Is there any reason to own real assets?

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Snowjob
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Is there any reason to own real assets?

Post by Snowjob »

Is there any reason to own real assets (Land, a business, a stock pile of comodities etc) when there are so many ways to gain access to these types items through financial assets? (Stocks, bonds, futures etc).

Owning the financial assets are generally.
A.) Less work for the owner
B.) Ability to easily diversify
C.) Much smaller costs of initial investment
D.) Better liquidity when trying to sell your assets

Owning the real assets can
A.) Provide better tax benefits
B.) Additional low correlated asset

I suppose the answers are going to depend on how much money you have --

Imagine two 25 year olds are asking you for advice about incorporating real assets to their portfolios

Person A expects to make between 50K and 100K per year over the course of their working lives and currenlty has 15K in savings

Person B expects to make between 200k and 400k per year and starts with 1M in savings

Would your recomendations be different based on their current/expected financial status?

Also -
I do understand the benefits of owning your own house, but as that has a specific personal consumption benefit I would ask that you AVOID that as part of this discussion. Im mostly interested in the investment purpose.
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docneil88
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Re: Is there any reason to own real assets?

Post by docneil88 »

Buying a total market stock index fund will give you substantial exposure to real property (perhaps 20-30%? of purchase price) since most medium to large sized businesses own some real property. Also, REITs are included in the index, albeit at a small percentage.

To add to your lists, the transaction commissions and tax-accounting costs are generally far less with REITs than (directly-owned) real property.

On the other hand, when you own real property directly, you have control over decisions on maintenance and improvement. You also have the right to toss out the renters and then take possession of the property for your own personal use. Be aware that most REITs are leveraged, whereas you can choose to buy real property without leverage. With real property you can avoid a management fee, if you want, by managing the property yourself. Best, Neil
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Snowjob
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Post by Snowjob »

All true.

In my hypotheical scenario, I dont think I could recomend adding real assets to person A's portfolio. I'm not sure if thats good or bad just interesting. I'm sort of supprised that no one else has cared to comment. I suppose that means most people would choose to ignore holding real assets all together. Given the relative affluence on this board that in itself seems peculiar as well.
Dandy
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Post by Dandy »

I not recommending real assets.

I believe I read when hyper inflation hit some South American country (Brazil?) awhile ago real assets, at least some of them, were a major hedge. e.g. As I recall they were adjusting salaries for inflation weekly.Things like new cars etc rapidly became too expensive so quickly that if you owned one rather than depreciate it appreciated. I don't know how more typical real assets such as land, houses, apartment buildings etc fared.

I believe a bout of hyper inflation would make most typical bond/bond funds almost worthless. Equities usually have a hard time when economies are under stress like hyper inflation but they may have done better than bonds. TIPS may be the financial product of choice in this case as an alternative to real assets.
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Snowjob
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Post by Snowjob »

Dandy wrote:TIPS may be the financial product of choice in this case as an alternative to real assets.
I agree. I guess what it boils down to is, I fail to see why anyone who expects to earn less than say 250k per year would ever bother

- buying land
- start their own business
- investing directly in any physical goods.

The better opportunies in financial assets cause a disincentive to actully own anything "real" outright for all but the richest people. In some ways I wonder if this is actually a deterent of entrepneurship.
The Dude Abides
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Post by The Dude Abides »

I actually believe it is the opposite. The higher one's pay at his 9-5, the less incentive to invest directly in businesses/real estate, etc. Conversely, the lower one's pay, the higher the incentive to start his real estate empire or open a Subway franchise. Higher opportunity cost. The underlying principle being that "real" assets pay on average a higher rate of return than financial assets (sometimes much higher), but require more attention.
90% sure on indexing. Still thinking about buying duplexes though.
grberry
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Post by grberry »

Yes, for at least two types of real asset:

1) Real assets that you will be using and valuing the use of - a home, a boat (though most don't use their boats enough to value them), and so on. This eliminates transaction costs and unavailability risk. It may or may not be the right decision for an individual, but for some it is.
2) Your own business - the risk/return has a much wider distribution for your own business than any financial equivalent; the probability of a complete loss is higher and probability of making a fortune is higher.
traineeinvestor
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Post by traineeinvestor »

It depends on which real assets you are talking about.

As examples, I sleep very well holding real real estate - the feeling (rightly or wrongly) of comparative financial stability, the ability to use low cost leverage, reasonably predictable cash flows and limited amount of work involved make rental property something I am happy to invest in.

In contrast, I prefer to hold precious metals in paper form - the costs are lower for both transactions and holding and there is no risk of theft. Credit risk on the bank does not concern me.

As a reasonably high income earner, I tend to agree with The Dude Abides that the opportunity cost of real investments that would require me to quit my day job is a relevant consideration.
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LH
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Post by LH »

According to "When money dies"
in Weimar Germany circa early 1920s, with Hyperinflation occuring, it was the landowners, specifically farmers, who were the most well off. Why? They directly held real assets that produces real goods.

Comparatively everything else depreciated quickly. You could own a house, but you still had to eat, and had to sell your piano, etc, until you had to sell the house perhaps.

You raise an interesting question though:

Why business ownership at all?

I have read that on average, perhaps business owners are NET donors to their customers. Hard to say, but perhaps true. Go into business, is net expected loss all comers?
headnet
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Post by headnet »

Unless you are president of a bank the only way to make real money is to have your own business. You can have a great deal of fun too. But you must make sure you are the right type of person and are doing something you enjoy. You will have stress but it is positive stress. You must also be able to handle all the aspects of running a business – marketing, finance and tax, production, legal etc.

I ran my own company for 20 years. I worked twice as long as anyone else and many times harder. I did not earn that much more than my employees. But when I came to sell the company at the end of the day it was I who made the capital gain
lazyday
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Post by lazyday »

For someone with tens or hundreds of millions, real assets such as real estate or oil and gas might make sense, if the portfolio is large enough to justify paying for expert, efficient management of the assets. I don't know how large an investment that takes.

With a smaller portfolio, investment in real estate might still be worthwhile, but I would view this as a part time or full time job, for those with appropriate skills. Many people have made good money owning and renting properties, but you need to collect rents and manage the buildings and tenants. I believe there's threads on that here.

I wouldn't call a small business a real asset. Might make sense though for some to own, if can be purchased at much lower price than marketable securities, as they often do sell for. But same problem with management. And probably worse diversification problem within the asset.
Or as headnet says, maybe it's your thing to build and/or grow businesses, which can pay off big for some.
Beagler
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Re: Is there any reason to own real assets?

Post by Beagler »

docneil88 wrote:Buying a total market stock index fund will give you substantial exposure to real property (perhaps 20-30%? of purchase price) since most medium to large sized businesses own some real property. Also, REITs are included in the index, albeit at a small percentage.
You aren't kidding:
Image
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
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DiscoBunny1979
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Re: Is there any reason to own real assets?

Post by DiscoBunny1979 »

Snowjob wrote: Person A expects to make between 50K and 100K per year over the course of their working lives and currenlty has 15K in savings

Person B expects to make between 200k and 400k per year and starts with 1M in savings

Would your recomendations be different based on their current/expected financial status?

Also -
I do understand the benefits of owning your own house, but as that has a specific personal consumption benefit I would ask that you AVOID that as part of this discussion.
-----------------

I don't believe you should AVOID including Primary Residence into the discussion. The reason is that while it might be a consumption item to some. . .it can be a place to protect equity value depending upon where you live . . . for instance. . .

In California, the rules to qualify for MediCal (California's version of Medicaid) requires that you only have a small amount of $$ in the bank and that your car is not worth much. The BIG However is that you can qualify for MediCal by owning your own house - paid for or not. This makes home ownership for someone in a low or high tax bracket a good choice because no one can see into the future to know when they will be out of a job/disabled and requriing the State to cover medical costs.

In addition, MediCal works with Medicare in that MediCal can pick up the 20% that Medicare doesn't pay, unless rules are different than I'm familiar with. Therefore, owning a primary home makes sense not only through working years, but in retirement if low income and needing assistance with health care or other issues.

In addtion, Bankruptcy laws in California (unless changed) allow for a Homestead exemption of $75,000 of equity in a house (for a single person) that is protected from creditors and potential law suits.

The two above items makes a Home not just a consumption item, but a place to potentially keep certain amounts of equity protected.

There are at least three reasons for someone making $50-100K to own their own house:

1) It takes time to build up equity. The working years enables one to qualify for a loan. It is during this time that equity can be built and the Homeowners exemption can help in times of crisis.
2) The Homeowners exemption of $75,000 is a years salary for someone in the $50-$100K income bracket. Therefore, it makes sense to have a place in addition to a ROTH IRA/401K where assets can be protected against creditors or law suits.
3) Qualification for MediCal does not take into consideration one's home value in determining benefits. Planning for such need has to take place before one needs it. Again, this planning needs to be done during the working years when paying for a mortgage and building equity is easier.

When one thinks of "diversification" one should consider not only whether the money is allcocated in a tax protected manner, but is also protected from crisis situations - such as law suits, bankruptcy, and even community property state situations.
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docneil88
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Re: Is there any reason to own real assets?

Post by docneil88 »

Beagler wrote:
docneil88 wrote:Buying a total market stock index fund will give you substantial exposure to real property (perhaps 20-30%? of purchase price) since most medium to large sized businesses own some real property. Also, REITs are included in the index, albeit at a small percentage.
You aren't kidding:
Image
Thanks for that graph Beagler. The high correlation between Total Stock Market and the REIT index is also due to the heavy exposure banks and other financial companies had to real estate via mortgage loans they had made and mortgage securities they held. And financial companies are so central to the world economy that there was a huge ripple effect throughout the financial markets. As the banks' book values shrunk, their ability to provide credit of any kind was hit hard. The Fed stepped into that vacuum to try to save the day. Whether they will succeed in the long-term is yet to be determined.

Also, thanks DiscoBunny1979 for pointing out key ways that a home helps protect one in the case of bankruptcy or other financial distress. Best, Neil
happytrades
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Post by happytrades »

Owning rental property is about the only way for a working stiff to get rich, i.e., net worth of a few million dollars. If you buy rental property with 20% down or sweat equity and apply the income to reduction of debt, you can pay it off in 15 years. You can't make that kind of consistent return in the market because of the number of hands that are in the till.

The problem is that you basically have to take on a second job. You work nights and weekends for many years until your operation is big enough to justify hiring help.

A friend of mine is a good case in point. He was an alcoholic welder, and didn't get sober till he was 30. When he quit drinking, he applied himself to working all the time. 20 years later he owned 150 houses, had paid them down so the overall debt in the aggregate was about 40% of value. Now he is semi retired, having turned over the operation to a management company.
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3CT_Paddler
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Post by 3CT_Paddler »

The Dude Abides wrote:I actually believe it is the opposite. The higher one's pay at his 9-5, the less incentive to invest directly in businesses/real estate, etc. Conversely, the lower one's pay, the higher the incentive to start his real estate empire or open a Subway franchise. Higher opportunity cost. The underlying principle being that "real" assets pay on average a higher rate of return than financial assets (sometimes much higher), but require more attention.
I would agree with this. If you earn a higher income you don't need the high risk/extra time that goes with starting one's own business. Owning your own business is a high risk/reward thing and it isn't for most people.
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Snowjob
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Post by Snowjob »

LH wrote:According to "When money dies"
in Weimar Germany circa early 1920s, with Hyperinflation occuring, it was the landowners, specifically farmers, who were the most well off. Why? They directly held real assets that produces real goods.

Comparatively everything else depreciated quickly. You could own a house, but you still had to eat, and had to sell your piano, etc, until you had to sell the house perhaps.

You raise an interesting question though:

Why business ownership at all?

I have read that on average, perhaps business owners are NET donors to their customers. Hard to say, but perhaps true. Go into business, is net expected loss all comers?
I agree that farmland would be a great hedge for that environment -- much more so than anything else. But what about the ability to purchase ownership shares in farmland? If I recall back in 2007 / 2008 that was a new fad. I wonder how those would work out in the Germay scenrio?
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