The Target is Real Estate

When the subject of investing came up, one of my old business school professors always told us, “If your outflow exceeds your inflow; then your upkeep will be your downfall.” I can still hear his gruff voice saying, “Folks, it doesn’t matter how much money you make, just spend less than you take home, save the rest, and life will be good!”  It’s such a simple concept, but sadly we live in a leveraged generation where it is lost on the vast majority.

By Scott Wright, manager of business analytics

Now, it’s certainly not easy being a saver, but if you figure out how the rewards indeed should be plentiful. Unfortunately, savers have been mercilessly attacked in this age of Central Bank meddling. It used to be that savers could get fairly good yields by parking their money in a savings account, a savings bond, a CD or a conservative money market or guaranteed income fund. These days, you lose money by putting it in vehicles such as these. With Real Interest Rates in the negative, savers and investors have been forced to seek yield elsewhere.

The Real Interest Rate is the rate you receive after allowing for inflation, calculated simply by subtracting the inflation rate from the nominal interest rate. The best representation of the nominal interest rate is the yield from one-year U.S. Treasury bills, represented by the white line in the chart below. For the inflation rate, we use the U.S. Consumer Price Index, its year-over-year change represented by the yellow line. Then, when you subtract the CPI from the one-year T-Bill, you get the Real Interest Rate, which is in blue. If you’re a saver and this chart doesn’t induce a feeling nausea, then check your pulse!

Up until 2001, it had been over 20 years since investors were faced with negative Real Rates, and the impetus was policy changes by the Federal Reserve to combat the stock bear market that was unfolding. This was the start of a 15-year stretch where the Fed’s overbearing action has left investors’ heads spinning. Blatant manipulation really has cast a pall on folks’ understanding of what healthy markets truly are.

Real Estate and Real Rates

Since 2008, Real Rates have spent the majority of the time below the zero percent axis, which is a huge smack in the face to savers. Fortunately, the smart investors understand that with the inflation rate higher than the nominal rate, which has been teetering near zero percent, they are losing money by leaving it alone in safe investment vehicles. They’ve been forced to get creative in how they’ve deployed their capital, and real estate has been a huge beneficiary of this.

The chart on page 13 shows Real Rates since 2012, the year housing prices started trending upwards following the big declines spurred on by the Great Recession. Faced the grim reality of negative Real Rates some investors took to acquiring real estate, not only for long-term appreciation potential but also for instant yield given the hot rental market in most places.

Hungry Investors

It’s no secret there’s been a staggering inventory issue, but provocatively it’s not because of population growth or a huge influx of first-time homeowners. The inventory issue is due to investors gobbling it up. It’s also important to understand that this is not just a United States phenomenon. Central Banks all over the world are bleeding out savers, which has sent them on a global search for somewhere to park their capital. As we’ve seen, a lot of this country’s real estate has been acquired by foreigners.

Overall, what’s happening with Real Rates is not going to be the primary driver of secular trends in the housing market, but it is a big factor. While Real Rates are creeping back to par as you can see in the chart, par still isn’t acceptable for investors. Until Real Rates rise materially higher, you aren’t likely to see a radical shift in where investors are funneling their capital. Real Rates and how they affect the housing market is something on which we need to keep an eye.

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This article originally appeared in the November 2016 issue of the REAL Trends Newsletter and is reprinted with permission of REAL Trends Inc. Copyright 2016

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