People follow a “set it and forget it” nest egg strategy. That means faithfully putting money each month towards one or more retirement accounts.
But the global economy has become unpredictable, making it harder to distinguish between winning and losing investments. Thanks to quantitative easing (where governments and central banks print money to stimulate the economy), there’s too much cash chasing too few returns.
QE has led to negative interest rates, an unprecedented economic phenomenon. As of August, there were $15 trillion of negative yielding bonds worldwide, according to Bloomberg. That represents 30% of government bonds and 15% of the total bond market. These levels are all-time highs according to JPMorgan, especially in Europe and Japan.
Negative interest rates has a few consequences, which we explore below. If you’re a real estate investor, you’ll want to read on.
Cheap Debt and Inflated Asset Prices
An important consequence is the availability of cheap leverage. Borrowers win because the abundant supply of cash lowers borrowing costs. However, depositors lose because banks aren’t compensating savers nearly enough for storing (cheap) cash in checking or savings accounts.
Moreover, pensioners and retirees are seeing lower income from their debt investments. Thus, some will pursue riskier investments to acquire sufficient income.
One executive cautions people from being overly aggressive, and suggests that real estate may be a safe haven that provides both cash flow and asset appreciation.
“Real estate valuations may be pushed higher because of expansionary monetary policies, but it remains a sound investment as long as there’s demand and reasonable amount of development,” says Baruj Avram, CEO of Titanium Group, one of the biggest real estate companies in Panama. “It’s good to look at the fundamentals. Emerging markets have high population growth, and people always need a place to stay, live, and work.”
That translates to rental income and higher asset valuations, so long as investors watch out for local conditions (such as too much construction or inventory) that could lead to a bubble.
Seeking Returns in Properties
A result of quantitative easing (excess cash) is inflated asset prices, particularly stocks and real estate. Bondholders don’t get returns from negative yielding notes, therefore more investors will look towards stocks, real estate, and other properties (gold, Bitcoin, etc.).
As such, we could see a large shift in capital allocation worldwide.
The global real estate market stood at $217 trillion in 2016, while bonds were $92 trillion and stocks $70 trillion. The question that everyone is asking is how capital will be allocated when there are negative interest rates.
“Common sense still has a place in the global financial system, and that means viewing real estate as a tangible, physical investment,” says Avram, whose company provides real estate services such as hotels, office rentals, and apartments. “Currencies are nice to have but these are soft, unbacked notes that central banks have printed too much of. And it doesn’t pay to deposit cash with a bank. Aside from negative yields, there’s a risk of inflation due to excess fiat cash placed in the hands of consumers.”
So what’s a safer game plan?
Debt is now very cheap. Therefore, property owners can refinance their mortgages and lower monthly payments. With real estate, steady rental income is a nice yield. The cash flow means an investor gets paid (by renters) to see his property value go up.
Warren Buffett preaches that investors should acquire assets that produce something, anything — whether dividends, rental income, farm harvest, or yield. In the long-run, he says, 70% of returns come from cash flow while only 30% are derived from asset appreciation.