Every now and then we get into it a bit here in the office.
This morning the subject was interest rates and real estate
prices, and more specifically where they are headed in the coming
The topics came up because we're evaluating potential
investments for a couple of our newsletters. Contrary to what you
may believe, we disagree quite a bit here in the office, and I
think that's a good thing. Different perspectives mean that people
have to support their positions, and think about whether or not
their reasoning is sound.
On the subject of interest rates and real estate, I have a lot
to say. But to be quite honest, none of it is all that exciting.
From my perspective, my reasoning is sound, reasonable, and over my
time horizon, likely to be right.
Being right is important when you give investment advice for a
living, but often being right or wrong on complex matters like the
future of interest rates and real estate prices looks more like
shades of gray than black and white.
That's because there are so many influencing factors that muddy
the waters. One can't simply say that rising interest rates will be
a drag on real estate (
see Kevin McElroy's editorial in today's Resource
Prospector for a divergent opinion
) since as interest rates climb that increases the cost of property
One simple example of why this is flawed reasoning is the
concept of opportunity cost. This concept refers to other
opportunities one could pursue with their capital.
In other words, if somebody suggests that rising interest rates
will drag on housing, they assume that people won't be willing to
pay more for housing simply because it costs more than it used to.
That reasoning completely ignores the reality that people need to
live somewhere (there are only two realistic options: rent or own),
and no state of the market lasts forever.
Thing change, and if interest rates begin to rise that means
that property ownership will be more expensive in the future than
in the present.
As interest rates rise and the cost of property ownership
climbs, so too do rental rates because landlords know that housing
costs are rising. Also, as rates begin to rise people will likely
realize that they only have one way to go, and that creates a sense
of urgency, thus spurring demand.
***My point in this morning's discussion wasn't that rates will
rise happen tomorrow, but that it's more likely than not to happen
in the coming years. Being more right than wrong is one of those
shades of gray - and it usually leads to profitable investments.
It's seldom that an investment thesis is 100 percent right. And in
fact that degree of accuracy isn't necessary.
***I think as a practical matter yields have nowhere to go but
up, at least on a percentage basis of where they are now. They
certainly can go a little lower in the short-term, or just stay low
for a while, but at a certain point investors will not be willing
to buy Treasuries at a guaranteed inflation adjusted loss of -1 to
-5 percent (depending on what you use for your inflation
Right now, investors will just about break even on 5-7 year
Treasuries, and only make 1-3 percent if they invest in longer
dated Treasuries. The fed's policies are guaranteeing that
investors in Treasuries will lose money on an inflation adjusted
basis - that's what the fed wants to happen in order to drive
investors to seek out higher yielding assets and stimulate economic
But real estate prices are also depressed, and housing sales are
at multi-decade lows.
Value-oriented investors should add exposure to unloved areas of
the market for at least a portion of their holdings. This type of
strategy has been shown to work over the long-term, and if
investors wait for a big recovery in real estate, the biggest gains
will have already been made.
As I said to my co-workers, I don't think today's interest rate
environment is going to keep the real estate market where it is
over the next three years. The real estate recovery has the full
support of our federal government. Its policies to keep interest
rates low are directly aimed at spurring investors to buy other
assets, including property.
Interest rates will at some point rise, and I believe that when
they do the real estate market will be stable enough to handle it.
And once rates begin to rise, potential buyers will likely realize
that if they don't move to buy that property soon, they will have
less expendable income the longer they wait - because rates will
continue to climb.
To be clear, I'm not calling for a ten or twenty percent rally
in real estate prices. I think the market will remain beaten down
for a while. But that doesn't mean you should stay away.
***I've recommended a housing related stock to subscribers of
Small Cap Investor PRO
. We're currently up 25 percent on the position after just over two
I'd say that's being far more right than wrong, and I'm looking
forward to making more money on my real estate related investments
over the coming months and years. You can too. To learn about
my stock investing strategy, and to find out what
housing stock I'm recommending please click here