Stocks -- Ball and Chain -- Real Estate

[Jack Miller]

Several "prisoners" have broken free from jail but they are having trouble getting away.  The problem is that they are anchored by ball and chain to a big rock.  The prisoners are also known as stocks and the rock is also known as real estate.  The total value of real estate in the USA is many times the total value of publicly traded stocks.  The the extent that big money is buying real estate, there is none with which to buy stocks.  The big question for smart investors is:  "Why buy stocks when real estate is so cheap?"  

Under similar circumstances in 1991, my wife and I invested about $300,000 in real estate and continued to buy all the "no money or little money down" deals we could find for the next few years.   Only 5 years later, our equity had soared to several million dollars.  

Today, many people enjoy saying that this recession is worse than the recession of 1991.  The fact is that the depth of the two recessions is very similar.  The number of unemployed today, is higher than the number unemployed in 1991 but not as high as a percentage of the workforce.  The collapse of values were more severe in 2008 than in 1990 but, in several sectors, the total percentage decline from top to bottom was greater from 1988 to 1991 than from 2005 to 2008 (this was even more true during the 1973-74 recession).   The "big bank" bust in 1990, the Bank of New England, was not as large as the most troubled banks today, but more than 9,000 banks went busted then compared to something like 26 so far in this cycle.  More importantly, arguing over how bad the recession is takes ones eye off the ball.  The fact is that 1991 was a fantastic time of opportunity as is 2009. 

Even those who expect to make a killing in stocks during the coming rebound are playing in the wrong ball game.  A person who puts 10% down on a real estate investment has a higher probability of making 10 times his money than does one who buys stocks.  

One of the mistakes being made is to put ones investments inside a 401-K account.  The tax benefits are an illusion.  When the money is withdrawn, it will be taxed as ordinary income.  The fees and hidden costs will never be recovered.      

Anyway, if a non leveraged share purchase doubles twice while the real estate doubles once, the stock investor has made 4 times his money while the real estate investor has made 10 times plus or minus his cash flow.  The 401-K investor will owe ordinary income tax and the real estate investor will only owe capital gains taxes.    Because construction has virtually ended, rents are set to rise, making it likely that real estate will payout handsome tax sheltered cash flow while it increases in value.  The 10% down investor, who has money in reserve to cover contingencies, is likely to make capital gains and net rental income.    

The mistreatment that Marilyn and I received by the government of South Carolina does not take away what we accomplished.  In the late 1980's, we and thousands of others rented beach houses and condos without collecting the "hotel accommodations taxes".  When the policy changed, smaller investors were allowed to pay without penalty.  In good faith, we planned our real estate investment, we modified the plan as conditions dictated and we executed the plan.  We are too old to do it again, buying so aggressively requires work and homework, but the opportunity is there.  

The real estate cycle, which averages 18.3 years, made bottoms in 1955, 1974, 1991 and 2009.  I was too young to enjoy the 1955 or 1974 bottoms and too old to enjoy the 2009 and 2027 bottoms.  If you plan to buy a second home, homes that are far more volatile in price than normal residences, then you should buy now or wait until around 2027.  Yes, if necessary, you should even consider withdrawing funds from a 401-k to buy while the opportunity is great!  In about 9 years, there will be a "mini" buying opportunity but at substantially higher prices than are available today.  Most people who buy beach or mountain property live to regret the day.  The reason is that the majority buy late in the cycle when life seems so grand.  They pay far too much and can't believe how high the total cost of ownership.    

Growing up in North Carolina in the 1960's, I heard numerous "tall tails" about "soaring" beach property.  Hurricane Hazel had hit North Carolina in 1954, wiping out thousands of beach cottages.  Hazel just happened to hit very close to the bottom of the real estate cycle (perhaps because of the several 18 to 19 year lunar cycles that certainly have strong effects on weather patterns).  Because many of the beach cottages were not covered by insurance, it was a horrible disaster.  However, some rebuilt quickly and caught the "big ride".  Rents went out the roof because supply was very low just when the economic recovery got underway.  The "old timers" who tell the tails generally give credit to Hazel for the disaster and for the huge profits made over the next 15 years, however, the baby boom was on and the real estate cycle was in full gear.  The combination of three forces was powerful.  

All cycles are different (history rhymes, it does not repeat).  This time, the baby boom generation is retiring.  Instead of an oceanfront rental for a few weeks, they are generally more interested in a lower priced accommodation to be used more as the term second home implies.  Furthermore, the continued rapid growth of the Internet is creating an environment where people live where they wish.  Most of the population growth over the next 50 years is projected to be within 20 miles of the ocean.        

One reason that Marilyn and I did so well in the 1990's was because the steep decline in the price of gasoline after the Gulf War of 1989-90.  We also benefited from the destruction caused by Hurricane Hugo in 1989.  These factors helped push the purchase prices down but the future rental prices up.  Prior to the recovery, rents had fallen due to recession and high fuel prices.  This rhyme sounds very familiar!  We were buying in 1991, immediately after a drop of about 50% in the price of gasoline.  Those who could not "afford the gas" in 1990 returned to the beach in 1991 and those who recovered from the recession returned in 1992.  By 1995, Marilyn and I were charging 2.5 times our original weekly rental rate.  Rents reflected the absence of construction and the lower gasoline prices.  Prices at the beach are low right now, partly because gas was too high last summer.    

Stocks are tied to real estate partly by the fact that the smart money is buying all the real estate it can.  This is the good old law of substitution at work.  The demand for stocks is lessened by the increase in demand for real estate.  One gentleman purchased 6.5 billion dollars worth of real estate at deeply discounted auction prices in 2008.  This was a drop in the bucket compared to the total transfers that took place.  Two years ago, when 6 million homes were sold at prices close to the prices of the prior year, it was no big deal (about 1.2 trillion dollars worth).  This past year, something like 4 million homes were sold but at prices well below the prior year.  6 million times a minor change is small relative to 4 million times a major change.  Huge commercial deals are also being done at great discounts.  Furthermore, monthly payments have declined because of lower mortgage rates.  Beach condos at half the price and at three percent lower interests makes for payment discounts of 70%!    

Don Angel, Clemmons NC, just purchased a nursing home chain in Kentucky.  Don made millions in this business, sold out, stayed out and has now re-entered at deeply depressed prices.  This is just one of thousands of examples of smart money buying real estate while it is cheap.  

Because current value is the value of income streams discounted by an interest rate, current very low interest rates are pushing up the value of equity from the bottom.  The force pushing down from the top is lower expectations of future income.  Some of the expectations will be realized and some are only fearful figments of imagination. 

We fear the unknown and we are being told that we don't know how bad this recession is going to be.  Lagging indicators, such as the spikes in unemployment and in real incomes suggest that the worst of the recession is over.  On the other hand, the best real estate and share price deals will be done 6 to 9 months before the end of the recession.  Recently, the November 20 low has been under assault but it has stood its ground.  I believe the November bottom will stand, but again, let's not take our eye off the ball.  Tremendous values are being scooped-up now.  The real estate market is the turning of the battleship.  It takes longer to turn the real estate market than the stock market.  

You only live once and you are likely to live through only 4 real estate bottoms.  The next one should come around 2027.

Jack 

PS:  This email will be posted as a Facebook note, along with several complementary charts.  I hope you will become a member of Facebook.  I have come to realize that the current communications shift is as big as the earlier shift from telegraph to telephone.  You will ultimately communicate through so called "social networks" because they are a "better mouse trap".  

Facebook has taken the lead over MySpace.  About 200,000 people join Facebook every day.  There are 30 million users in America and 150 million world wide.  Google is moving rapidly to pull together its various programs into a "community system".  Many a Youtube is available on Facebook, while Microsoft paid billions for certain "exclusive" advertising rights on Facebook.  It is going to be fun watching these systems develop.  The pace of development will jump into hyper-speed after TV goes digital and as low battery usage wireless computers become all the more common, later this year.  I plan to continue occasional investment emails for a while before posting directly to Facebook.  One option I have is to put an RSS feed from my blog to my Facebook page.  During the transition, a growing number of my posts will be done by means other than email.  I hope you will continue to read my work.  I look forward to seeing you online.  Learning Facebook is easier than learning to ride a bike.  If you want a direct invitation send me an email at jack....@gmail.com.      

  
Cast all your anxiety on him because he cares for you.  I Peter 5:7

Jack Miller
1825 Curraghmore Road
Clemmons, NC 27012