Real Estate Is Like A Bond Plus Investment: More Upside Potential

9 minutes, 22 seconds Read

Selling bonds to buy real estate is a much easier decision than selling stocks to buy real estate. Real estate works like a bond plus investment because bonds are more similar to real estate than stocks.

The word “plus” is added to bonds to describe real estate as a type of bond that has more upside potential and less downside potential. Nothing is certain though, so the term is probable.

This post is for people who:

  • Trying to better understand the dynamics between investing in real estate vs. bonds
  • Consider selling bonds to buy real estate or vice versa
  • Trying to properly build their net worth based on their risk tolerance
  • Looking for ways to achieve financial freedom faster with more risk than bonds

Why Real Estate Works Like a Bond Plus Investment

Real estate and bonds work the same way.

When interest rates fall, bond values ​​and real estate values ​​rise. When interest rates rise, bond values ​​and real estate values ​​fall.

So, if you sell bonds after interest rates rise to buy real estate, you may be at a loss for one. You will likely lose money on bonds if you own a bond fund or sell a bond before maturity in a rising interest rate environment.

Conversely, if you sell bonds after interest rates drop to buy real estate, you can trade a winner for more winners. As a result, the shift in asset class isn’t as large as you would a shift from stocks to real estate.

The correlation between real estate and bonds makes owning bonds less necessary for diversification if an investor already owns real estate in their portfolio.

Real estate is a bond plus in an upside scenario

In a bull market, you will likely make a higher percentage and greater absolute return from real estate than from bonds. This is where the “plus” comes in “Bond Plus”.

Because of leverage, real estate has higher cash-on-cash returns. Additionally, because of the larger absolute dollar value of real estate holding bonds, the absolute return from real estate tends to be higher as well.

If we talk about a primary residential investment, there are bonds on other plus real estate that the home owner can enjoy the house. Where bond investors cannot enjoy their bonds. Bonds have no utility.

In the below 20-year annual return by asset class chart, you can group REITs and Homes together. For investing in REITs and private real estate funds. Houses are for living. Although Homes only shows a 3.7% return, with leverage, the cash-on-cash return is much higher.

Returns by Asset Class - Comparing Real Estate and Bonds

Real estate as a bond plus in a bad situation

Real estate can outperform bonds in a negative scenario.

For example, when interest rates rose aggressively in 2022 and 2023, bond funds were hit. IEF, the iShares 7-10 Year Treasury Bond ETF, is down ~15% in 2022. TLT, the iShares 20+-Year Treasury Bond ETF, is down 30% in 2022.

Meanwhile, real estate outperformed as average home prices in America fell by just ~8% in 2022. Hence, compared to long-term treasury bond funds, intermediate real estate outperforms.

Median real estate prices also outperformed the Bloomberg US Aggregate Bond Index, which fell 13% in 2022.

If you compare median real estate prices with riskier corporate bond funds, median real estate prices outperformed.

Real estate investors can more easily take steps to protect against downside risk

In 2023, median real estate prices in America are actually up a few percentage points while bond funds are down. Why? Most homeowners refinanced when prices were low and therefore are unwilling to sell. Low supply supports high prices.

Real estate investors are better able to hedge against downside risk action taken. These actions typically include refinancing, finding high-paying tenants, and remodeling.

On the other hand, bond investors can’t do much to hedge other than short. Bond investors, like stock investors, are essentially passive investors who cannot affect positive change.

Real estate offers more benefits in times of extreme hardship

Investors buy Treasury bonds and high-rated municipal bonds for safety. At the same time, many investors also buy real estate for protection because it is a real asset with utility. Residential real estate values ​​usually don’t just go poof overnight.

Here are two extreme hardship examples to illustrate why real estate is a plus over bonds for peace of mind.

Example 1: There is hyperinflation of 1,000% a year. Government bonds will probably collapse, while real estate values ​​probably won’t. Instead, real estate values ​​will likely be hyper-inflated because it is a finite good. People work and earn money to buy real estate, not the other way around.

Example 2: Your country is going to war. Government bonds can also collapse due to capital flight. Fear that a new regime will take over and devalue your country’s currency. However, as long as your house isn’t bombed, it pays more than a bond because it provides shelter. Although the value of your home will also decrease, at least it is enabling you to live.

To understand financial concepts more easily, it helps to think in extremes.

Type of bond subject to relative performance

Although real estate can often outperform bonds in a rising interest rate environment or recession, this is not always the case.

Let’s say you buy $1 million worth of one-year Treasury bonds that yield 4.5% before interest rates start rising. You sold the entire position nine months later to buy real estate.

With a one-year Treasury bond, you likely won’t lose any principal due to the bond’s extraordinary liquidity, a long-enough holding period, and relatively short duration. Instead, you might have returned 3.375% ($33,750) after nine months instead of a 4.5% return after twelve months.

Holding an individual Treasury bond to maturity is a guaranteed return. Holding a short-term Treasury bond increases the likelihood that you won’t lose money if you need to sell before maturity.

In the example above, a 3.375% return outpaces an 8% decline in median real estate prices in 2022. So, if you bought a $1 million property that depreciated to $80,000, your net gain would be $80,000 plus $33,750 of your one-year Treasury bond gain.

Invest based on your understanding

I don’t like owning bond funds because there is no maturity date to get all the principal and interest back. You can certainly earn higher returns by buying bond funds if you time your trades correctly, such as selling when interest rates are at their peak and selling when interest rates are at their lowest.

Many bond investors invest in risky junk bonds, corporate bonds, and high-yield bonds and try to provide higher returns. However, this type of investment is not for me. I am happy as a buy and hold investor.

To invest in riskier assets for greater potential upside, I’d rather invest in stocks or real estate because I’m most familiar with these assets. For capital preservation, I prefer to invest in private treasury bonds or AA-rated municipal bonds and hold them to maturity.

Consider selling Treasury bonds to buy real estate with cash

Before selling individual Treasury bonds to pay cash for a new home, consider the following:

  • Will I lose money if I sell before maturity? If you sell, check your Treasury bond purchase price against the bid price. If you think you will sell the bond at a loss, you can hold it until maturity and sell a different bond instead.
  • How much monthly risk-free interest income would you give up if you sold before maturity? Not earning interest is the main reason I wrote the post, How to Delay Closing Escrow to Make More Money.
  • How much federal ordinary income tax do you have to pay on Treasury bond income? You pay less ordinary income tax if you sell Treasury bonds sooner because less income will be generated. Treasury bonds are not subject to state income tax.
  • What would your net worth and investment portfolio structure look like if you sold Treasury bonds to buy a new home? Personally, I am not a fan of any single asset class that accounts for more than 50% of one’s net worth.

Selling Treasury bonds to buy real estate was an easy decision

Given that real estate is like a bond plus investment, over the long term, I think my house will appreciate in value at a faster rate than my Treasury bond yields. Part of the reason is because interest rates will eventually fall, making Treasury bonds less attractive.

If I were to sell junk bonds or long-term treasury bond funds that are too short to buy real estate, that would be a much tougher decision. Junk bond and long-term Treasury bond funds will likely outperform real estate if interest rates fall because they are much more volatile.

My biggest lament for selling treasury bonds to buy a home is no longer getting ~5% risk-free returns. A 5% guaranteed return with inflation of around 3.5% is a solid real return.

Although I paid cash and have no mortgage, I now earn a little from a lot of risk-free income. Additionally, I got to pay more property taxes and maintenance bills.

Summary of real estate as a bond plus investment

  • Bonds and real estate react similarly to changes in interest rates
  • Real estate can provide higher returns than bonds in good times
  • Real estate can lose less than bonds in bad times because real estate investors can take action
  • If you own real estate, you don’t need to own as many bonds to diversify your portfolio.
  • Selling bonds to pay cash for a house is easier than selling stocks to pay cash for a house
  • Should your down payment fund consist of short-term individual treasury bonds versus treasury bond funds or riskier bond types?

Real estate is my favorite asset class for regular people to build wealth. Real estate generates income, provides shelter, diversification, can be improved, generally benefits from inflation, and has a positive historical return. The average American household net worth will increase to $1.06 million in 2022, largely due to real estate.

Bonds are good and have a historical average return of around 5%. But you can’t enjoy your bonds or improve your bonds, bonds just aren’t an attractive enough investment compared to real estate.

Achieving financial freedom is easier with real estate than with bonds. As a result, I’m going to continue owning real estate over bonds for the rest of my life. The key is to invest in real estate properly. If you borrow too much to buy too many houses, you may face financial problems in the future.

Reader questions and suggestions

What are your thoughts on holding bonds if you already own real estate? Do you see real estate as a bond plus investment? When does owning bonds outweigh the benefits of owning real estate?

If you want to dollar-cost average in a weak real estate market, take a look funds. Fundrise primarily invests in residential and industrial properties in the Sunbelt, where valuations are low and yields are high. Fundrise is a Financial Samurai Affiliate Partner.

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