Real Estate vs Bonds and the Flight to Safety

Wall Street continued to send its messages of anxiety to Capitol Hill today, with the Dow Jones Industrial Average dropping 161.52 to 10,853, or 1.47%. But in a positive sign for the Bush Administration, legendary investor Warren Buffett told CNBC's Becky Quick, when asked about the $700 billion bail-out: "It's what I would do if I were there."

In real estate news, the Office of Federal Housing Enterprise Oversight's House Price Index showed that home prices slipped 5.3% over the last 12 months ending in July and slipped .6% from June to July. This is the largest decline since another period that ended in April 2007 (the index began in January 207). All regions were affected, giving further proof that the decline in prices is a national rather than regional issue.

Now, on to today's real estate educational tip...

Real Estate versus Bonds and the Flight to Safety

The recent financial crisis has many investors seeking "safety" above returns as the emphasis shifts from creating above average returns to preserving capital. As millions of Americans watch their stocks, bonds, retirement accounts and general investment portfolio's drop by 10 or even 20 percent (or more) they are turning to the safety of Treasury Bonds. Is this the best an investor can hope for? Is it even wise? Let's take a critical look at short sales versus the "safety" of Treasury Bonds to see if the numbers really add up.

Treasury Bonds

The flight to government securities has taken on a new urgency as investors seek safety above returns. While it is true that the principle amount is guaranteed by the "full faith and credit of the United States government", not everyone would agree that government bonds are truly safe. In fact, some may argue they are some of the most risky investments possible.

Few people would argue the low yield of Treasury or Savings Bonds leave much to be desired especially when adjusted for inflation. Even if you agree with the governments estimated rate of inflation as recorded on the CPI, the real return on government securities is close to zero...in fact, last week it went negative for a short period! Since inflation is not calculated into the "profit" but rather the nominal rates only, taxes earned on the "profit" further reduce yield leading to an actual loss of purchasing power. Let's use a deliberately simplistic example to demonstrate.

Assume you had $100,000 to invest into treasury backed securities with a current rate of inflation at 5 percent and a yield of 4 percent. At the end of one year, the balance in the account would grow to $104,000 showing a "profit" of $4,000 which is then taxed at a minimum of 15 percent or $600 for a total of $103,400.

However, inflation of only 5 percent (the government estimate is higher and most analysts put it into double digits) means that $103,400 can now only purchase $98,230 worth of goods. In only 12 short months you have actually lost nearly $1,800 of purchasing power. Unfortunately, the actual numbers are much worse since inflation is rising rapidly. As the real rate of inflation approaches double digits, the actual loss of purchasing power can reduce your investment by half in as few as five to seven years!

Short-Sales & Real Estate

Now let's examine real estate. Let's assume you had the same $100,000 to spend and used it to put 20 percent down on five short sale properties (a nice hefty sum to be sure...and with the Short Sale System something you can likely avoid) with an average price of $200,000 each. Let's further assume that each of these properties was formerly priced at $250,000 and have each lost $50,000 prior to being indexed to the current rate of inflation. Since this is a short sale, we will assume the sales price is close to the actual value of the property today but notice, even if it continued to fall for a short period of time, you have other options available to offset the losses (tax incentives for example).

You now control $1 million of real estate. "Real" or physical assets tend to increase in value with inflation as it drives the cost of goods and services to higher and higher levels. Using the same 5 percent rate of inflation, the holdings would grow by 50k in just the first year alone...nearly ½ your total cash outlay!

This is a very simplistic example but it demonstrates the power of inflation to build or destroy wealth. Throughout history there have been two primary means to building wealth in this nation: building a corporation or building real estate holdings.

So where do you go with this information? What are you doing right now to help investors understand that it is time to move money away from equities and into real estate? Are you continuing on the sidelines of real estate hoping for a market rebound, or are you mastering the market of the moment and learning everything you can about short sales and REOs? I hope it is the latter.

See you at the top!

Republished with permission from the following:

http://www.shortsalesriches.com/welcome.html