Is Now The Time To Add Real Estate To Your Assets?

Is Now The Time To Add Real Estate To Your Assets?

May 14, 2012

Real Estate is an important part of a well-rounded wealth planning process (remember our “Four Foundations”).  There are several types of real estate investments. There are those that generate cash flow as investment properties, some are structured as long-term capital appreciation plays without providing cash flows, and there are pure speculative plays in which a property is purchased in anticipation of a short holding period with the intent to “flip” to another buyer in a short time period, and there are real estate purchases from necessity (need a place to live or to operate a business).

A part of the financial crisis that boiled to a head in 2008 was driven by real estate speculation, and low-to-no money down real estate purchases. Many of the general investing public now sees real estate as a “dirty word”, as they have seen the results of many foreclosures and quite a bit of vacant property that resulted from the construction boom that ended with a sudden stop late in the first decade of the 2000’s.

Real estate is like any other market in that there are 4 periods in its “life cycle”: 1) Boom, 2) Decline, 3) Bust, and 4) Recovery. If one can see these periods as the face of a clock, Boom is at 12:00, Decline is at 3:00, Bust is at 6:00, and Recovery is at 9:00.

Where do you think we are in this cycle? I would propose that we are certainly not at 12:00 (Boom), and that we may have already seen, or are preparing to see 6:00 (Bust) in the cycle. This means that we may have already seen 3:00 come and go, and may either be approaching 4:30 or 7:30, depending upon your perspective, which are typically the best times to participate in a recovering market for any asset class. As always, our general investment rule always applies, “Buy Low and Sell High”.

I don’t believe it matters whether it is 4:30 or 7:30 in the cycle, provided that we are not investing at 12:00, and that our time horizons are sufficiently long enough to weather any short term storms and noise in the marketplace.

What does all of this mean with regard to adding real estate to your assets? It means that we may have an opportune time to buy assets at a discount to their ultimate values.

In 2006, as a student of Economics, I was personally concerned with all of the building that was taking place because it did not seem to be sustainable. We saw the building boom undergo a change from being residential to commercial in nature, as builders became more prosperous.

It seemed to me that the builders were looking for areas to allocate their resources and began expanding into more commercial projects than had been undertaken to date. They could utilize larger amounts of capital to build commercial projects, which one normally would assume that would result in larger returns.

A typical commercial project has about a 2 year “life cycle” from idea to completion. At the end of the 2 years, the environment typically changes, and many of the projects that seemed to be good ideas 2 years earlier, now result in overbuilding and oversupply. Oversupply typically results in vacant buildings, which become liabilities to their current owners for as long as they remain empty.

At some point, those same buildings become more attractive as investments and places from which businesses can operate. We are now beginning to see many of these real estate assets being purchased at substantial discounts by a wide variety of investors: some individuals, some hedge funds, some real estate investment trusts, etc.

With the current inventory of real estate with lowered (depressed may be a valid description) valuations, a low interest rate environment, and recent stock and bond market volatility vivid in investors’ minds, it seems there may be a “Perfect Storm” brewing to consider adding real estate to our wealth portfolios.

By utilizing real estate, we can accomplish a couple of objectives: 1) lower our dependence on interest-bearing/dependent investments, 2) add an asset class to portfolios that will not be directly influenced by events in the stock and bond markets (there is not a direct relationship between financial markets and real estate), and 3) act as a potential hedge versus inflation (When inflation is present in an economy, real estate typically moves in the same direction as inflation or deflation).

This may an opportune time to strengthen this portion of our “Four Foundations of Wealth”.

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