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Building your Assets – Is Real Estate a necessary part of a Larger Asset Portfolio?

There is a school of thought that says that in an ever uncertain world, you need a solid foundation to your assets. Something where you win through times good and bad. Some people used Gold, or Government Treasuries for this, some maybe would consider corporate bonds or cash. 

These assets have one thing in common – while they’re generally considered low risk, and don’t make much profit, they’re easy to liquidate if times get tough. 

So where to invest the rest? How racy you want to be really reflects your own risk profile, and since you’re reading this newsletter, it’s likely you know where you stand on this. Equities and Real Estate have both been perennial favourites over the years (as well as more recent options like bitcoin, but perhaps that’s a subject for another article) Equities and Real Estate have a lot in common, but also sport some key differences.

If you’re buying commodities or equities, it’s most likely you’re looking at a liquid asset that you can sell easily if need be. The downside of this is of course the risk is higher but the returns in the past year have been less than stellar, (The Dow fell 9% so far this year)

https://ycharts.com/indices/%5EDJI/one_year_return

https://www.macrotrends.net/1358/dow-jones-industrial-average-last-10-years

Typical equity buyers don’t gear (the companies they invest in do though). When they do, they buy derivatives, like CFD’s or Options, which often takes out the cashflow but multiplies the potential gain and potential loss. 

Cashflow is also not strong, with typical yields ranging from 1-5%, so investing in equities is generally a ‘capital growth’ play with less of an income emphasis, which means a bad year in the stock market doesn’t tend to be compensated with decent cashflow.

Real Estate, or rather the real estate that we buy, is different in a number of ways – 

Like with shares, returns come in the form of both cashflow and capital growth. However expectations should be a lot higher – prices in Buffalo are up 13.2% year on year according to Zillow.com and are expected to rise 15.1% in the year ahead- rather better than the equity prices this year. Detroit and trendy Portland were flat. Chicago is up 2.1%, while other major markets (Houston, New York , LA, San Francisco) rose 5-7%. Curiously the other ‘local’ markets like Pittsburgh and Cleveland had similar strong years, both in double digit growth. 

While Gross yields have fallen slightly as prices rise more quickly than rents, annual net cashflow is still likely to be 7-10%

Also similar to shares, gearing (via mortgage debt) is easy to do. This tends to increase returns (see my previous article) and due to the slower, longer term nature of real estate is less risky than when trading equity or commodity derivatives.

The trends in real estate are generally more predictable than equities (look at the quick unravel of world equity markets this month, for example) and values are easier to predict, especially compared to newer investments like bitcoin or other digital currencies. As far as I’m aware, it’s impossible to accurately value digital currency because its value is based simply on what the market guesses its worth. With real estate there is a tangible physical commodity backing the investment (the land, plus the bricks and mortar and its income potential) which (unlike gold or bitcoin) has a fundamental use that isn’t going anywhere (people will always need to live somewhere) Buying an asset that costs less than it would cost to build (like the houses we buy in Buffalo) always seems like good value.

Although it’s a commodity of sorts, and enjoys many advantages over equities, cash and commodities (higher expected returns, lower perceived risk) Real Estate is not as liquid as either. It can take months to exit from a real estate asset, even a residential one. But while no asset class is perfect (otherwise we’d buy nothing else) the robust, inflation beating returns of real estate assets on a long-term basis should be a cornerstone of any serious portfolio. A solid income producing base allows you to take your chances investing in whatever digital whatsitsname gizmo of the day, safe in the knowledge that when you lose your shirt on that, your houses will still be there, producing income.

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