Real Estate Thoughts From a Stock Market Guy

Financially, the next 18 months are the best time to buy a house that any of us will see in our lifetimes. Price to rent ratios are back to levels we haven’t seen since the 1990’s, and that’s before factoring in record-low mortgage rates.

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But that doesn’t mean it’s the best place for your money. Let me explain. 

I don’t have a real estate background. I’ve never bought a piece of property in my life. My experience is in the financial markets, where there are no bad assets, only bad prices, and every asset is just a different piece of the global capital structure, and it’s my job to figure out where the best place to be is.


Sometimes that means US treasuries. Sometimes it’s investment grade or corporate bonds. Sometimes foreign bonds. Sometimes US stocks. Sometimes foreign stocks. You get the idea. The relative attractiveness of all of them depends on the safety of cash flows, their growth prospects, how much you’ll have to pay for them, and in the case of foreign assets, your view on currency movements and political stability (sorry, Europeans).


Right now, with core inflation in the US running at 2.3%, and 10-year treasury notes yielding less than 2%, that means if I buy treasuries I’m locking in a negative real return. And that’s something I’d rather not do. Corporate bonds, with low risk free rates and plenty of liquidity sloshing around, aren’t a whole lot better. Equities, on the other hand, are interesting.


Baby Boomers have had their nest eggs rocked over the past 15 years between the dot com bust and the 2008 financial crisis, and despite the 100% rally in the markets since early 2009 we continue to see net selling of US equities on the part of ordinary investors nearly every week. That’s created opportunity for those with a stomach for volatility and a long-term time horizon.


Take a stock like Wal-Mart. Yeah, it’s boring. But despite the bear market we’ve been in for a decade or so, Wal-Mart earnings per share have risen from $1.47 in 2001 to $4.52 last year, an increase of over 200%. That’s not so boring. Will a company with revenues of nearly half a trillion (with a T) dollars a year in revenue grow as quickly going forward as it has in the past? Unlikely. But the company should continue to grow at around the same rate as the US economy, plus they’re expanding overseas. And the price for those cash flows is compelling — as of May 1st it was trading at $59.07 per share, for a price to earnings ratio of 13, or, if you’re a real estate guy, think of it as a cap rate of 7.65%. Okay, so not all the earnings are paid out to shareholders, but a large chunk of them go towards the dividend and buying back the stock, and in theory the rest is going towards growing the business so that cash flows will be even higher down the road.


In the past 5 years, which hasn’t been the greatest of times for anyone, Wal-Mart earnings per share have risen over 10% per year. Let’s say growth slows going forward, and over the next 10 years averages more like 7% per annum. That means that 10 years from now Wal-Mart would be earning around $9/share. And along the way as an investor I’d be collecting dividend checks, currently $1.60/share per year for a yield of 2.7%, and probably growing at a rate of 5-10% per year if not more.


So by buying today and holding for 10 years I’m collecting 2.7% per year at today’s prices and 10 years from now own an asset making $9/share per year. And who knows, maybe a decade from now people are feeling good about stocks again and Wal-Mart gets a P/E multiple of more like 15, for a price per share of $135, or a pre-tax return of 130%. Can your property put up that kind of return over the next decade? And remember, in the stock market there are no closing costs, no contracts to sign, no open houses, no leaky roofs to fix, and you can sell tomorrow if you change your mind.


As a property owner looking to sell, you’re not just competing with other owners or developers, you’re competing with Wal-Mart for my hard-earned capital. You’re competing with General Motors bonds, Greek bonds, and even Facebook stock. The residential side is a bit of a different story because we all need a roof over our heads, but on the commercial side I don’t care if you’re talking about the Empire State Building or Bank of America Plaza — if I don’t think I can make as much money buying your building as I think I can owning a little slice of Bentonville, then either your asking price is too high, or you’re out of luck.


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