Inflation Dictates Real Estate Over Treasuries

Prudent and Slightly Contrary

In his latest research, Wall Street Greek's Real Estate Analyst, Michael Douville, suggests passive investors might reconsider their perennial safe-haven, the treasury market, and instead look toward affordable income producing real estate properties. Douville notes that the Federal Reserve intends to boost inflation, which works against bonds but for the real estate he favors.

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Inflation Dictates Real Estate Over Treasuries

Nothing in life is completely risk free. There is no free lunch. The journey of life and the process of investing involve a series of choices. These choices carry inherent benefits or liabilities, but all have intrinsic risks and managing these risks becomes important. As individuals approach retirement, most develop into more conservative and risk averse investors. The fixed income portion of the portfolio expands to provide a reliable income source, while diminishing the growth portion with the express intent to reduce risk of loss due to market action.

Recent economics have favored US Treasuries, and not only have the bonds generated cash flow, but also a sizable capital gain. The value of most bond portfolios has risen to historic highs. Yields on 10-Year Treasuries have dropped to the 2.5% range from 4% just in April, a mere 6 months ago. Bond yields could continue to decline; the Federal Reserve has announced new Quantitative Easing and will be buying more bonds which may further reduce yields. However, the Federal Reserve has also announced the express intention to raise the inflation rate. Inflation eventually will pressures interest rates to rise and even with the artificial lowering of interest rates brought about by the QE of the Federal Reserve, rates will rise, perhaps substantially. If bonds are today at or near a historic high, to be prudent, profits should be taken.

Housing across the United Sates has dropped from historic highs to pricing levels in most regions of the country that are at or near historic affordability levels, indicating an extremely undervalued asset class. The media, and in particular Time Magazine in their September, 2010 issue, has ridiculed the idea of home ownership and is endorsing leasing for life; great news for landlords. With bad news piled onto worse news for Real Estate, contrarians should be delighted; and select pricing levels of homes seem ripe for investment dollars, specifically those funds allocated to Fixed Income.

On a risk adjusted basis, residential rentals seem to make very good investment sense. Deeply discounted distressed properties offer an alternative that probably generates twice the monthly cash flow of 10-year Treasuries, offer growth of income and growth of value, plus hedge against inflation. Further, should a very conservative investor leverage the investment by using a simple 30-year fixed rate mortgage, a very compelling idea with loans at historic low rates, not only will there be cash flow, but the tenants will payoff the mortgage. A very passive investment just about guaranteed to produce returns is easily created.

Here in my home market of Phoenix, Arizona, entry level homes are generating better than 5% returns after costs, including the standard taxes and insurance, but also management fees, vacancy costs, repair escrows, HOA fees, and leasing fees. These are initial returns which should grow producing net cash flow increases year-after-year. Should inflation ignite, which is the stated goal of the Federal Reserve, residential rentals become the ideal investment, historically appreciating at or above the inflation rate. Unlike bonds, the timing for properties is exquisite. Twice the return of the current 10-Year Treasury, growth potential in both monthly cash flow, as well as the capital gains, and coupled with inherent inflation protection, makes this asset class a very good alternative for a portion of a qualified investor's portfolio.

Perhaps it is time to take profits from the fixed income portion of most portfolios and re-allocate a portion to residential rentals. Very good investment quality properties at deeply discounted prices are available across the United States. Many foreign investors have recognized the opportunity and are already purchasing properties having a distinctly different perspective and investment horizon than shell-shocked Americans. A passive investment is available in most regions of the nation, however, Southern California, Nevada, and Florida appear to offer excellent opportunities. In sunny Phoenix, a passive, cash flowing investment where an investor is the owner and a management company is the landlord is certainly available….but not forever.



Editor's Note: Article should interest investors in Bank of America (NYSE: BAC), Freddie Mac (OTC: FMCC.OB), Fannie Mae (OTC: FNMA.OB), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), Toronto Dominion (NYSE: TD), UltraShort Real Estate ProShares (NYSE: SRS), Ultra Real Estate ProShares (NYSE: URE), ING Clarion Global Real Estate Income Fund (NYSE: IGR), Xinyuan Real Estate Co. (NYSE: XIN), Rydex Real Estate Fund H (Nasdaq: RYHRX), T. Rowe Price Real Estate Fund (Nasdaq: TRREX), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), D.R. Horton (NYSE: DHI), Beazer Homes (NYSE: BZH), Lennar (NYSE: LEN), K.B. Homes (NYSE: KBH), Pulte Homes (NYSE: PHM), NVR Inc. (NYSE: NVR), Gafisa SA (NYSE: GFA), MDC Holdings (NYSE: MDC), Ryland Group (NYSE: RYL), Meritage Homes (NYSE: MTH), Brookfield Homes (NYSE: BHS), Standard Pacific (NYSE: SPF), M/I Homes (NYSE: MHO), Orleans Homebuilders (AMEX: OHB), Vanguard REIT Index ETF (NYSE: VNQ), PNC Bank (NYSE: PNC), J.P. Morgan Chase (NYSE: JPM), Hooker Furniture (Nasdaq: HOFT), Ethan Allen (NYSE: ETH), Pier 1 Imports (NYSE: PIR), Williams Sonoma (NYSE: WSM), Home Depot (NYSE: HD), Lowes (NYSE: LOW), AMEX: VAZ, AMEX: NKR, AMEX: MZA, AMEX: NXE, AMEX: NFZ, Nasdaq: XNFZX, Nasdaq: FSAZX, Avatar Holdings (Nasdaq: AVTR), Apartment Investment & Management (NYSE: AIV), Equity Residential (NYSE: EQR), Avalonbay Communities (NYSE: AVB), UDR Inc. (NYSE: UDR), Essex Property Trust (NYSE: ESS), Camden Property Trust (NYSE: CPT), Senior Housing Properties (NYSE: SNH), BRE Properties (NYSE: BRE), Home Properties (NYSE: HME), Mid-America Apartment (NYSE: MAA), Equity Lifestyle Properties (NYSE: ELS), American Campus Communities (NYSE: ACC), Colonial Properties (NYSE: CLP), American Capital Agency (Nasdaq: AGNC), Sun Communities (NYSE: SUI), Associated Estates (NYSE: AEC), PennyMac Mortgage (NYSE: PMT), Two Harbors (AMEX: TWO).

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