Archive for January, 2010

The previous book review of The Modern Survival Manual: Surviving the Economic Collapse covered the insider’s view of the Argentina financial crisis of 2001 and what happens when a society sees their currency lose more than 2/3rds of its value in a short period. It was an interesting read with unique insights into economics and sociology that you just won’t find in a standard textbook on the subject.

Now, I’m impartial to investment assets and don’t believe in extremes. I had some questions along the lines of going to extremes in investments and wrote to FerFal (Fernando – author of the book above) about his views having lived in a time when extremes did happen in his country. He gives his thoughts below.

On extremes in investing in gold (100% gold vs. not owning any gold) and real estate:

Extremes are bad, and I know what you mean. There’s people that believe anything other than gold is worthless and others that state “When the world ends I’ll trade an egg for a bar of gold!” You can only roll your eyes and think ok buddy, you sit there waiting for doomsday while I live in the real world.

I’ve noticed that both my father and grandmother have one thing in common. Grandma was a farmer in Spain, when she came to Argentina she started a successful bakery shop, lost their savings several times for many reasons, inflation, change of currencies, takeovers, etc.

My father is an accountant, he worked in banks most of his life, was on the board of directors of bank Boston in Boston, Massachusetts, practically lost the money he had to put into his retirement fund in Argentina.

The thing they both have in common? After a number of economic changes, inflation and corralitos of various kinds, the only thing both of them have left  were their real estate investments. Those survived better than money in the bank, and unlike the almost useless retirement plans, the rent will be what really allows them to retire and live well.

Thought it was worth mentioning. I consider real estate an important part of one’s portfolio as well.

FerFal brings up a point that I hope to explore more in the future. I believe strongly that investors should have what a poster at the Bogleheads forum “chicagobear” aptly called a “have money” and a “make money” side of their portfolio.

Inside the Permanent Portfolio you have four assets: Stocks, Bonds, Cash and Gold. Stocks and bonds are your “make money” portfolio as they pay interest, dividends and have capital appreciation. Cash and gold are more of your “have money” portfolio because they pay little in interest (such as cash) or have no interest or dividends like gold (but may have capital appreciation). However these “have money” assets have tremendous ability to ride out very bad markets when your “make money” assets are doing poorly. The “make money” and “have money” halves of the portfolio work together to lower volatility and provide good returns.

But FerFal brings up another interesting asset: Real estate. It combines the aspects of “make money” by giving you an income stream from rent but also is a “have money” as it is an asset that can’t be inflated away easily.

For the Permanent Portfolio, Harry Browne cautioned against using real estate as an investment as he considered it speculative in nature. In many respects this is true. However if you own rental property you do have potential to make money if you choose a good location, have good renters, can manage maintenance costs, have a good management company, etc. This is the speculative risk part. It could work out, but there is risk that one or more things could happen to make it not profitable.

What about Real Estate Investment Trusts (REITs)? You get the high income streams from owning real estate, but don’t get the calls at 3AM in the morning about a leaking roof. REIT index funds own a wide variety of companies that have exposure to malls, office buildings, public storage companies, etc. So you get geographic and industry diversification as well. However, by owning stock you don’t own the actual property itself which may defeat the purpose of real estate entirely as a hard asset like gold. Yet, for investors that want to have some real estate exposure, but don’t want the hassle, it may be an acceptable trade off.

As it is, in terms of “make money” and “have money” side of things, real estate seems to straddle the fence. It combines elements of stocks and gold investing (along with both of their risks). It is a hybrid asset. If owned directly it can provide inflation insurance that stocks and bonds may not. Yet it can also provide an income stream that gold and cash cannot. With REITs you give up the direct ownership, but they do provide a nice income stream which is hard to ignore.

Are there risks? Of course. There are risks involved just as you’d suspect and they need to be managed effectively. For instance, property management seems like one of the biggest headaches for real estate investors (but not for REIT owners). In Argentina FerFal handles it this way:

About managing real estate, I’ve found that in most cases its better to spend a couple bucks each month and let a real estate agency collect the rent and argue with the people you rent to.

In few cases, you find the right person and things run smoothly, most often it doesn’t and a middle man like the real estate agency collecting rent and making the calls if they get behind saves you time and lots of headaches. Besides, they [the renters] pay better ( pay when they are supposed to) when they dont have the actual owner in front of them to cry to.

Never heard of owning real estate through stocks [REITs]. Here, most people manage their own property, with a real estate office always taking care of the contract ( very important to have a good contract) and some have real estate managers like the ones I mentioned.
Here its important to be good at haggling like I say in the book. I’ve had very serious, suit wearing real estate agents cut down their managing asking fees down to 10% of what they where originally asking for. It’s important to know the market, know what a realistic asking fee is.

I’m a nice guy and dont like pushing people ( people that come up with excuses for not paying rent) but like everything else, you learn little by little, know when someone really just needs a couple more days, or when he’s playing with you. Again, best thing is to have someone else take care of it, specially if you’re not planning on having much time to chase people around to get paid.

Here in the states many rental property owners do use management companies and this does seem to lessen the stress. They manage the renters, the maintenance, etc. There are some potential pitfalls to navigate though (such as the management company overcharging you for services and maintenance, carrying insurance, etc.). So rental property ownership is far from a sure thing and will take some work on your part to choose wisely.

However if you think you have the stomach for it, rental properties may be a consideration if you’re looking to have exposure to hard assets but also want that asset to deliver an income stream. BTW. I don’t think time shares fall into this category. I think time shares are the kind of investment made to be sold, not bought. Also, when we’re talking about owning real estate I feel we’re talking about property where you own the note yourself and not taking out loans to buy properties and risk you can’t make the payments. Taking out large loans to buy property other than your own home is a violation of Rule #7 of the 16 Golden Rules of Financial Safety.

If you don’t want to deal with any of these risks, or don’t have funds to buy additional real estate outside of your home, it may make more sense to look into a REIT fund like Vanguard’s REIT index (Ticker: VGSIX)  or the iShares Realty Majors Index (Ticker: ICF). If you are eligible, the TIAA-CREF Real Estate Fund has an excellent reputation as well. These options provide inexpensive exposure to real estate with the trade off being you don’t own the property itself. If you are comfortable with that, the REIT funds above provide an easy way to get real estate exposure. They also have the other advantage that they are very liquid. Meaning that you can sell them in 60 seconds to get your funds instead of waiting days, weeks, months or even years to unload a physical property plus realtor commissions.

In terms of asset allocation, real estate is in the variable portfolio side of the house. Basically, only do it with money you can afford to lose. Also realize that if you own a broadly based stock index fund like the Total Stock Market you already own REITs. You just don’t own a lot of them in proportion to everything else.

Also remember that real estate does have risk just as all investments do. It’s just a question of diversifying these risks against all your other assets to reduce losses if they should show up. REIT funds dropped over 65% from their 2007 highs to their lows in 2008 as a recent example. And despite what realtors always claim about physical property prices, many areas experienced significant price drops in real estate that could take years, or decades, to recover. Yet, with the real estate bubble clearly popped in the US this asset could be a reasonable buy for someone looking to diversify a little of their play money and have some protection against unexpected events as well.

Thank you Fernando for answering my questions. Please be sure to visit his blog where he provides information on many topics.