You Need To Own Real Estate Now


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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 years.

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 ownership.

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 proxy).

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 growth.

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 months.

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 .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks

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