also the underlying equity component that helps investors build wealth.
3) Longevity: While this may be a two way street when you consider liquidity, Real Estate investments are on a longer timeline. When the market softens, it does so over months or years. With stocks, a competitor, or a lawsuit could sink your investment into the ground overnight.
4) Tax Free Income. The consequence of being able to write off interest that is paid on an asset that is gaining value is no small one. Laws allow up to $10,000 to be deducted from you federal taxes. Try that with stocks you bought on margin! Also, no other asset can be purchased, utilized and not taxed up to $250,000 in profit ($500,000 for married couples) for an asset that sheltered you for two years in the last five. Expenses associated with managing your rental properties are also deductible from income received from the asset.
5) Leverage: Considering that real estate has at least tracked inflation over the long run, at a 3% increase of inflation on a 20% downpayment yields a 15% return. In fifteen years you will have more than doubled your equity. Note that while 3% inflation is historically realistic, leverage will move against you in a negative inflation environment (as we saw in 2007-2011).
6) Local and National: If you buy in an area you know, your local knowledge will help protect you from unknowns. But on a national level, the government is behind you. Not only do you get tax deductions and tax free profits, you get bailouts if you can’t pay your mortgage. Non-recourse states such as California and Nevada don’t go after your other assets if you can’t pay your mortgage. For some, modifying a loan may be an option if you find yourself under water. When was the last time the government bailed individual investors out of their stock investments?
So the market is down and you’re wondering where to put your money. Give me a call. I’d love to chat!