Paul Winkler: And welcome to “The Investor Coaching Show.” This is the Jim and Paul Hour. The Paul and Jim Hour. Jim and Paul Hour.
Mr. Jim Wood is hanging out with me here, for this hour, talking about money investing. All right, man. You ready to rock?
Jim Wood: Indeed. Always.
PW: So what are you going to talk about? I don’t know. No, I do know what we’re going to talk about.
I figured we’ll just throw some data out there, have a little fun with some of this stuff. So I’m just going to spring this upon you, and then I’ll have some things to throw out there as well.
Somebody was asking a question about real estate investment trusts. They had seen an article about real estate investment trusts, and this is something that is quite often used for income and retirement, and the idea being, “Hey, I would need to get income from my investments in retirement, and a good way to do it is to buy investments that create income.”
Back in the day it might be CDs or bonds or something like that paid interest, but not much is going on there these days. Not in the bond interest department, anyway.
What Drives Inflation?
JW: And for the foreseeable future, I was just talking with a client today, and still the long term … and over the next few years, anyway, look for interest rates to still appear to be really, really low.
Even though they’re talking a lot about inflation long term, that can definitely put some upward pressure on interest rates, the idea of spiking to 1970s levels or early ’80s, that type of thing. This certainly doesn’t seem likely in any foreseeable future, that type of thing.
PW: No. And if you look at what drives inflation, of course increase in money supply is supposed to drive inflation, but if it is expected that inflation is going to be high for a significantly long period of time, then you’ll find that your government bonds, your federal government bonds, are going to have a much higher interest rate for the longer-term bonds.
Because if you think about it, if I have, let’s say, money that I want to lend to the government and I’m going to lend it to them for 30 years or something like that, then what I would do, I would go, “Well, if inflation is going to be 3, 4, 5, 6, 5%,”—we had this recent bump where there was, it was reported inflation at 5%.”
Well, I’m not going to go and lend money for 30 years at 2% if it’s going to be an inflation rate of 5%. I would go, “That’s crazy,” so I’m going to go and spend the money now or I’m going to do something different with my money now versus going and investing in and locking in a 30-year rate of return of 2%.
If you look at recent data on that, it’s like less than 2% is actually what the 30-year bond rate, the yield is. It’s less than 2%.
JW: Well, it’s funny. What you were just saying, though, is exactly what a lot of people do.
It’s because they have money that they just put in cash and they just leave in cash because they just don’t want to deal with any volatility. But the cost to that, especially as prices rise, can just be devastating.
PW: And if I look at, though, lending it out for that period of time, knowing that inflation’s going to be really, really high.
And it’s interesting because if you look at government bond yields, that gives you kind of an idea, do we think this is transitory or not? Do we think that inflation is a long-term thing?
And a lot of reasons, as I’ve talked about in previous shows, that it looks to be more transitory because of the fact that supply chains finally, “We’re going to figure that out.”
Right now you’ve got situations where companies are making products, and they’re having to find different suppliers for their raw materials or their parts for their products because of the fact that their normal supplier can’t make it or can’t put it out. So you’re going to have some inflation in the short run.
You got the issue with chips with the cars that we’ve talked about. So at some point that gets solved, and you don’t have that anymore.
But in reality, inflation is something that comes and goes. But typically it doesn’t. We don’t see the early 1980s right now, and that could change.
If it changes, then you’re going to see those longer-term bonds. You’re going to see the yields go up on them because people won’t go and lend for super, super long periods of time.
PW: But when we look at investments, we don’t want to go and put money in short-term, fixed-income investments for our retirement money because you’re guaranteeing yourself to break even or lose money.
And after inflation, you definitely have some problems. And after taxes, definitely you have a problem with that.
Are REITs a Good Source of Income?
So real estate investment trust might be a choice for people because by real estate investment trust, they kick off income.
Somebody sent an article along with their question about, “Hey, how about real estate for a long-term investment for my retirement?” And the article was titled “Real Estate Investment Trusts: Definition, Types, Pros, and Cons.”
And here, I’m just going to read the first paragraph. Then, Jim, you just kind of go and throw your two cents regarding this, because it’s really going to be open season on this article.
For many, real estate represents the ultimate investment. It can generate both passive income and appreciation. So you got passive income, the rental income that comes from renting the real estate, and then appreciation, the value of the real estate going up, hopefully, boasting a long track record of strong returns. One joint study by the German Central Bank and several U.S. universities compared real estate returns with other asset classes like stocks and bonds over nearly 150 years and found real estate combined the highest returns with low volatility and risk.
The highest returns compared to what? It doesn’t say, number one. “With low volatility and low risk.”
So just knee-jerk, what are your thoughts regarding that?
JW: Well, every client that comes … I can’t say every client, but we have clients walk in that have been sold to these real estate investment trust all along the way in various forms or whatever. And I rarely see one that actually worked as advertised.
The most frequent thing we see are these problems where people buy the thing. It’s a non-traded one so it’s a private one, and they can’t get out of it.
PW: They can’t get out of it.
JW: They can’t sell it.
PW: The Hotel California of investing as I call it.
JW: We have one person right now that has to apply to take out a certain percentage every quarter, and they approve or deny and they say, “Okay, you can sell this much of it.”
So you’re kind of stuck with it. They’re certainly out there, some of them have worked out and done what they advertise and paid the income and stuff like that.
PW: I haven’t seen that.
JW: But to talk about these as not having any risk and being low volatility just doesn’t jive with the evidence.
PW: And this is not something we have a dog in the fight in because, obviously, if you know anything about this show and about us, we don’t sell things. So this is an educational type of opportunity here for people.
But in effect, if it were a good thing, I would definitely recommend it to clients, but I would never recommend anything that’s commission-based.
Number one, real estate investment trust, very, very high commissions. So typically you’ll have advisors recommending these things for all the wrong reasons because of how much they get paid, not necessarily how much you get paid as the owner or the buyer of it.
JW: Just when I was on the broker dealer side, that’s how they tried to sell it to me as a broker. It wasn’t about, “This is the best thing ever for the client.” It’s about, “Hey, you can make these commissions and stuff.”
PW: “Hey, you can make a lot of money.”
JW: “Oh yeah, and this is how it works for the client, but you can make these big commissions.”
The Other Side of REITs
PW: And you don’t always get to hear the other side of the story. That’s what I like about this show. We’re going to tell you kind of our experience because that’s where we came from.
The side of the investment industry that you don’t normally hear about.
But we would go to these broker-dealer conventions and they would go, “Hey, you know what? You got this real estate investment trust. And here’s what it’s investing in.”
And what it would be, many times, are very well-known businesses, and it would be triple net leases, for example. So they would have these triple net leases where these are big, well-known, maybe it would be franchises, well-known restaurants or mall properties or things like that.
And it would be, “Hey look, you know who these guys are.” And it’s this perception you’re investing in something safe because you’re investing in something well-known.
And that’s part of what you would have in these brochures that they would give us. These pictures of these properties of restaurants you probably have had meals at before.
JW: I can literally picture a brochure with an Arby’s.
PW: So often it is passed off as being very, very safe.
And then maybe there are tax advantages. I remember we would have certain things that you’d have tax advantages to investing in these types of properties that you could do.
And a lot of times, what would happen … mall properties were absolutely notoriously marketed as something that would be safe because, “this is malls.” Then, all of a sudden what happened to malls?
They’re just not nearly as popular as they were when we were kids. People don’t go there anymore, and it’s not because they’re too crowded. It’s just because people don’t go there anymore.
JW: Well, that and just about anything you could get at the mall now, you go online, spend two minutes online and it shows up at your house in a couple of days.
PW: Yeah, no question.
JW: So it makes it tough to be in a mall.
PW: Yeah, absolutely. Now, so they’re saying that these studies show long rates of return.
Well, there was a guy that won the Nobel prize for economics in 2013 by the name of Shiller. What he is known for is his research in real estate. I know his research in real estate, and I know his Nobel Prize-winning research and the things that he has done research on.
He said literally the direct opposite of what this article is saying not too long ago. I talked about it here on the show.
And what he was saying is that the rate of return on real estate has been a bit anemic for the long, long run. He even predicted more challenging returns for real estate into the future for reasons that are kind of fascinating.
Now, real estate, as far as recently we hear of big runs up, and what happens, we tend to complete these patterns in our mind.
If we see something that has done well like real estate in recent years, what do we think automatically? “Oh, this is a really high-returning investment, and it will continue to do very well into the future.” Now, we’re completing that pattern.
It’s the same thing we do with the stock market. If the stock market is going down or it has gone down, I should say. I should word it that way.
If it has gone down, what we do is we go, “Oh my goodness, the stock market is going down.” We rephrase it to, “It’s going down,” and we believe that it will continue to go down.
Now, if it’s going up, we believe it’ll continue to go up. The sky’s the limit; it’s going to keep going up. So we tend to do that as humans: complete patterns in our mind. But in essence, he said this.
He said an interesting thing about real estate. We are figuring out ways of actually getting by with smaller plots of land.
Like for example, when you’re dealing with horticulture and growing products and growing and doing agricultural work. What we’re finding is we have ways because of technology to actually produce crops with smaller pieces of land than we did before.
And as a result, that drives down the value of the land in the long run. Now, it is not a short run. You can have these short-run jumps in value in properties and things like that.
But he said long run, that is his long run foreseeing what is really happening in the downward pressure on upward returns for real estate. He said the same thing with cities, too.
In essence, what he meant by this is that we are able to live in smaller spaces, in smaller apartments, because we can fold beds into walls. There are technologies that we’re able to live in minimalism.
JW: Watched a fascinating video on YouTube, and they have stuff like this all over it. But literally took about $2,200 of materials and built a little cabin in the woods. It had a stove—
PW: Get out.
JW: … and they had, and so everything. It was just like some lumber, some cement, base things to put at the bottom, a little wood burning stove, and everything like that. For $2,200.
PW: Fascinating.
JW: All the comments are, “Oh, I’m going to build this.”
A Changing Landscape Affects REITs
PW: Oh, how fascinating. That’s interesting.
While you’re talking about that, I was thinking about this guy out in Phoenix that I was talking to. He’s a roofer and he was talking about these new housing technologies that they’re using.
And literally, what they’re taking is foam core. They’re building houses out of it, and they’re using cement and foam core and they’re building, it’s like Legos.
JW: Like 3D printing.
PW: Yeah, exactly.
JW: On a big scale.
PW: I guess not Legos. Well, Lego, yeah, Legos. Those little snap together things, right? Those are Legos.
JW: Yeah, those are Legos.
PW: There you go. It’s been a while since I had kids that played with stuff like that.
But you had literally putting them together that way. And what you do is you stack them.
Very, very energy efficient, number one, because it’s basically foam. It’s like a cooler. Upside-down cooler, think of it that way.
And then what they were doing is they’re burning channels in the foam core and that’s where they would put the electrical wiring in there. Then, they would cover it over with some kind of a cement type of a material.
Then, they would put cement on top of it. It was really heavy so it was actually windproof as well. Up to like 300 miles per hour or something crazy like that.
But the idea being that, as time goes on, technology also has an effect on the value of real estate as well and to be able to build it for cheaper and, who knows, that may be coming to a neighborhood near you. So that’s another thing.
The third thing is this. As time goes on, technology gives us a better ability to actually move and transportation.
So where it used to be and who would’ve known, this is something I talked about a couple years ago, but we actually saw it in a totally different way than I expected last year and this year so far.
In that you don’t actually have to necessarily be located in a city. You don’t have to be located in the city to actually be with a company and work with a company.
The reality of it is that you can work with a company that’s located in downtown Nashville, maybe, and I can imagine you’re living in southern Kentucky and you’re George Jetson flying into work, bypassing all the traffic, just flying into work, going to work and going back, because you have the ability to move further out.
Well, what does that do to land values if you’re able to actually locate further away from the epicenter of where the economic activity is happening?
Well, it makes the epicenter of activity, the city, the value of those properties, go down to some extent. Another thing, we need to conserve land because we need to move out.
JW: Well, the thing too is just, and cities in general, people are leaving cities. I mean, there was for years and years, people are flocking to cities, but at least a lot of cities are losing people. Not all big cities but certain, because of the way they’re run, crime, et cetera.
PW: And taxes, sure.
JW: People are hitting the roads, whether it’s leaving that city or leaving that state or something like that. These changes really can impact.
I mean, look at Detroit. Detroit was one of the most populous, wealthiest cities, and now Detroit struggles. They went through some horrible years. Maybe they’re doing a little bit better, but they’re still not what they were.
And certainly real estate prices all over Detroit. There’s abandoned houses all over Detroit.
PW: And that’s just it. And we have demand for housing in other places. Right now we’re sitting in a situation where people are going, “Well, there aren’t enough houses for the number of people.”
Well, that’s very different based on the part of the country that you’re in. But eventually that demand is actually satisfied with supply.
And when that happens, then you have a downward pressure on housing prices. That’s one of the things you got to think about with real estate.
It’s just like any other asset category. It has risks is my point.
JW: And I think one of the best things I ever heard Ken French say was-
PW: Academic Dartmouth. Yes, Dartmouth University.
JW: Well, you mentioned him earlier in the comments, actually.
PW: Oh, did I?
JW: I think you mentioned momentarily.
PW: Oh, okay.
JW: Anyway, anytime you deviate from a market portfolio, there’s got to be a compelling reason to do so based on academic evidence. That’s something going to be, and I’m paraphrasing him and maybe butchering him, but the idea is sound.
If you deviate, it’s got to be for a reason that’s evidence-based that has the evidence behind it. That’s going to suggest that doing so gives you better returns, less risk, or both.
PW: And deviating is a very, very dangerous thing to do because it’s a form of market timing. He was a very, very staunch supporter of the idea that markets are efficient and you don’t do that. And that’s just a case in point.
When you really look at these types of things, when we’re looking at investing in something, moving over and buying real estate instead of something else, a stock portfolio, it is a market-timing move. It’s a tactical asset. Allocation is actually what it’s called, which is a form of market timing.
What the Data Shows About REITs
Let’s do this. Let’s take a quick break and continue this conversation.
Because I’m actually going to give you some data regarding this on the other side and go, “So this is what they basically said in the article. Is it backed by actual data? Where were these studies?”
Because they actually conflict with other studies that are out there, number one. So I always find that, when they just name a study or whatever … which one? Why would one asset class have a higher return than everything else? And why would somebody have to want to pay more to use your money than other places?
That’s really what investing is. People using your money and paying to use your money.
JW: Yeah, if it’s got a higher return, then you expect, “Well, if I’m getting a higher return, then what am I doing? I’m likely taking more risk.”
Risk and return, at least, prudent risk and return are related.
Again, that was a phrase I like to just repeat over and over with my clients because it just really tells you so much that you need to know about investing.
PW: And if you look at stocks, when you’re owning stocks, you already have a lot of exposure to real estate. So it’s part of it.
JW: Well, exactly. That’s one of my comments earlier about Ken French and deviating from the market portfolio.
And so if you go, “Okay, I’m going to load up on a bunch of extra real estate; then, does it give me the extra return for adding risk? Does it reduce risk and not hurt my return?” You have to ask all those questions.
The academic premiums, I talked about when you do that, it’s for something that has massive amounts of evidence like the small company premium, owning small companies over large, like owning value companies over growth. That type of thing that long term has delivered academically based premiums.
PW: And the data that I’ve seen going back 150, 200 years, and there’s one data, that one piece of data, that actually goes back 400 years. The returns were actually less than large U.S. stocks in both of the studies that I had seen.
Which actually corresponds with, I actually looked up, I pulled up Morningstar and I pulled up the data from Morningstar regarding anything investing in real estate. All the funds that invest in real estate. I got that data, that’s a 15-year data point.
Then there’s another data point that actually goes back to the 1970s. I’m going to use the Morningstar data point first. If you look at all the mutual funds that invest in real estate over 15 years, the rate of return versus the S&P 500 is almost under by 4% per year over that period of time. Negative 3.86%.
Now, it didn’t mean that they lost money. Real estate actually, real estate funds made money. The rate of return was 7.04%.
But the rate of return compared to the S&P 500 was under it by 3.86% per year. So you look at that and go so that’s a very, very different picture right there.
The second data point is actually there’s a software program, Dimensional, that actually tracks data on virtually almost any asset category that you could possibly want to find information on.
They have the Dow Jones U.S. Select Real Estate Securities Index that they actually track the returns on. I just compared it before the show started.
I went and grabbed the data on the S&P 500 versus the Fama-French. Fama is the gentleman that won the Nobel Prize in 2013, with his research, and high-book-to-market research, and research on multifactor, and market efficiency, and the large value research index by Fama-French. French is the one that Jim was just naming.
The CRSP 9–10 index, which is Center for Research and Securities Prices, out of the University of Chicago. Then, I used Dimensional’s International Small Cap Index, international smaller companies, and MSCI, Europe, Australia, Far East Index.
So I compared it, and just for the fun of it, let me just use the growth of a dollar. In other words, if I had invested a dollar in these various investments from January 1, 1978, through July 7, 2021, what would have been the growth of a dollar investing in these?
Now, the Dow Jones U.S. Select Real Estate Securities Index, a dollar grew to, it was impressive, I mean, $112.
But what if I’d put the same amount of money in large U.S. stocks, the S&P 500? $153.39.
How about the Fama-French U.S. small research value research index? It’s basically small value stocks. Companies who have a low price compared to book value.
So what is that … $575?
If this real estate higher returns $112 versus $575, I think $575 is bigger than $112.
How about the large value U.S. stock? In that area of the market? $167. Still higher.
How about the CRSP 9–10, excuse me. Those are the 20% smallest companies on the New York Stock Exchange and all like-sized companies on other exchanges. What did that grow to?
That grew to $220, which is a bit bigger than $112. How about international small companies? Almost $200. Again, higher.
The only asset category that real estate did better than?
Jim, You’ll find this interesting.
It was international large. Which is interesting because remember where this supposed study came from, that they said that real estate had done better?
Germany.
So you could see where they would be more focused on international large companies and where they would come to that conclusion.
So you look at that and you can say, “Oh man, how easy is it to actually mislead investors by withholding or just only comparing to one thing?” If you want to make something look bad, compare it to something else that looks bad.
JW: Even worse.
PW: Yeah, that’s exactly right. And you just go, “Oh wow. Isn’t that interesting?”
In reality, I don’t use real estate in my own personal portfolios simply just because of the fact that I have so much exposure to real estate when I own stocks because companies own real estate.
JW: I always think that’s such a great point that bears repeating because people get that, “Oh, real estate. House prices and stuff.”
Real estate isn’t just houses. It’s commercial; it’s things like that. It’s all the companies. It’s the warehouses. It’s all the buildings that Home Depot owns. All the McDonald’s that are out there. All the other companies.
That’s the real estate that’s in your portfolio and that’s the stuff, if real estate is appreciating, the value of those companies that own those properties are appreciating.
PW: And often what you hear people say is, “Well, I like real estate because I can touch it. I can feel it. I can put my hands on it.”
And I say, “Well, what’s your evidence that you can keep that real estate?” Well, it’s called the deed. So I have evidence that I can own that real estate.
Well, the same thing happens in the stock market. You own a stock certificate. You have a stock certificate, which is your evidence of ownership.
And I say that I feel very comfortable with stocks and equities because I can walk into any of these companies and I can touch them as well.
It’s just I have a more diversified portfolio instead of just owning one property that I hope maintains its value. I own hundreds, thousands, tens of thousands of companies when it comes down to the stock market.
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