Is Real Estate Bond-Like?

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Stormbringer
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Is Real Estate Bond-Like?

Post by Stormbringer »

I own a dozen (and growing) residential income properties, as well as the property management company that manages them. My intent is keep the properties well into my retirement years. The portfolio as a whole is consistently cash flow positive with some fluctuation from year to year depending on maintenance expenses and other factors. The capital structure is currently around 40% equity and 60% fixed-rate debt.

My question relates to how I should view the properties when making decisions about my retirement fund. I feel that the real estate is fairly defensive -- even in the depths of the financial crisis the rents kept coming in. So I'm wondering if it should displace some bonds in my overall asset allocation.

Thoughts?
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Re: Is Real Estate Bond-Like?

Post by knpstr »

I personally consider it "bond-like" or more accurately "fixed income"

Bonds
Real Estate
Social Security

All accomplish the goal of "fixed income"

While stocks are for growth/appreciation. That's my view.
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Re: Is Real Estate Bond-Like?

Post by Kevin M »

Real estate is a pretty risky asset, so more like stocks than bonds. The value of some houses dropped by 50% in 2006-2012, and leverage makes a loss like that even worse. The Case-Shiller index of 20 cities dropped by about 35% from July 2006 through March 2012. That seems a lot more stock-like than bond-like to me.

You can think of your real-estate income as being similar to stock dividends.

I include my real estate, rental and home, as part of my risky assets, but I don't include it explicitly in my portfolio of financial assets (stocks and fixed income), other than my REIT fund, which is included in stocks.

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dbr
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Re: Is Real Estate Bond-Like?

Post by dbr »

Firstly I think you are running a business. That business does have assets, but it is a business and not passive investment.

Real estate is most certainly not a bond-like asset. The fact that real estate can generate an income stream means that real estate can generate an income stream. So can bonds, stocks, and lots of other assets. That does not make those assets all the same thing. Also remember that "fixed income" is neither fixed nor income.

That said I would apply the concepts of need, ability, and willingness to take risk to the liquid assets you own, actual stocks and bonds. The existence of the business certainly affects how you would allocate your liquid assets.

Finally, there is an issue of considering the circumstances should you sell out your real estate holdings and have cash to invest. That is an alternate scenario/
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Re: Is Real Estate Bond-Like?

Post by knpstr »

Kevin M wrote:Real estate is a pretty risky asset, so more like stocks than bonds. The value of some houses dropped by 50% in 2006-2012, and leverage makes a loss like that even worse. The Case-Shiller index of 20 cities dropped by about 35% from July 2006 through March 2012. That seems a lot more stock-like than bond-like to me.

You can think of your real-estate income as being similar to stock dividends.

I include my real estate, rental and home, as part of my risky assets, but I don't include it explicitly in my portfolio of financial assets (stocks and fixed income), other than my REIT fund, which is included in stocks.
Long-term bonds are quite volatile as well. However, if you're using them for the income (no intent on selling) the fluctuations (volatility) in "market price" are functionally meaningless (in both real estate and long term bonds).

My view of it as more bond like is perhaps from my local market as well. Very modest appreciation with a 10% "dividend/interest" payment.
Seems more like a bond to me! However, say in San Francisco I would probably be telling you real estate is like a stock, any cash flow is just a bonus.
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Re: Is Real Estate Bond-Like?

Post by magneto »

Real Estate IMHO is not like a Bond.
Neither is Real Estate like Stocks.
Real Estate is like Real Estate and comes with a varying and unpredictable correlation to the other asset classes.

There are four main income producing assets open to us.
Stocks/Bonds/Cash/Real Estate
A not-know-better investor (possibly a good thing); might allocate 25% to each in the name of diversification.

The leverage offered by the mortgage can be considered as being applied to the whole portfolio mix.
Thought needs to be given as to whether each asset class is producing a positive real yield, or a yield greater than the real cost of the debt (mortgage interest rate minus anticipated inflation).
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Re: Is Real Estate Bond-Like?

Post by Johno »

Rental properties (plus my house) also make up a significant % of my assets. The house isn't much of it, but for a lot of people even without rental properties their house is a big asset, so this issue actually applies to a lot of people ('my house isn't an asset' is nonsense, 'asset' doesn't always mean something good so it's not 'conservative' to make believe the *risk* this *asset* presents in your portfolio doesn't exist, though it could also have a good return or a 'meh' return, but it's an asset regardless).

Real estate is not very similar to govt bonds in terms of risk. It's considerably more risky, I mean the RE itself even before considering leverage. But it's not generally as risky (again unlevered asset alone) as stocks, and it probably has a relatively low return correlation to stocks. Raw stats say a very low return correlation, but one must IMO take with grain of salt calculation of past instantaneous return correlations on assets as different as stocks and rental properties. Still, the correlation is probably relatively low and IMO that's an important benefit of RE in portfolio which also has significant stock exposure.

Real estate does though tend to have more interest rate sensitivity than stocks. So it might be accurate to call it somewhat 'bond-like' if it's clear we mean 'risky bond-like' as opposed to 'treasury bond-like'.

Wrt to leverage the risk impact depends if it's recourse or not. If the loans have recourse to the borrower personally (mine don't) it's really just a general levering of your whole portfolio to have them. If they are non-recourse then it's more accurate to think of them as raising the risk/return (but reducing max loss) of the particular pieces of RE which are pledged against those loans.

Either way fixed rate loans offset some of the interest sensitivity of the real estate, but also depends on maturity. My loans are commercial type pretty short maturities so a rise in all rates including long ones is likely to depress the value of my properties more than the benefit of having locked in low borrowing rates for a medium term. Even on buy and hold basis I'd have to refinance in a higher rate environment where the bank says the property is worth less and may be willing to lend less (though having pretty low leverage ratio is a safeguard against that), but also interest cost would go up but rents not necessarily go up any faster nor other expenses go down. But of course nobody says rates have to go up a lot soon or ever actually, and stocks IMO are probably more sensitive now to a sudden rate rise than in the past after such a long period of 'free' short term money.
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Re: Is Real Estate Bond-Like?

Post by randomguy »

Stormbringer wrote: My question relates to how I should view the properties when making decisions about my retirement fund. I feel that the real estate is fairly defensive -- even in the depths of the financial crisis the rents kept coming in. So I'm wondering if it should displace some bonds in my overall asset allocation.

Thoughts?
This time it happened. Maybe next time your tennants all lose your jobs and due to unemployment in your area going to 15%, nobody wants to rent. Through in the fact that if you all of sudden you need 200k, it is easy to get that from bonds. Real estate can be a lot trickier to cash out.

I don't think you can really think of real estate as either bond or stock like. It is different than both of them. You would need to evaluate your property (renting the land for a McDonalds is different than low income housing rentals, owning the rentals versus having a lot of debt,..) and see how it fits into your needs.
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Re: Is Real Estate Bond-Like?

Post by packer16 »

I think it depends upon the term of the lease and creditworthiness of the tenant. Some real estate is bond-like, NNN leased real estate with 15+ year leases to good credits across real estate, geographies and tenant types can be looked upon as bond portfolio of tenant bonds. On the other hand, real estate rented on a month-by-month basis to credit questionable clients in a poor neighborhood can be more risky than stocks. You have to estimate where in this range of riskiness of cash flows your property is to know where to place your specific real estate assets.

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Re: Is Real Estate Bond-Like?

Post by Kevin M »

knpstr wrote: Long-term bonds are quite volatile as well. However, if you're using them for the income (no intent on selling) the fluctuations (volatility) in "market price" are functionally meaningless (in both real estate and long term bonds).
Total return is what really matters; inherent in your thinking is that your principal is safe, and that it will be returned in full when the bond matures. Real estate does not mature, so there is no point in time at which you can be confident about the value, unlike a default-free bond.

You may not be concerned with intermediate price change of a bond you plan to hold to maturity, but you should be concerned that your full principal will be returned at maturity. So it's not the short-term volatility that matters, but the long-term uncertainty of total return, which is much, much lower for a default-free bond than for real estate.

If you really only care about income, you probably should buy an annuity, since the mortality credits allow you to earn a higher return than on a safe bond.
My view of it as more bond like is perhaps from my local market as well. Very modest appreciation with a 10% "dividend/interest" payment.
Seems more like a bond to me!
So house values in your area did not drop in value at any point since mid-2006? That's even more evidence that real estate is riskier (more stock-like), since you have significant unsystematic risk due to serious lack of diversification (a big reason I sold 2/3 of my rental property in 2005).

Also, bonds do not gradually increase in price over time. They may rise or fall in value over their lifetime, but if bought at par, you will not experience any net appreciation at maturity. This is a key aspect of a bond that is unlike riskier assets that have no fixed maturity date. I can quite precisely match a nominal or real liability with some sort of Treasury, but I can't do that with stocks or real estate.

Also, my rental house does not earn nearly 10% in net income. Even without allocating anything to maintenance, it's maybe 3.7% - 4.3%, and that's with low property taxes thanks to CA prop 13. Roughly, rent is $30K/year, property taxes are $3K, and let's say insurance is $1K (it's a bit less). Zillow tells me the value is $687,397, so if I lowball it at $600K, I come up with the 4.3% number (30,000 - 3,000 - 1,000) / 600,000. If I round up to $700K, I get the 3.7% number.

So better yield than large-cap US stocks or intermediate-term bonds (ballpark 2% for each), but that's with nothing set aside for maintenance, so it's really not quite as good as the numbers shown. I'd say it lost about a third of its value between 2006 and the low point; value has been coming back, along with most housing, but still is not back to its peak 2006 value.

So I'd say in terms or risk/expected-return it's more like a high-yield stock than a bond, and more like an individual high-yield stock than a high-yield stock fund, due to the unsystematic risk.

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Re: Is Real Estate Bond-Like?

Post by Abe »

As has already been said, Real Estate is riskier than bonds, not as liquid and involves some management. However, I have owned mortgages that, for all practical purposes, were very much like bonds in that they were virtually trouble free and produced income. Back in the high interest days I had mortgages, purchased at discount, that yielded as high as 24%. Some might say they were not liquid, but I didn't care. When you are getting 24%, you want to keep that going as long as possible.
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Re: Is Real Estate Bond-Like?

Post by nisiprius »

Real estate is not at all bond-like.

At the time you buy a bond, you have a promise, as good as the creditworthiness of the issuer which for an investment-grade bond is very good,

--to make equal interest payments, known at the time you buy the bond, for the life of the bond,
--to pay back the exact amount of the principal on the day of maturity.

Market value plays a role only when the bond is issued--it determines the interest rate the issuer must offer to sell the bonds, and a small discount or premium.

For a piece of rental real estate, the income stream is not as definite as it is for the bond; perhaps the tenant's payments are as reliable as a bond issuer's, but:
--you have no guarantee that you can keep the property rented;
--the amount of the rental is not guaranteed for any period of time longer than the first lease;
--the rental each time it is rented will vary with the market, and--
(the biggy)
--you don't know what the property will bring at the future time when you eventually sell it.

A bond has a known value at one specific point in the future--its maturity date. Real estate does not. In fact it is a fairly speculative investment, subject to potential huge gains or losses at the time when it is finally sold.

Although REITs are not exactly the same as individual ownership of income rental properties, the enormous difference in characteristics between the two assets comes out clearly in this chart. Orange, bonds; Blue, real estate investment trusts.

Source: Morningstar
Image

Real estate is often described as a unique asset class--but one that has risk and return that are comparable to stocks, not bonds. The difference from stocks is that they are supposed to be uncorrelated and have a valuable diversification effect when combined with stocks. (To which I say "Oh, yeah? And how did that work out in 2008-2009?")
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Re: Is Real Estate Bond-Like?

Post by knpstr »

Kevin M wrote: Total return is what really matters; inherent in your thinking is that your principal is safe, and that it will be returned in full when the bond matures. Real estate does not mature, so there is no point in time at which you can be confident about the value, unlike a default-free bond.

You may not be concerned with intermediate price change of a bond you plan to hold to maturity, but you should be concerned that your full principal will be returned at maturity. So it's not the short-term volatility that matters, but the long-term uncertainty of total return, which is much, much lower for a default-free bond than for real estate.
Well I know real estate isn't actually a bond, I'm saying it can replace the bond portion of my portfolio. Provide income, maintain value.

Also:
Values dropped only slightly. Rural Michigan wasn't in a "bubble" to start with, so not much "crash" either.
My rentals produce 10% free cash flow on full asset value (unlevered)

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Re: Is Real Estate Bond-Like?

Post by afan »

It is probably a great idea to hold real estate, particularly if you collect the fees for managing it rather than paying someone else. But that does not mean it should be viewed as equivalent to bonds. As others have noted, it is risky and illiquid. In part, those characteristics are the sources of the return. Riskless highly liquid T bills pay very little.

Real estate is risky even if well diversified and even more if all the properties are in one area. In your case, it appears that the real estate is also your source of earned income. So a downturn could cut this, the value of the assets and the cash flow from rentals. This would imply a need for a lower overall risk in your investment portfolio. You do have the problem that there is some correlation between stocks, bonds and your real estate business. But I suggest you treat your real estate as a high risk asset and build the rest of your portfolio around that.
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Re: Is Real Estate Bond-Like?

Post by rfowler »

We also have income-producing home rentals (plus other commercial real estate) and I posted a similar on this forum (and have also posed the question to two fee-only financial advisors).

This is how I framed the question for myself:
How should we factor our real estate holdings and income into our decision regarding asset allocation of "liquid" investments (equities/bonds/cash)?

After receiving two different opinions from the financial advisors (one said equity-like, one said bond-like), what I did was evaluate "best case" and "worst case" scenarios. Overall my view is that I am hedging somewhat our liquid investments with real estate, and vis versa.
A "bad case" scenario with the rentals would be an economic downturn that would force rent rates downward in order to keep occupancy stable.
Worst case scenario is that for some reason we felt it necessary to sell a property at well below purchase (counting cash outlay only).
We are managing that risk by sticking with smaller homes in better neighborhoods that would sell easier should we choose to (i.e. aim for 10 small homes vs 5 large homes). I also keep a cash "escrow" in a CD ladder just for big expenses down the road (e.g. roof) which will dampen swings in expenses.

Back to the question then: How does our real estate influence our asset allocation of equities/bonds?
Again, in balancing best and worst case scenarios for our liquid investments, I came up with three main objectives our equity/bond holdings had to meet:
1) be a supplement to real estate income and even out the ebs and flows of rental income,
2) serve as a back-up (along with SS) should the world implode on real estate or if we decided to liquidate the rentals as we got older and values were low, and
3) position our family for legacy and charitable giving.

Ultimately the question became, "What allocation will allow me to sleep at night?" given these objectives. [Note: I found Paul Merriman's tables (Ultimate Buy and Hold, Fine Tune Your Asset Allocation) immensely helpful with the sleeping well at night question.]

After a long process of analysis and discernment, we are at 60/40 for now.....and of course that is a personal decision.
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Re: Is Real Estate Bond-Like?

Post by Stormbringer »

Thanks for all the great information! I think I'm coming around to the idea that real estate is it's own thing, not quite like a stock but not like a bond either. Maybe I should just treat it as another leg in the stool.

One thing that might be worth mentioning is the option to have all the properties (or maybe a smaller portfolio or properties) paid off before retiring. That would certainly reduce the risk (and return) and barring a 50% vacancy rate, provide a fairly reliable income.
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Re: Is Real Estate Bond-Like?

Post by travellight »

^that is my strategy, storm. I did a back of the envelope analysis of one of my properties and the returns vary from 6% based on current value of the property, to 7.7% based on the value when I bought it and what I paid for it. Weird how it looks like a poorer investment as it becomes a better investment... i.e. as it appreciates in value, the denominator increases to make the return look lower. I plan to pay off all my properties before I retire; that helps with the sleep at night factor. I haven't figured out an exit strategy yet as far as best time to sell them off gradually or if I should hold them in perpetuity and have it be part of the inheritance. I think tax-wise, keeping them for the heir(s) is best.
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Re: Is Real Estate Bond-Like?

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Re: Is Real Estate Bond-Like?

Post by JPH »

I consider real estate to be more like a stock. Both are equity investments because you have an ownership position. The two basic types of investment instruments are equity and debt. Well, that's what I learned when I was teaching personal finance merit badge to Boy Scouts.
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Re: Is Real Estate Bond-Like?

Post by whaleknives »

JPH wrote:I consider real estate to be more like a stock. . .
:thumbsup And comparing Vanguard Total Bond (blue), Total Stock (orange), and REIT (green) shows it:

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Re: Is Real Estate Bond-Like?

Post by knpstr »

There is a difference between holding a REIT and owning real estate itself.

Like I said in my situation (and everyone's is certainly different) real estate values were NOT that volatile here.
Also 2008/09 was certain "crash" were it actually was a real estate crash that affected the financial markets through subprime lending. This could absolutely happen again, but was a different animal from say the tech bubble, or other bubbles. And real estate can boom/bust entirely independent of the stock market as well. Your location matters.

And bonds have gone to $0. Or have been sold at a loss as well.
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Re: Is Real Estate Bond-Like?

Post by Stormbringer »

travellight wrote:I haven't figured out an exit strategy yet as far as best time to sell them off gradually or if I should hold them in perpetuity and have it be part of the inheritance. I think tax-wise, keeping them for the heir(s) is best.
You might want to check out Umbrella Partnership REITS (UPREITs). Because of the way they are structured, supposedly you can buy them via 1031 exchange proceeds from your rental properties. It may provide a way out of the "hands-on" direct ownership of property without incurring the wrath of the IRS.
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Re: Is Real Estate Bond-Like?

Post by Johno »

knpstr wrote:There is a difference between holding a REIT and owning real estate itself.

Like I said in my situation (and everyone's is certainly different) real estate values were NOT that volatile here.
Also 2008/09 was certain "crash" were it actually was a real estate crash that affected the financial markets through subprime lending. This could absolutely happen again, but was a different animal from say the tech bubble, or other bubbles. And real estate can boom/bust entirely independent of the stock market as well. Your location matters.

And bonds have gone to $0. Or have been sold at a loss as well.
I agree, it's pretty meaningless to show graphs of REIT results in a discussion of typical small scale rental properties. Firstly there's the leverage of REIT's, which obscures the issue of how risky *underlying real estate assets* are. An individual might have more or less leverage than a typical REIT (if leveraged to the max, probably more; I have less). Then there's simply an anomaly or conundrum or comprehensive statistical or data problem, but even the best and cleanest direct real estate price shows a quite low correlation to REIT prices. And it's not actually even very different between apartment buildings (S&P data) and single family homes (Case Shiller*). Those have had generally low to even zero-ish return correlation with the REIT fund VGSLX. Anyone doubting can run the numbers themselves, somewhat strange but true. And with RE being able to continue carrying the property is as important as what the price theoretically is, a real risk but again further removed from direct connection to what the stock market (including REIT's) is doing. As I said, I don't take the low return correlation literally in making my RE v other investment decisions**, but REIT price dynamics aren't particularly relevant.

Again I would go with 'direct RE is somewhat bond-like' if it's sufficiently clear that means *risky* bond-like. The fact that a bond promises a particular amount at a particular date is a difference but mainly a form over substance difference in the case of a bond where's a significant chance that promise won't be fulfilled. What the two have in common is a relatively greater sensitivity to interest rates than stocks do. And even though the overall risk is pretty different between treasuries and direct RE, the direct RE investor must take into account the extra rate risk of RE when considering overall rate risk. So he or she might take a bit less duration risk in high grade bonds as a result of having significant RE, it's not a question of confusing the overall risk of RE with that of long term high grade bonds: they still have high interest rate risk in common.

*and that's Case Shiller NY, an area where you'd think RE/fin market correlation would tend to be higher than other places.
**as somebody else said, I do that more on basis of 'worst' or at least bad case, in terms of downside protection via *non recourse* financing (where leverage actually reduces max loss), cash flow adequacy with 1, 2, etc tenants not paying (failing to find tenants for vacant apts is not much of a risk where I own, tenants being unable/unwilling to pay but it takes forever to get them evicted, that's the main risk), again possible much higher future financing cost but rents don't go up much (interest rate risk), and so forth, risks of not being able to carry the property, in which case you know sudden forced sale isn't likely to work out well.
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Re: Is Real Estate Bond-Like?

Post by itstoomuch »

We recently bought a rental condo with inheritance money. Targeting 5% net yield. Currently receiving 7.5%. This income and asset is above our needs and this asset or an equivalent in the tax advantaged accounts will probably be a inheritance to our Only. The RE is a diversifier to our other assets.
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Re: Is Real Estate Bond-Like?

Post by travellight »

Thanks storm! I will check out those reits.
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Re: Is Real Estate Bond-Like?

Post by Abe »

Stormbringer wrote:
travellight wrote:I haven't figured out an exit strategy yet as far as best time to sell them off gradually or if I should hold them in perpetuity and have it be part of the inheritance. I think tax-wise, keeping them for the heir(s) is best.
You might want to check out Umbrella Partnership REITS (UPREITs). Because of the way they are structured, supposedly you can buy them via 1031 exchange proceeds from your rental properties. It may provide a way out of the "hands-on" direct ownership of property without incurring the wrath of the IRS.
Is is possible to defer tax using a Umbrella Partnership (UPREIT), 1031 exchange, with residential property (single family house) as opposed to commercial property?
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Re: Is Real Estate Bond-Like?

Post by abuss368 »

Have you considered U.S. and International REITs?
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Re: Is Real Estate Bond-Like?

Post by SDBoggled »

Hi,

Lots of good thoughts. I particularly like Kevin's analogy to high-yield stock. Though with more than 12 properties, it could be more like a sector fund than an individual stock. ie IMHO value won't go to zero but without geographic diversity may be subject to large single risk (for me it is earthquake).

However from a retirement perspective, I think a paid off portfolio of rentals can replace some functions of bonds: Provide regular income and prevent having to sell stocks. I hope to fund all our regular retirement income from 50% of rental income. ie utilize the option that if rents drop, then defer expenditure.

IMHO, the biggest disadvantage over stock/bonds is that you can't sell 10% or even 50% of a house to fulfil the need for a chunk of cash (above rents)... and selling a whole house may have large tax costs. So I still need bonds, HELOCs, cash.
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Re: Is Real Estate Bond-Like?

Post by dbr »

SDBoggled wrote:
However from a retirement perspective, I think a paid off portfolio of rentals can replace some functions of bonds: Provide regular income and prevent having to sell stocks. I hope to fund all our regular retirement income from 50% of rental income. ie utilize the option that if rents drop, then defer expenditure.
The providing of income is a possible function of real estate, to the degree there is net income, but that is not a function of bonds. Preventing the selling of stock is also not a function of bonds in general.
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Re: Is Real Estate Bond-Like?

Post by Raladic »

"Investing" in individual real estate such as rental properties is much closer to speculation than investment.
Sure you may make something in the short run, but so does investing in the next AAPL or MSFT.

Historically real estate was about even with Inflation (based on the research as can be seen in the Case-Schiller index) but using it as an investment vehicle it is much more risky, so you could argue you take on the same or more risks as with stocks, in return for (again historically speaking) at-or-below inflation returns, not very attractive.
itstoomuch
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Re: Is Real Estate Bond-Like?

Post by itstoomuch »

Stormbringer wrote:I own a dozen (and growing) residential income properties, as well as the property management company that manages them. My intent is keep the properties well into my retirement years. The portfolio as a whole is consistently cash flow positive with some fluctuation from year to year depending on maintenance expenses and other factors. The capital structure is currently around 40% equity and 60% fixed-rate debt.

My question relates to how I should view the properties when making decisions about my retirement fund. I feel that the real estate is fairly defensive -- even in the depths of the financial crisis the rents kept coming in. So I'm wondering if it should displace some bonds in my overall asset allocation.

Thoughts?
We recently bought a rental condo with inheritance money (no mortgage). What is a good rate of return on money invested. ? First foray.

We are treating this as a deferred Income Variable Annuity; Bond like while taking income but Stock like for risk and appreciation/depreciation. Our purchase came about rather quickly after receiving inheritance. We really didn't want or need to do CD, bonds, or equity. We are Complete no nothing here.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo
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Stormbringer
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Re: Is Real Estate Bond-Like?

Post by Stormbringer »

itstoomuch wrote:We recently bought a rental condo with inheritance money (no mortgage). What is a good rate of return on money invested. ? First foray.
That's a trickier question to answer than you would think. Profits in real estate are made in three ways:
  • The net cash flow
  • The appreciation
  • Tax benefits
The overall return or loss on your equity is amplified by debt, if any. You have to account for all of this when you look at your return.

Properties in bad neighborhoods tend to be heavy on cash flow (and headaches) and light on appreciation. Properties in hot areas tend to be the reverse.

The properties I own are in stable, middle-class neighborhoods in a Midwestern city. Appreciation over the years has run around 2.5%. Cash flow after expenses runs around 6% for an overall 8.5% return. By applying some leverage, such as buying two properties with 50/50 debt/equity the return can be boosted into the teens. Your results could be considerably different, depending on your area and whether you are renting the condo as a vacation vs. traditional rental.
"Compound interest is the most powerful force in the universe." - Albert Einstein
dbr
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Re: Is Real Estate Bond-Like?

Post by dbr »

I think people keep asking whether or not things are "bond-like" because this forum is actually about investing in stocks and (actual)bonds as in the kind of assets one finds in mutual funds at Vanguard. Then we go on and on and on about asset allocation and leave people hanging about how to figure real estate, commodities, the "asset value" of income streams, etc. into the theory. The answer is that most of that does not fit a discussion about how to invest in stock and bonds, and that is pretty much the end of it.
itstoomuch
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Re: Is Real Estate Bond-Like?

Post by itstoomuch »

Stormbringer wrote:
itstoomuch wrote:We recently bought a rental condo with inheritance money (no mortgage). What is a good rate of return on money invested. ? First foray.
That's a trickier question to answer than you would think. Profits in real estate are made in three ways:
  • The net cash flow
  • The appreciation
  • Tax benefits
The overall return or loss on your equity is amplified by debt, if any. You have to account for all of this when you look at your return.

Properties in bad neighborhoods tend to be heavy on cash flow (and headaches) and light on appreciation. Properties in hot areas tend to be the reverse.

The properties I own are in stable, middle-class neighborhoods in a Midwestern city. Appreciation over the years has run around 2.5%. Cash flow after expenses runs around 6% for an overall 8.5% return. By applying some leverage, such as buying two properties with 50/50 debt/equity the return can be boosted into the teens. Your results could be considerably different, depending on your area and whether you are renting the condo as a vacation vs. traditional rental.
We quickly realized this and consulted a CPA who said the same thing. 'RE held for current income and investment purposes has made me rethink how and when to take IRA retirement income and decumulate IRA assets .
My sister is buying out my share of the beach house (don't get excited. 1919, last remodel 1974) which I am asking considerable less to rid myself of the problem. DS advises us to use it for a downpay for a studio or 1 bedroom near DS. :confused :annoyed
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo
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Kevin M
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Re: Is Real Estate Bond-Like?

Post by Kevin M »

SDBoggled wrote:I particularly like Kevin's analogy to high-yield stock. Though with more than 12 properties, it could be more like a sector fund than an individual stock. ie IMHO value won't go to zero but without geographic diversity may be subject to large single risk (for me it is earthquake).
Glad you appreciated the analogy. Perhaps the sector-fund idea has some merit--I had to think about it.

I think a sector fund still has more diversification, if for no other reason than many more companies than 12. But I still think there is less diversification in 12 real properties in the same geographical area.

There are some property-specific risks, but at least some of these are or can be insured (e.g., fire, liability, possibly flood and earthquake, etc.).

Even having the properties in different neighborhoods or sub-regions provides some diversification (e.g., Santa Cruz vs. Mountain View vs. San Jose vs. Stockton), as appreciation/depreciation can vary widely even within a radius of 10 miles. Also different types of real estate, like single-family vs. apartment building, adds diversification.
However from a retirement perspective, I think a paid off portfolio of rentals can replace some functions of bonds: Provide regular income and prevent having to sell stocks.
But now you seem to have forgotten that high-yield stocks also provide regular income in the form of dividends. SEC yield of Vanguard High Dividend Yield Index fund (VHDYX) is 3.18%, so not that much less than the ballpark 4% net of my rental house. For comparison, estimated yield of Vanguard REIT fund, adjusted for cap gain distributions and return of capital, is only 2.6%.

And what's so bad about selling shares of stocks or stock funds? Tax-advantaged treatment can make this preferable to receiving rental income or bond fund dividends. True that depreciation shelters some of the rental income, but this will eventually be recaptured if the property is sold before death.

Kevin
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edge
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Re: Is Real Estate Bond-Like?

Post by edge »

Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
dbr
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Re: Is Real Estate Bond-Like?

Post by dbr »

edge wrote:Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
Producing income is exactly the source of much confusion about bonds and wrong thinking about things being "bond-like." This is proved by the persistence of threads on this very forum where that miss-perception flourishes. I think this may be an artifact of people's first understanding of investing being an understanding of how an interest earning savings account works without proceeding into the more general world of other kinds of investments.
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Re: Is Real Estate Bond-Like?

Post by edge »

You are probably right. I guess folks don't really operate on a first principles basis very often. I try to avoid those types of traps as much as possible - throwing in a bunch of assumptions when trying to understand how/why something operates.

Basing the foundation of investment understanding on fdic insured savings accounts is not a great start.
dbr wrote:
edge wrote:Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
Producing income is exactly the source of much confusion about bonds and wrong thinking about things being "bond-like." This is proved by the persistence of threads on this very forum where that miss-perception flourishes. I think this may be an artifact of people's first understanding of investing being an understanding of how an interest earning savings account works without proceeding into the more general world of other kinds of investments.
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Stormbringer
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Re: Is Real Estate Bond-Like?

Post by Stormbringer »

edge wrote:Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
Consider the following:

Person A has a $3 million portfolio of stocks and bonds.
Person B has a $2 million portfolio of stocks and bonds, plus a well-maintained and managed apartment building in a stable neighborhood, worth $1 million and owned free and clear. After all expenses and contributions to a capital reserve fund, it averages a positive cash flow of between $40-60K per year.

All else being equal, do you think both people should have the same % allocation to stocks and bonds?
"Compound interest is the most powerful force in the universe." - Albert Einstein
edge
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Re: Is Real Estate Bond-Like?

Post by edge »

No
Stormbringer wrote:
edge wrote:Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
Consider the following:

Person A has a $3 million portfolio of stocks and bonds.
Person B has a $2 million portfolio of stocks and bonds, plus a well-maintained and managed apartment building in a stable neighborhood, worth $1 million and owned free and clear. After all expenses and contributions to a capital reserve fund, it averages a positive cash flow of between $40-60K per year.

All else being equal, do you think both people should have the same % allocation to stocks and bonds?
dbr
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Re: Is Real Estate Bond-Like?

Post by dbr »

Stormbringer wrote:
edge wrote:Direct ownership of real estate is absolutely nothing like owning a bond. Especially if it is leveraged.

REIT ownership is also nothing like owning a bond.

I am a bit confused why/how anyone would think they are similar or what the purpose would be in trying to equate them. 'Produces income' is really a horrible answer. The risk/reward profiles are so different it is a terrible idea to equivocate them.
Consider the following:

Person A has a $3 million portfolio of stocks and bonds.
Person B has a $2 million portfolio of stocks and bonds, plus a well-maintained and managed apartment building in a stable neighborhood, worth $1 million and owned free and clear. After all expenses and contributions to a capital reserve fund, it averages a positive cash flow of between $40-60K per year.

All else being equal, do you think both people should have the same % allocation to stocks and bonds?
Of course not. But the reason is not because the real estate asset is a bond or anything like a bond. That is what people are discussing. If you want to propose that investor B is better off financially than investor A, then that can be argued on the merits, probably in either direction, but that issue has nothing to do with real estate being bond like either. I would tend to liken the real estate to owning and operating a business, but no one has to take that view either.
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