One of the wealth tenets I’ve followed since the first dotcom crash in 2000 is to always convert funny money into real assets. My definition of funny money is an investment that makes an irrational return in excess of fundamentals. There are obviously various levels of irrationality.
Some friends and colleagues went from huge stock market returns in 1999 only to lose everything and more in 2000. Going on margin was partly to blame. While some stocks like Webvan and Pets.com literally went to zero.
Over time, I noticed those who turned their dotcom fortunes into Manhattan or San Francisco real estate during the early 2000 era were able to extend the value of their fortunes and do quite well. As a result, young Samurai followed suit.
Of course, many homeowners ended up getting slaughtered during the 2008-2009 financial crisis buying too much home, just like stock investors who went on margin in 2000. But those who bought responsibly and were able to refinance and hold on saw their gains return.
The question I have now is whether we should cash out of stocks and buy real estate since the S&P 500 is already up 16% YTD April 2019 and back to an all-time high.
I’d like for everybody to thoughtfully pitch in with their opinion. Everybody’s circumstance is different, which is why it’s important to listen to as many different perspectives as possible.
There is no perfect answer.
Cashing Out Of Stocks To Buy Real Estate
The reasons why I’m wondering whether to cash out of stocks and buy real estate are due to the following:
1) We’ve recovered all our funny money gains. My House Fund, consisting of stocks and bonds, went from about $1.95 million down to $1.7 million during the 2018 correction (-13%) and now is back up to $2.1 million (+23%) for a $400,000 swing. I’m sure many of you have seen similar percentage magnitudes of recovery if you calculate recent trough to peak levels in your portfolio.
2) Real estate was weak in 2018. San Francisco median home prices went down ~11.5% from its 2018 peak. We’ve seen similar weakness across many major cities in America and around the world. The weakness provides some solace that some steam has already been let out of the real estate market.
3) Affordability increasing. With lower median prices and declining mortgage rates, interest in real estate is increasing. There’s also a strong demographic trend as Millennials are the largest home buying demographic and are starting families.
Below highlights the 10-year bond yield at close to a 5-year low as of August 13, 2019. The 10-year bond yield was about 3.3% in 4Q2018. This 1.5% move down should boost demand due to increased affordability.
4) Tech IPO spillover. Uber finally filed its S-1 and I know the tech IPO hype is only going to grow over the next two years. While I’ve written there is a chance the hype will awaken a slumbering supply bear, my experience post-Facebook’s IPO is that it will take about one year for the wealth effect to spillover into real estate.
The lockup periods for tech IPO employees such as Pinterest, Uber, Zoom and more is in November 2019 and later. I suspect the Spring of 2020 will be very strong for housing again.
5) A strong desire to create utility out of stocks. Stocks provide no utility, whereas real estate does. It is a wonderful feeling to make money in stocks and convert gains into something tangible. To be able to use real estate as a second home, an office space, or as a new primary residence for an expanding family to enjoy for decades is a win.
Living Our Best Lives Now
The entire purpose of achieving FIRE is so that we can live our best lives now.
When we invest in stocks, our hope is to generate profits so that we can live better lives in the future. Of course, we can also invest in stocks to produce dividend income to live off of today.
But if we really wanted to generate income to live our best lives today, there are more prudent, better ways to earn higher amounts of steady passive income with lower volatility.
The downside to cashing out of stocks and buying real estate is that one might be jumping out of the frying pan and into the fire. With rising inventory and a slowdown in the economy, real estate prices could continue to soften in the coming years. Leverage up too much and financial pain could ensue.
I just keep going through what played out during the 2000 dotcom bubble. As stocks crumbled in between 2000-2002, real estate picked up steam because mortgage rates began to decline. Stock investors started seeking shelter in real estate and REITs in particular performed the best between 1999-2018.
The $400,000 recovery in my House Fund portfolio feels like funny money to me. It’s like buying a $2 million property for only $1.6 million or a $500,000 property for only $100,000. What a bargain!
Further, the real estate market generally lags the stock market by around six months in terms of recovery or declines. Therefore, with the stock market up so strong YTD, it feels like there’s a window of opportunity to buy property right now before prices catch up.
Finally, depending on how much wealth you have, you don’t have to cash out 100% of stocks to buy real estate. You can consider rebalancing your net worth more towards real estate while still investing a good percentage in stocks.
Taxes can really put a damper on returns, so make sure to calculate the resulting tax consequences of cashing out before making any moves.
Where And What Real Estate To Buy
The obvious question is where and what real estate to buy if one does cash out of stocks.
We should buy what we intimately know and buy in markets that will see the strongest job growth while also having attractive valuations.
I know San Francisco the best, hence I will focus one part of my search looking for ocean view properties that have expansion potential. Fixers listed by out of town agents are always my favorite types of properties to buy.
Then I’ll continue to look at non-coastal city real estate that has the highest potential to be the next Silicon Valley. Cities like Austin, Houston, and Denver have already been discovered.
But there are many other cities like Birmingham and Des Moines that have yet to receive much fanfare that can be invested in through real estate crowdfunding platforms like Fundrise or RealtyMogul. Both are free to sign up and explore.
As of now, I am 70% leaning towards cashing out of stocks to buy more real estate. Stocks are back to all-time highs and I see opportunity in real estate.