A Look at Real Estate

A Look at Real Estate

July 12, 2017 Off By Chuck

I received a request (thanks, Cheri) to give my view of the (securitized) Real Estate market. While I include it as a part of my weekly sector analysis top down look at the markets, I typically look to other areas for investment of risk capital. It’s not because I dislike it or have a bias but rather because almost all my clients live in California and have more than their fair share of real estate holdings when considering their homes. As such, adding more real estate into their portfolios (even though it may be a bit different — commercial REITs vs residential) I don’t feel comfortable over-weighting a portfolio unless everything is perfectly aligned.  We are risk managers first and foremost.

Below is a 5 year chart of IYR (with no dividends reinvested so we can get an idea of movement of price appreciation). In the middle pane, the green bars are the weekly price movement of IYR. Over the past 5 years, the price, without dividends, is up around 20%. In the lower pane is the ratio of IYR to the SP500 stock index. Because the ratio is falling that tells us that real estate (using IYR as a proxy) has under-performed the broader market stock index, SP500.  It may be hard to tell from the chart, but the amount of under-performance has been more than 20% over this 5 year look-back.  And to insure I am comparing apples to apples I have it set up such that this ratio DOES take into account dividends for both holdings.

Finally, you will see behind the green bars (IYR price) in the middle pane I have included another plot of the 10 year bond yield with a purple dashed line. You can see the almost perfect inverse correlation that exists between bond yields and real estate. The relationship tells us that as interest rates rise the price of IYR falls.  And vice versa. Intuitively, hopefully this inverse relationship makes sense.

With the potential for higher interest rates in our future a real probability, if that were to occur one would expect real estate to struggle. When combined with real estate’s ongoing struggle against other risk assets options (ie. non-real estate global stocks) and my client’s existing exposure, I still find no compelling reason to commit risk investment capital to this part of the market. If and when the economy slows down and interest rates begin to reverse course or the FED changes direction, I will be more than happy to change my mind but until then, there are much better opportunities available for your investment dollar.