Sunday, October 19, 2008

Where Do I Put My Money - Investment Properties or Stocks?

I have been quiet about the recent collapse of our banking and credit systems and the impact on myself and my clients. In a recent opinion editorial printed in the New York Times, Warren Buffet is quoted saying "Be fearful when others are greedy, and be greedy when others are fearful". This is a cornerstone on why Mr. Buffet says he is buying stocks, specifically American.

I agree with Mr. Buffet, a pretty easy thing to do. In my short lifetime I have seen three significant drops in the overall stock market and you would have been well served to invest after the drop/adjustment and wait while the general market recovered over the next two years. What to buy? I have followed Scott Burns advice, looking for low fee index tracking funds and avoiding specific securities.

What about Real Estate? In the past I have followed a 50/50 strategy, with 50% invested in long term real estate and 50% in equities. Right now I will spend my cash 20% on real estate and 80% in equities hoping to benefit from the expected return to "proper" value. George Will was on a recent Sunday morning show and stated Charles Schwab had a market capitalization of $24 billion but had cash and receivables of $31 billion. If this is the case then there must be an adjustment at some time. Buying Schwab under this scenario is the definition of value investing, the type of value misalignment Warren Buffet looks for when buying a company (along with other values).

You may ask - why would I put any money into real estate, shouldn't I put it all in the stock market? I still want to diversify because there is a potential that a market recovery will not be broad based and it could take a very long time. If you study history of markets you know about Japan's "Lost Decade". Japan's lost decade showed no significant increase in equity values or increases in real estate values. If our current adjustment turns into an American lost decade then you will not see a return on investments in stocks for a very long time. However, if you can identify quality income producing real estate opportunities you have an opportunity to get a return on your dollars even if the real estate asset does not increase in value.

The facts are that in Prime Properties real estate markets the real estate values have stayed fairly flat, not going up or down significantly. This is not true in the over heated California, Arizona and Florida markets which have seen significant drops in value, and there could still be more to come in those markets. Even more important is that average rents have increased in our markets, again a different outcome from what has been seen in the over heated markets which have seen significant drops in rental rates.

In our markets there continue to be buying opportunities where you can achieve positive cash flow with 20-30% down on a home where the replacement value is higher then what you will pay for the home. As long as people continue to move into our markets you have a level of protection that the value will not drop significantly.

Since I am young(ish) and will have 20-25 years before I need to access my money I plan on shifting a higher percentage into equities, gambling that the stock market will see a significant recovery. I will not sell my real estate to make this happen, as the costs to divest are too high so I will only be making these investments from cash on hand. If I wanted a more conservative approach I would still use a 50%/50% strategy.

My personal results over the past ten years would have been better if I had followed 80% real estate and only 20% stocks but I am looking forward not past. I cannot deny the current situation where many stocks appear under valued when compared with the intrinsic value of the assets of the company. Whatever I do, I will do it slowly and my long term strategy will continue to have a high focus on real estate and being a landlord.

Speaking of values. My wife came home from Costco with five $20.00 Starbucks gift cards, a $100.00 value. She paid $80.00 for these five cards! Now think about this for a minute, and if what George Will said was true about the Schwab valuation, go call your broker and buy some Schwab stock.

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