In case someone has not heard it sometime over the past two years, the Chairman and CEO of FINRA, Richard Ketchum, pointed out that broker-dealers need to engage in a vigorous due diligence process. Investment News has a story about a news conference that Mr. Ketchum delivered at FINRA's annual meeting in Washington.
Mr. Keetchum is referring specifically to Reg D offerings, private offerings not required to register with the SEC or the states. These offerings especially come under scrutiny because there is no regulatory review of the disclosures made in connection with the offerings. His remarks apply to other investment products that advisors recommend to their clients.
The bottom line is that broker dealers and advisors have an obligation to conduct an investigation into an offering that is sufficient to uncover the material facts which will have an impact on the riskiness and profitability of an offering. Reading an offering document and third party reports is a part of the process but not sufficient. The broker-dealer and advisor must also satisfy himself that the characteristics that promote profitability exist, verify any risk mitigation, and reconcile any discrepancies uncovered. Occasionally this can be accomplished in a single desktop session. Usually, it requires multiple management interviews and extensive telephone follow up. It especially requires that the work be conducted on behalf of and under the direction of the broker-dealer or advisor. The firms that provide third party due diligence reports are consummate professionals with extensive knowledge and experience and and are of great value in the process. Broker-dealers can consider their work product only as another input into its own due diligence process.
(Disclosure: Clarity Finance, the sponsor of this blog, provides due diligence services on a consulting basis to broker-dealers and financial advisors)
Thursday, May 26, 2011
Wednesday, May 25, 2011
Real Estate Transparency?
The Wall Street Journal carried a small article about an affiliate of Cantor Fitzgerald acquiring a real estate services firm and speculating on the types of products that could be forthcoming. Specifically, derivatives based on commercial real estate rental rates are expected. The Chief Executive is quoted as saying, "You know you can hedge orange juice and you can hedge corn, but real estate you can't? It doesn't make any sense."
Cantor has a history of developing products that bring transparency to otherwise opaque markets. In the late 80s and early nineties, Cantor maintained a trading desk for units of limited partnership. As a part of the business, Cantor published a bid/ask quote for scores of partnerships, and stood ready to trade at the published prices. The revitalization of the REIT market, which allowed for the rollup or buyout of all of the big partnerships of the 80s, led Cantor to close the desk.
I can envision a family of swap contracts that have a group of rental rats on one side (e.g. northeast Class A office, national enclosed retail) and traditional financial rates on the other. Sophisticated investors might even want to swap one rental stream for another.
The development of derivatives based on rental rates will have a number of affects: Rental rates on comparable buildings will tend to converge, leases will reference the derivatives market in escalator clauses, Landlords will be willing to sign longer term leases. the greatest benefit, though, will be the creation of the reference indexes that will be the basis for the derivatives. This will bring a level of transparency to the commercial real estate market that has never existed. This should reduce both the cost and the time required to execute transactions, both leases and acquisitions. And as this information drives convergence and encourages liquidity in the marketplace, real estate will move closer to becoming a mainstream asset class rather than an alternative.
Cantor has a history of developing products that bring transparency to otherwise opaque markets. In the late 80s and early nineties, Cantor maintained a trading desk for units of limited partnership. As a part of the business, Cantor published a bid/ask quote for scores of partnerships, and stood ready to trade at the published prices. The revitalization of the REIT market, which allowed for the rollup or buyout of all of the big partnerships of the 80s, led Cantor to close the desk.
I can envision a family of swap contracts that have a group of rental rats on one side (e.g. northeast Class A office, national enclosed retail) and traditional financial rates on the other. Sophisticated investors might even want to swap one rental stream for another.
The development of derivatives based on rental rates will have a number of affects: Rental rates on comparable buildings will tend to converge, leases will reference the derivatives market in escalator clauses, Landlords will be willing to sign longer term leases. the greatest benefit, though, will be the creation of the reference indexes that will be the basis for the derivatives. This will bring a level of transparency to the commercial real estate market that has never existed. This should reduce both the cost and the time required to execute transactions, both leases and acquisitions. And as this information drives convergence and encourages liquidity in the marketplace, real estate will move closer to becoming a mainstream asset class rather than an alternative.
Tuesday, May 24, 2011
The Intersection of Doing Well and Doing Good
I have discussed impact investing and one version of what it might look like. The January 14 issues of Forbes describes another model.
VisionSpring is a non-profit organization formed to address unemployment in the developing world by providing corrective lenses to people who are unemployable due to poor eyesight. They have trained some six thousand local salespeople to fit basic reading glasses for the potential workforce. The article states that VisionSpring has distributed 600,000 pairs of glasses in seven countries. Thus the social aspect of the venture, promoting employment in third-world countries, is being accomplished directly and indirectly.
The finances of VisionSpring still resembles a charity. Revenue of $290,000 was dwarfed by charitable contributions of $1.7 million in 2010. However, there are signs that sound business decisions are being pursued and applied. The cost of a pair of eyeglasses has declined from nearly $20 per pair in 2005 to under $8 in 2010, partly as a result of changing the organization's distribution model. The company has opened its first optometrist's office in El Salvador, serving clients who need glasses beyond the drugstore readers, with higher margin product. VisionSpring is also investigating new sourcing for its product through strategic partnerships.
The model for this type of social investing is definitely in the venture capital/private equity mold. The capital sources are funding the long-term growth of the organization until it becomes self-sustaining. The measure of success is the amount of funds that are diverted from maintaining the social safety net for the local that become employed as a result of the introduction of VisionSpring versus the capital and time invested in growing the organization to sustainability.
VisionSpring is a non-profit organization formed to address unemployment in the developing world by providing corrective lenses to people who are unemployable due to poor eyesight. They have trained some six thousand local salespeople to fit basic reading glasses for the potential workforce. The article states that VisionSpring has distributed 600,000 pairs of glasses in seven countries. Thus the social aspect of the venture, promoting employment in third-world countries, is being accomplished directly and indirectly.
The finances of VisionSpring still resembles a charity. Revenue of $290,000 was dwarfed by charitable contributions of $1.7 million in 2010. However, there are signs that sound business decisions are being pursued and applied. The cost of a pair of eyeglasses has declined from nearly $20 per pair in 2005 to under $8 in 2010, partly as a result of changing the organization's distribution model. The company has opened its first optometrist's office in El Salvador, serving clients who need glasses beyond the drugstore readers, with higher margin product. VisionSpring is also investigating new sourcing for its product through strategic partnerships.
The model for this type of social investing is definitely in the venture capital/private equity mold. The capital sources are funding the long-term growth of the organization until it becomes self-sustaining. The measure of success is the amount of funds that are diverted from maintaining the social safety net for the local that become employed as a result of the introduction of VisionSpring versus the capital and time invested in growing the organization to sustainability.
Friday, May 20, 2011
How Much Green To Develop Green Energy?
Jerry Taylor and Peter Van Doren have a column in the April 25 issue of Forbes discussing what a green energy economy would look like and how much it will cost to get there. According to Taylor and Van Doren we have lived in a green economy - in the 13th century! Mankind has spent the intervening 700 years making life easier and cheaper, in no small part by harnessing energy sources that are plentiful, portable, and cheap. To return to the energy sources of seven centuries ago is going to cost on the order of 1/4 of the annual economic output of the United States. This capital goes into overcoming the four negative characteristics of green energy that the authors identify: diffusion, expense, unreliability, and scarcity. That subsidies are required to attract capital to these projects indicates that the economics of the concept are inadequate to properly compensate for the risks of the venture. The money quote of the article:
If green energy is so inevitable and such a great investment, why do we need to subsidize it? If and when renewable energy makes economic sense, profit-hungry investors will build all that we need for us without government needing to lift a finger. But if it doesn't make economic sense, all the subsidies in the world won't change that fact.I couldn't say it any better myself.
Thursday, May 19, 2011
Hedging Longevity
Possibly the biggest risk faced by today's retirees is outliving their assets. With active lifestyles and improvements in health care, life expectancy has been increasing steadily over the past seventy years. Now it is having an impact on pension plans and other institutions. These organization are having difficulty managing the tails of their liability because there are so few market participants that would naturally assume the risk that plans want to lay off.
Now Bloomberg reports that large investment banks are developing products for these institutions to hedge their risks. These instruments are talking the form of longevity bonds and swaps, and the payout are based on indexes developed by Credit Suisse and JPMorgan. These derivative are complex and illiquid, not least because their payouts will not be known for another twenty years or so.
These markets are very early in development and are limited to very large institutions. Right now, the only mechanism for hedging longevity risk for the typical retiree is an annuity with a cost of living rider. It seems to me that some combination of endowment contract and deferred annuity could be packaged to provide a contingent deferred annuity for pennies on the annual income dollar.
What would it look like? Assume the client is a male, age 65, wanting to produce $40,000 a year in income after he turns 85. A 20-year Treasury strip is yielding about 4.5%, which is about the same as a 30-year strip. The Social Security Administration estimates the life expectancy of an 85-year-old at 5.65 years, and the probability of a 65-year old reaching 85 at 40%. The present value of the $40,000 per year single life annuity at age 85 with a 3.75% discount rate (giving the insurance company a 0.75% spread) is $181,709. That investment would require the deposit of $75,344 today earning the current Treasury strip rate. That alone is not bad; less than two years of income to ensure that incremental $40,000 per year for life. However, if the probability of achieving age 85 is factored in, it would take a premium of only $30,138. The downside is that there would be no benefit paid in the event of death before age 85, and annuity payments would stop at death after age 85.
These insurance companies are full of very smart marketing executives and pricing actuaries. When they realize that this type of product is a natural hedge against their straight life insurance portfolio, in addition to the structure investment banking products being developed, I expect these longevity annuities to be available through the advisor market in 2-3 years.
Now Bloomberg reports that large investment banks are developing products for these institutions to hedge their risks. These instruments are talking the form of longevity bonds and swaps, and the payout are based on indexes developed by Credit Suisse and JPMorgan. These derivative are complex and illiquid, not least because their payouts will not be known for another twenty years or so.
These markets are very early in development and are limited to very large institutions. Right now, the only mechanism for hedging longevity risk for the typical retiree is an annuity with a cost of living rider. It seems to me that some combination of endowment contract and deferred annuity could be packaged to provide a contingent deferred annuity for pennies on the annual income dollar.
What would it look like? Assume the client is a male, age 65, wanting to produce $40,000 a year in income after he turns 85. A 20-year Treasury strip is yielding about 4.5%, which is about the same as a 30-year strip. The Social Security Administration estimates the life expectancy of an 85-year-old at 5.65 years, and the probability of a 65-year old reaching 85 at 40%. The present value of the $40,000 per year single life annuity at age 85 with a 3.75% discount rate (giving the insurance company a 0.75% spread) is $181,709. That investment would require the deposit of $75,344 today earning the current Treasury strip rate. That alone is not bad; less than two years of income to ensure that incremental $40,000 per year for life. However, if the probability of achieving age 85 is factored in, it would take a premium of only $30,138. The downside is that there would be no benefit paid in the event of death before age 85, and annuity payments would stop at death after age 85.
These insurance companies are full of very smart marketing executives and pricing actuaries. When they realize that this type of product is a natural hedge against their straight life insurance portfolio, in addition to the structure investment banking products being developed, I expect these longevity annuities to be available through the advisor market in 2-3 years.
Wednesday, May 18, 2011
Stimulus and Jobs
I found a paper addressing the effect of the Stimulus Bill of 2009 on jobs and job creation: "The American Recovery and Reinvestment Act: Public Sector Jobs Saved, Private Sector Jobs Forestalled" by Timothy Conley and Bill Dupor, economics professors from University of Western Ontario and the Ohio State University, respectively. The best estimate of the study is that ARRA created/saved approximately 450,000 state and local government jobs, while it destroyed/forestalled about one million private sector jobs. The authors discuss the margin of error for their estimates and the differences with the conclusions of others in assessing the effectiveness of the program. I am comfortable with the rigorous methodology applied to empirical data, and the impartiality of the authors.
The major conclusion to be be drawn is that the results of this traditional Keynesian prescription were not realized. The theory is that the government sector, with its unlimited borrowing and taxing authority, should take up the slack in generating aggregate demand in the economy. In this case, though, the policy had a negative effect of 550,00 net jobs lost.
This is not meant to be a criticism of the policy embodied by ARRA. Rather, I bring it up to inform future economic analysis in the investment decision making process when similar policies are pursued. That is, Keynesian spending can not be counted on to preserve private sector jobs, though it can offset those losses somewhat with public sector employment.
Special Thanks to: QandO.net
The major conclusion to be be drawn is that the results of this traditional Keynesian prescription were not realized. The theory is that the government sector, with its unlimited borrowing and taxing authority, should take up the slack in generating aggregate demand in the economy. In this case, though, the policy had a negative effect of 550,00 net jobs lost.
This is not meant to be a criticism of the policy embodied by ARRA. Rather, I bring it up to inform future economic analysis in the investment decision making process when similar policies are pursued. That is, Keynesian spending can not be counted on to preserve private sector jobs, though it can offset those losses somewhat with public sector employment.
Special Thanks to: QandO.net
Wednesday, May 11, 2011
New Rules for Money Market Funds
According to an Investment News article, the SEC is heading a a review of the regulations governing money market funds. The immediate objective is to stem any run on the fund that breaking the buck might cause. A couple of proposals adopt a kind of "loss reserve pool" mechanism to allow for defaults and provide liquidity when markets dry up. The most disruptive is a proposal to have money market fund NAVs float on a daily basis.
On the surface, these proposals seem reasonable. The sanctity of the $1 NAV is one feature that has made money market funds so popular. Investor confidence in the security of the funds invested. However, the new regulations would be costly. And in an era of 0.1% yields, it is not clear that the new costs could be born by the funds and still offer investor an attractive yield.
Perhaps the experience with The Reserve Fund is an indication that we are asking too much of a mutual fund. After all, most money finds rely on an arcane accounting methodology (called income equalization) to maintain that $1 NAV as it is. Most brokerage firms now offer an FDIC insured cash management option, often with comparable services and higher yields than their money market funds. Even the plain cash balance accounts at brokerage firms are insured by the SPIC, even if they don't pay interest. Money funds could be merged into short-term bond funds, which is what they would become under floating NAV proposals.
Update: FDIC Corp. Chair calls money market fund stable NAV a "fiction," and is not overstating the case.
On the surface, these proposals seem reasonable. The sanctity of the $1 NAV is one feature that has made money market funds so popular. Investor confidence in the security of the funds invested. However, the new regulations would be costly. And in an era of 0.1% yields, it is not clear that the new costs could be born by the funds and still offer investor an attractive yield.
Perhaps the experience with The Reserve Fund is an indication that we are asking too much of a mutual fund. After all, most money finds rely on an arcane accounting methodology (called income equalization) to maintain that $1 NAV as it is. Most brokerage firms now offer an FDIC insured cash management option, often with comparable services and higher yields than their money market funds. Even the plain cash balance accounts at brokerage firms are insured by the SPIC, even if they don't pay interest. Money funds could be merged into short-term bond funds, which is what they would become under floating NAV proposals.
Update: FDIC Corp. Chair calls money market fund stable NAV a "fiction," and is not overstating the case.
Monday, May 9, 2011
10-K Season - Inland
10-Ks have all been filed and the scrutiny just begun. I have run a basic financial statement analysis on the most recent Inland offerings - Inland Western Retail, Inland American, and Inland Diversified - and present a summary below.
Inland Diversified opened its offering in August 2009 and is raising funds at a reasonable pace. At December 31, 2010, the REIT had $450 million of assets including $313 million of real estate owned directly. The company generated $19 million total revenue and a $2 million net loss. The shareholder 6% dividend is 46% covered by Funds from Operations and 69% by Modified Cash Flow. While subsidizing dividends is common during the capital raising phase, especially this early, continuing the practice of distributing funds in excess of those generated will result in the dilution of shareholder equity.
Inland American closed its offering in April 2009. At December 31, 2010, the REIT had $11.4 billion of assets including $9.6 billion of real estate owned directly. Inland American realized $1.2 billion total revenue and a $176 million net loss. The shareholder 5% dividend is 60% covered by Funds from Operations and 106% by Modified Cash Flow. The company reported approximately $168 million of asset impairments during 2010, partially offset by about $22 million of realized gains. The REIT appears to be managing its cash flow prudently, having already reduced its dividend to 5%. However, it has recorded significant impairments and losses over the past three years. Therefore, it would not be a surprise if share values are significantly lower than the original $10 share price, or even the current $8.03 DRIP price.
Inland Western has filed a Form S-11 with the SEC indicating its intention to list the shares on a stock exchange.
In Millions | Inland Western Retail | Inland American | Inland Diversified |
Total Assets | $6,387 | $11,392 | $450 |
Total Liabilities | $4,090 | $5,864 | $224 |
Equity Raised | $4,595 | $8,325 | $260 |
Net Real Estate | $5,686 | $9,563 | $313 |
Direct Debt | $3,603 | $5,532 | $193 |
Leverage Ratio | 63.3% | 57.8% | 61.5% |
Revenue | $647 | $1,232 | $19 |
Net Income | ($85) | ($176) | ($2) |
FFO | $135 | $253 | $3.9 |
Mod Cash Flow[1] | $153 | $442 | $5.8 |
Dividends | $95 | $418 | $8.4 |
Yield ($10 share) | 2.0% | 5.0% | 6.0% |
Inland Diversified opened its offering in August 2009 and is raising funds at a reasonable pace. At December 31, 2010, the REIT had $450 million of assets including $313 million of real estate owned directly. The company generated $19 million total revenue and a $2 million net loss. The shareholder 6% dividend is 46% covered by Funds from Operations and 69% by Modified Cash Flow. While subsidizing dividends is common during the capital raising phase, especially this early, continuing the practice of distributing funds in excess of those generated will result in the dilution of shareholder equity.
Inland American closed its offering in April 2009. At December 31, 2010, the REIT had $11.4 billion of assets including $9.6 billion of real estate owned directly. Inland American realized $1.2 billion total revenue and a $176 million net loss. The shareholder 5% dividend is 60% covered by Funds from Operations and 106% by Modified Cash Flow. The company reported approximately $168 million of asset impairments during 2010, partially offset by about $22 million of realized gains. The REIT appears to be managing its cash flow prudently, having already reduced its dividend to 5%. However, it has recorded significant impairments and losses over the past three years. Therefore, it would not be a surprise if share values are significantly lower than the original $10 share price, or even the current $8.03 DRIP price.
Inland Western Retail completed an internalization of its management in November 2007 and therefore has no formal affiliation with The Inland Group. At December 31, 2010, the REIT had $6.4 billion of assets including $5.7 billion of real estate owned directly. Inland Western realized $647 million total revenue and a $85 million net loss. The shareholder 1.96% dividend is 142% covered by Funds from Operations and 162% by Modified Cash Flow. The REIT's operations have been severely adversely affected over the past three years by economic and market conditions. Over this period, Inland Western has recorded impairments and realized net losses on the order of $659 million, partially offset by realized gains of $50 million from the sale of properties associated with discontinued operations. The company also worked through significant debt refinancings over 2009 and 2010, and continues to negotiate with lenders on the remainder of the debt portfolio. Close maturities include a $154 million line of credit due in 2011, $646 million of fixed rate and $26 million of variable rate debt in 2011, $411 million fixed and $88 million variable due in 2012, and $320 million of fixed rate mortgages due in 2013. While the REIT's management has worked diligently to preserve the value of the company's assets, it would not be unreasonable to estimate share value approximately equal to book value of $4.81 per share.
Inland Western has filed a Form S-11 with the SEC indicating its intention to list the shares on a stock exchange.
[1] Modified Cash Flow is an Clarity Finance measure which equals (1) net income plus (2) depreciation and amortization, plus (3) acquisition fees and expenses, less (plus) (4) any realized or provisions for capital gains (losses) on the income statement, less (plus) (5) income (losses) from unconsolidated entities, plus (6) distributions from unconsolidated entities.
Thursday, May 5, 2011
Supercharged ETFs
As I was catching up on my Forbes reading, I came across this article about leveraged ETFs. Now I have shied away from any of the leveraged funds because their performance has confounded naive expectations. For example, when a particular index would be up 20% one year, one would expect the 2x fund based on that index to be up 40%. Experience showed us, though, that the fund might be up any where from 0% to 50%. when the index registered a single digit gain, the fund may actually have lost money. The key to the disconnect is in the mechanics of managing that leveraged exposure. The fund rebalances to its leverage target every day. That is the leverage on the initial NAV changes each day based on the cumulative gains realized since the inception of the investment. Thus if the index experiences a 50% increase, the fund will take on 50% additional leverage, but the performance will still be calculated on the original investment.
Inn strongly trending markets this can actually work in the investor's favor, delivering performance that is greater than the advertised leverage. In a directionless market with some volatility, the leveraged fund will tend to decline. This result can be traced back to the mathematics of loss and gain that we all learned early on: if an investment loses 50% of its value, it will take a 100% gain to break even.
The article acknowledges all of this and essentially says use them anyway. I would recommend against using any of the leveraged funds, suggesting instead to use a brokerage account and buying your index tracking fund on margin. The investor can maintain his leverage relative to his original investment, according to his own comfort. Also, you can probably find a cheaper fund in which to invest.
Inn strongly trending markets this can actually work in the investor's favor, delivering performance that is greater than the advertised leverage. In a directionless market with some volatility, the leveraged fund will tend to decline. This result can be traced back to the mathematics of loss and gain that we all learned early on: if an investment loses 50% of its value, it will take a 100% gain to break even.
The article acknowledges all of this and essentially says use them anyway. I would recommend against using any of the leveraged funds, suggesting instead to use a brokerage account and buying your index tracking fund on margin. The investor can maintain his leverage relative to his original investment, according to his own comfort. Also, you can probably find a cheaper fund in which to invest.
Hazardous DRIPs
I am constantly amazed at the popularity of distribution reinvestment programs (DRIPs) on illiquid entities such as non-traded REITs. That as much as half of distributions from a non-traded REIT are reinvested indicates that investors are not carefully considering this decision.
First, I understand the rationale for wanting to reinvest. Compounding returns are a very powerful investment force for wealth accumulation, and we are taught that interest and dividend must be reinvested to achieve compounding. Furthermore, the REIT discounts the share price at which the distributions are invested.
However, these benefits do not overcome the major disadvantage of these securities, their illiquidity. These distributions offer a small amount of liquidity from an investment that is not currently marketable, and whose liquidity timing is distant if not uncertain. The bird in the hand principle applies here.
What about compounding? Yes, this aspect of wealth accumulation will be sacrificed. On the positive side, it will avoid compounding negative returns. More to the point, the sensitivity of real estate returns to acquisition and disposition endpoints, along with the relatively large minimum investment commitments required, suggest that time diversification could be more valuable than compounding in this asset class.
The discounted price is an even easier issue to address: it is an illusion. The regular price of a share is typically $10. That price includes say, 75 cents of commission and 25 cents of marketing assistance that is not spent on the the reinvested distributions. So the net proceeds to the REIT (comparable to a mutual fund's NAV) are $9. The dividend reinvestment program will sell shares at $9.50, so those reinvested shares are immediately diluted by 50 cents. Not a good deal.
I have long recommended that investors decline the reinvestment opportunity and accumulate the cash dividends in their investment account. If they are concerned about compounding, an option (albeit imperfect) is to invest in one of the REIT mutual funds or ETFs. Vanguard REIT ETF (VNQ) is a low cost option for tracking the MSCI REIT Index.
First, I understand the rationale for wanting to reinvest. Compounding returns are a very powerful investment force for wealth accumulation, and we are taught that interest and dividend must be reinvested to achieve compounding. Furthermore, the REIT discounts the share price at which the distributions are invested.
However, these benefits do not overcome the major disadvantage of these securities, their illiquidity. These distributions offer a small amount of liquidity from an investment that is not currently marketable, and whose liquidity timing is distant if not uncertain. The bird in the hand principle applies here.
What about compounding? Yes, this aspect of wealth accumulation will be sacrificed. On the positive side, it will avoid compounding negative returns. More to the point, the sensitivity of real estate returns to acquisition and disposition endpoints, along with the relatively large minimum investment commitments required, suggest that time diversification could be more valuable than compounding in this asset class.
The discounted price is an even easier issue to address: it is an illusion. The regular price of a share is typically $10. That price includes say, 75 cents of commission and 25 cents of marketing assistance that is not spent on the the reinvested distributions. So the net proceeds to the REIT (comparable to a mutual fund's NAV) are $9. The dividend reinvestment program will sell shares at $9.50, so those reinvested shares are immediately diluted by 50 cents. Not a good deal.
I have long recommended that investors decline the reinvestment opportunity and accumulate the cash dividends in their investment account. If they are concerned about compounding, an option (albeit imperfect) is to invest in one of the REIT mutual funds or ETFs. Vanguard REIT ETF (VNQ) is a low cost option for tracking the MSCI REIT Index.
Tuesday, May 3, 2011
Home Sweet Home
Smart Money examined the question of the value of home ownership as an investment. The article challenges the conventional wisdom that home ownership is always and everywhere a good economically and socially. There is little evidence presented, and I would daresay that there is little agreement among social scientists, about the societal value of a populace of home owners versus renters. On the other hand, the article does not shy from drawing the conclusion that home ownership is weak mas an investment. The story arrives at this judgement based on flat home prices between 2000 and 2010. In fact, the return on home ownership is more complex than just whether or not the property has appreciated.
Home ownership has three elements to its return. First is the appreciation of the asset. While prices were flat over the first decade of the current century, the article notes that "the rate of appreciation in housing seems likely to return to its long-term historical average, which is only slightly higher than the rate of inflation." While this growth of capital pales in comparison to the long term return to common stock, for instance, it is competitive with returns to Treasury securities.
Home ownership has three elements to its return. First is the appreciation of the asset. While prices were flat over the first decade of the current century, the article notes that "the rate of appreciation in housing seems likely to return to its long-term historical average, which is only slightly higher than the rate of inflation." While this growth of capital pales in comparison to the long term return to common stock, for instance, it is competitive with returns to Treasury securities.
Municipal Bonds Revisited
Bloomberg has a story a bout how "dumb" money is fleeing municipal bond mutual funds. Later in the article, though, do it yourself investors are credited with aggressively buying individual bonds. Advisors and brokers are also buying on behalf of their clients, but at about half the rate as DIY investors, according to BondDesk Group.
Municipal bonds may be the best value in the fixed income marketplace today. Muni bonds are trading at 40 to 90 basis points higher yields than treasuries, depending on the maturities. They usually trade at parity on a taxable equivalent basis. The pricing is suggesting that munis are expected to default at a rate of 1% per year, a rate six time higher than since July 2009 and 15 times the rate since the 1970s.
Right now, the muni market appears to be offering free money. There are some opportunities overseas as well, with European gilts trading at 100 basis points over Treasuries, and Australian governments at 200 basis points. These yield advantages assume no turnaround in the value of the dollar, which can not be assured. Certainly, the bonds on the taxable portion of client portfolios should be in tax exempts.
Municipal bonds may be the best value in the fixed income marketplace today. Muni bonds are trading at 40 to 90 basis points higher yields than treasuries, depending on the maturities. They usually trade at parity on a taxable equivalent basis. The pricing is suggesting that munis are expected to default at a rate of 1% per year, a rate six time higher than since July 2009 and 15 times the rate since the 1970s.
Right now, the muni market appears to be offering free money. There are some opportunities overseas as well, with European gilts trading at 100 basis points over Treasuries, and Australian governments at 200 basis points. These yield advantages assume no turnaround in the value of the dollar, which can not be assured. Certainly, the bonds on the taxable portion of client portfolios should be in tax exempts.
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