Selling bonds to buy real estate is a much easier decision to make than selling stocks to buy real estate. Real estate acts like a bond plus investment because bonds have more similarities to real estate than stocks do.
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. Although nothing is guaranteed, hence the word potential.
This post is for people who are:
- Trying to better understand the dynamics between investing in real estate versus bonds
- Considering selling bonds to buy real estate or vice versa
- Trying to properly construct their net worth based on their risk tolerance
- Looking for ways to achieve financial independence sooner with more risk than bonds
- Who believe in real estate since it is a tangible asset that generates income and provides utility
Why Real Estate Acts Like A Bond Plus Investment
Real estate and bonds act similarly.
When interest rates go down, bond values and real estate values tend to go up. When interest rates go up, bond values and real estate values tend to go down.
Hence, if you sell bonds after interest rates rise to buy real estate, you could be trading one loser for another. You will likely lose money in 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 decline to buy real estate, you could be trading one winner for an even greater winner. As a result, the shift in asset classes is not as large as if you were to shift from stocks to real estate.
The correlation in real estate and bonds also makes owning bonds less necessary for diversification if an investor already owns real estate in their portfolio.
Real Estate As A Bond Plus In An Upside Scenario
In a bull market, you will likely make a higher percentage and larger absolute return from real estate than from bonds. This is where the “plus” comes in in “bond plus.”
Due to leverage, real estate tends to have a higher cash-on-cash return. In addition, due to usually the larger absolute dollar value of the real estate holding versus bonds, the absolute return amount from real estate tends to be greater as well.
If we are talking about a primary residence investment, the other plus real estate has over bonds is that the homeowner can enjoy the home. Whereas the bond investor cannot enjoy their bonds. Bonds have no utility.
In the below 20-year annualized returns by asset class chart, you can lump REITs and Homes together. REITs and private real estate funds are for investing. Homes are for living. Although the return for Homes shows only 3.7%, with leverage, the cash-on-cash returns are much higher.
Real Estate As A Bond Plus In A Downside Scenario
Real estate may also outperform bonds in a downside scenario.
For example, when interest rates went up aggressively in 2022 and 2023, bond funds got hammered. IEF, the iShares 7-10 Year Treasury Bond ETF, declined by 15% in 2022. TLT, the iShares 20+-year Treasury Bond ETF, declined by 30% in 2022.
Meanwhile, real estate outperformed because the median home price in America declined by only ~8% in 2022. Therefore, compared to a long-duration Treasury bond fund, the median real estate price outperformed.
Compared to the Bloomberg U.S. Aggregate Bond Index, which declined by 13% in 2022, the median real estate price also outperformed.
If you compare the median real estate price to riskier corporate bond funds, the median real estate price outperformed even more.
Real Estate Investors Can More Easily Take Action To Protect Against Downside Risk
In 2023, the median real estate price in America is actually up a couple of percentage points while bond funds are down. Why? The vast majority of homeowners refinanced when rates were lower, and therefore are not willing to sell. Lower supply supports higher prices. Meanwhile, the Fed kept on raising rates.
Real estate investors are better able to protect against downside risk by taking action. These actions commonly include refinancing, finding higher-paying tenants, and remodeling.
Bond investors, on the other hand, can't do much to hedge against downside risk except to short. Bond investors, like stock investors, are mainly passive investors that cannot affect positive change.
Real Estate Provides More Benefits During The Most Extreme Hardships
Investors buy Treasury bonds and highly-rated municipal bonds for safety. At the same time, many investors also buy real estate for safety given 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 explain why real estate is a plus over bonds for peace of mind purposes.
Example 1: There's hyperinflation of 1,000% a year. Government bonds will collapse in value, while real estate values will likely not. Instead, real estate values will likely hyper inflate as well because it is an end good. People work and earn money to buy real estate, not the other way around.
Example 2: Your country goes to war. Government bonds may also collapse due to capital flight. There is fear a new regime will take over and make your country's currency worthless. However, so long as your home doesn't get bombed, it offers greater value than bonds because it provides shelter. Although your home's value will likely also decline, at least it is enabling you to live life.
To more easily understand financial concepts, it helps to think in extremes.
The Type Of Bond Matters For Relative Performance
Although real estate can often outperform bonds in a rising interest rate environment or a recession, it is not always the case.
Let’s say you bought $1 million worth of one-year Treasury bonds yielding 4.5% before interest rates started rising. You sold the entire position nine months later to buy real estate.
With the one-year Treasury bond, you likely didn’t lose any principal due to the bonds' tremendous liquidity, a long-enough hold period, and a relatively short duration. Instead, you likely made a 3.375% return ($33,750) after nine months instead of a 4.5% return after twelve months.
Holding an individual Treasury bond until maturity is a guaranteed return. Holding a short-duration Treasury bond further increases the probability you will not lose money if you need to sell before maturity.
In the above example, a 3.375% return outperforms an 8% decline in median real estate prices in 2022. Therefore, if you then bought a $1 million property that declined by $80,000, your net gain would be $80,000 plus the $33,750 you made from your one-year Treasury bond gains.
Invest Based On Your Understanding
I don't like to own bond funds because there is no maturity date to earn back all my principal plus interest. You can certainly earn greater returns buying bond funds if you time the transactions correctly, like the day interest rates peak and sell when interest rates bottom.
Plenty of bond investors do and invest in riskier junk bonds, corporate bonds, and high-yield bonds to try and make a greater return. However, these types of investments are not for me. I'm happier 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. To preserve capital, I'd much rather invest in individual Treasury bonds or AA-rated municipal bonds and hold them to maturity.
The Considerations Of Selling Treasury Bonds To Buy Real Estate With Cash
Before selling individual Treasury bonds to pay cash for a new house, consider the following:
- Will I lose money if I sell before maturity? Check by comparing your Treasury bond purchase price to the bid price if you sell. If it looks like you will sell the bond at a loss, you may choose to hold onto it until maturity and sell a different bond instead.
- How much risk-free interest income will you forgo a month if you sell before maturity? Not earning interest income is the main reason why I wrote the post, How To Delay The Close Of Escrow To Earn More Money.
- How much in federal ordinary income taxes will you have to pay on Treasury bond income. You pay less ordinary income taxes if tou sell the Treasury bond sooner since less income will be generated. Treasury bonds are not subject to state income taxes.
- What would the composition of your net worth and investment portfolio look like if you sell Treasury bonds to buy a new house? Personally, I'm not a fan of any single asset class accounting for greater than 50% of one's net worth.
Selling Treasury Bonds To Buy Real Estate Was An Easy Decision
Given real estate is like a bond plus investment, over the long term, I feel my home's value will increase at a faster rate than the yields on my Treasury bonds. Part of the reason why is because I believe interest rates will eventually decline, making Treasury bonds less attractive.
If I was selling junk bonds or long-duration Treasury bond funds that are down a lot to buy real estate, it would be a much harder decision. Junk bonds and long-duration Treasury bond funds will likely outperform real estate if interest rates decline because they are much more volatile.
My biggest lament for selling Treasury bonds to buy a home is no longer receiving ~5% risk-free income. A 5% guaranteed return with inflation at around 3.5% is a solid real return. However, with the latest CPI figures coming in below expectations, bond yields are declining and the opportunity to earn 5% yields is also declining.
Even though I paid cash and have no mortgage, I went from making a lot of risk-free income to now only making a little. In addition, I've got more property taxes and maintenance bills to pay. As a result, I will probably do some consulting or go back to work to help boost my cash and stock investments.
Summary Of Real Estate As A Bond Plus Investment
- Bonds and real estate act similarly to a change in interest rates
- Real estate can offer higher returns than bonds during good times
- Real estate can lose less than bonds during bad times because real estate investors can take action like remodel, refinance, or find better tenants
- There's less of a need to own as much bonds to diversify your portfolio if you already own real estate
- Selling bonds to pay cash for a home is easier than selling stocks to pay cash for a home
- Your down payment fund should hold short-duration individual Treasury bonds versus Treasury bond funds or riskier bond types
Overweight Real Estate Compared to Bonds In My Portfolio
Real estate is my favorite asset class for regular people to build wealth. Real estate generates income, provides shelter, offers diversification, can be improved upon, is usually a benefit of inflation, and has a positive historical return. The average net worth for American households grew to $1.06 million in 2022 mainly due to real estate.
Bonds are fine and have a historical average return of about 5%. But given you can't enjoy your bonds or improve your bonds, bonds are simply not an enticing enough investment to make when compared to real estate. If you want to simplify after you've amassed your fortune, bonds are an attractive investment, especially if rates are high.
It is easier to achieve financial freedom 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 appropriately. If you take on too much debt to buy too much house, then you could face financial trouble in the future.
Reader Questions And Suggestions
What are your thoughts on holding bonds if you already own real estate? Do you view real estate as a bond plus investment as well? When does owning bonds outweigh the benefits of owning real estate?
If you want to dollar-cost average into a weak real estate market, take a look at Fundrise. Fundrise primarily invests in residential and industrial properties in the Sunbelt, where valuations are lower and yields are higher. Fundrise is a Financial Samurai affiliate partner.
In addition, take a look at the Fundrise Innovation Fund that invests in private growth companies. Roughly 35% of its fund is in artificial intelligence companies, while the rest is in prop tech, fintech, software, and more. You can review the fund's holdings before you decide to invest, unlike traditional venture capital funds where you commit capital and hope the partners invest wisely.
Fundrise is a long-time sponsor of Financial Samurai and Financial Samurai is an investor in Fundrise funds.
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Counterpoint: Real Estate is like an inflation linked perpetual junk bond.
One kind of bonds you completely skipped over are inflation linked bonds. There are TIPS, Treasury Inflation Protected Securities, but there are also corporate inflation linked bonds. Some of those corporations don’t have great credit ratings. Inflation linked bond yields change with inflation (duh), so if inflation is higher, the reutrn will be higher.
Then comes the perpetual aspect. Perpetual bonds don’t have a defined maturity when they will be recalled (repaid). They’re not that common today, but used to be. The important feature, similar to real estate, is that there is no guarantee they will be bought at par (face value) at a specific date. You can try to sell them at any point and hope the mark to market price is what you want.
Finally, the junk (low credit rating): real estate prices might hold up better in aggregate, but individually they fluctuate a lot. A mall/transportation hub closes nearby? Prices drop. A new employer opens? they might go up. An industrial disaster pollutes the area: prices drop. The city rezones your area for medium density appartment blocks: Who knows what happens! This is in contrast to investment grade bonds that stay close to par value (excluding duration weighted impact of changing yields).
If you add a traditional fixed rate mortgage to the mix, you’re basically taking a swap of a fixed interest rate for a floating, inflation related one. With all the risks of perpetual bonds (no par value sale guarantee), junk bonds (people might not think it’s worth as much as you do) and normal swaps (what if inflation comes in lower than you expected?).
If bond plus means “an unusual mix of properties common on very old bonds and new bonds”, then you’re not far off
A reasonable replacement definition. Unfortunately, not something 90%+ of readers will understand probably. Hence, as a writer who is trying to explain concept as clearly as possible, I can’t go with that.
Would it be fair to say you’re more bullish on stocks than real estate?
You might enjoy this post: Why real estate will always be more desirable than stocks
Sam thanks for all your great content. Question, have you ever considered taking 10-20% of your net worth and investing in cash flow real-estate in a different country? If so what country? If not, why not?
It would be a great post to hear your point of view!
“Due to leverage, real estate tends to have a higher cash-on-cash return. In addition, due to usually the larger absolute dollar value of the real estate holding versus bonds, the absolute return amount from real estate tends to be greater as well.”
*clapping*
Like the comment I made on financialsamurai.com/housing-affordability, real estate tends to ratchet up in value when rates go down, but hold value better when rates rise. Inflation, scarcity, and illiquidity increase asset values, and real estate contains these more than bonds do.
However, I think the comparison of real estate to a dividend growth stock is more accurate.
As someone in another thread posted why not keep the bonds and take a securities based loan? This way you can keep getting the coupon and pay the diff in loan interest which is deductible. And if this is a rental depreciate the rental income. If keeping the bonds to maturity then there is little risk and possibly capital appreciation if rates drop plus lower loan servicing fees.
Sure. Your securities could go down in value, while you are paying high interest rate on the securities loan.
Please review the description on exchanging assets from treasury bonds to real estate.
What have you done in your experience when buying a house? How did you think about selling bonds or stocks to buy real estate.
Thanks for writing this Sam. I really learn so many new things from your site. Even though I own and also like real estate a lot, I hadn’t thought about so many of the angles you talk about in this post. You really know your stuff! I own some bond funds and used to own some individual munis, but I sold most of those already. I feel better about my investment portfolio allocation now after reading this. I have less exposure to bonds and more real estate investments this year. So I was feeling out of balance with holding less in bonds, but I feel a lot better now.