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Bogleheads University 501 2023 - Dr. Jim Dahle on Real Estate Investing


Whisper Transcript | Transcript Only Page

00:00:00.000 | >> All right.
00:00:08.000 | Let's take a look here.
00:00:09.920 | All right. Here is my subject matter today. Is this on?
00:00:13.760 | Okay. Real estate, it's really on now.
00:00:19.960 | Can it be added to a Boglehead portfolio?
00:00:22.320 | Should it be added? How should it be added?
00:00:24.640 | Let's talk about it. Something we don't talk about a lot.
00:00:27.480 | First, some disclosure. I am not a financial advisor.
00:00:32.600 | I'm not an accountant. I'm not an attorney.
00:00:34.920 | I'm not licensed to do anything in the great state of Maryland.
00:00:37.320 | So this is all for your entertainment and information only.
00:00:40.200 | I have conflicts of interest.
00:00:41.920 | I own a for-profit company called the White Coat Investor.
00:00:44.160 | Some of our advertisers are real estate investing companies.
00:00:46.880 | I'm not going to mention any of those today,
00:00:48.600 | but be aware I have that conflict of interest.
00:00:51.200 | The only company I'm probably going to mention today is Vanguard,
00:00:54.400 | which I have yet to get to advertise with me.
00:00:56.560 | So I don't have a conflict there.
00:00:58.200 | Okay. Here's what we're going to talk about.
00:00:59.720 | We're going to talk about the case for real estate in general.
00:01:02.440 | Then we're going to talk specifically about the case for private real estate,
00:01:05.960 | following which I'm going to present
00:01:07.480 | the most important slide in this presentation.
00:01:09.440 | I call the real estate continuum.
00:01:12.000 | All right. First, the case for real estate.
00:01:15.920 | The first reason why someone might want to
00:01:19.360 | invest in real estate is because the returns are high.
00:01:22.040 | When you're building a portfolio,
00:01:23.640 | you want multiple high-returning asset classes.
00:01:26.520 | Maybe you want some lower-returning ones as well.
00:01:28.760 | So what are we talking about? We're talking about stocks.
00:01:30.560 | We're talking about real estate.
00:01:31.480 | We're talking about small business.
00:01:32.760 | Maybe some speculative asset classes out there might have higher returns.
00:01:36.480 | But real estate returns in general are similar to stock returns,
00:01:39.500 | but are a little bit more easily leveraged.
00:01:41.880 | Once you leverage them, the returns tend to be higher.
00:01:44.720 | Second reason, low correlations.
00:01:47.520 | When building a portfolio, again,
00:01:49.220 | you want lower correlations between your asset class.
00:01:51.720 | If they're higher than about 0.8,
00:01:53.360 | you're not doing a lot of good adding that asset class at all.
00:01:56.120 | Correlations, of course, go from minus one up to one.
00:01:59.760 | The lower, the better when it comes to building a portfolio.
00:02:02.880 | For example, between US and international stocks,
00:02:05.560 | it's anywhere from 0.5 to 0.94.
00:02:08.120 | With bonds, it's almost zero.
00:02:10.120 | With commodities, it is zero.
00:02:12.440 | Bonds to commodities actually have negative correlation.
00:02:15.880 | In comparison, comparing US stocks to US publicly traded real estate investment trust,
00:02:22.360 | the correlation is about 0.45.
00:02:24.920 | If you compare that to private real estate,
00:02:27.320 | it's as low as 0.17.
00:02:29.880 | That's a good reason to invest in the asset class.
00:02:33.320 | The third reason, real estate tends to be very inflation resistant.
00:02:36.980 | These are real assets.
00:02:38.240 | They tend to go up in value with inflation.
00:02:40.600 | The value of income, of course,
00:02:42.600 | income property is highly dependent on the rents that you are charging and collecting.
00:02:46.520 | So as inflation rises and you can raise the rents,
00:02:49.360 | then that provides some inflation protection,
00:02:51.440 | at least in the long run.
00:02:53.000 | It's also easier to pay back fixed rate debt with inflated dollars.
00:02:57.880 | If you have a bunch of low interest rate fixed rate debt,
00:03:00.880 | like a lot of people do right now,
00:03:03.400 | and inflation goes up,
00:03:04.840 | that can be a really great place to be sitting in.
00:03:07.760 | Real estate also has relatively high cash flow.
00:03:11.280 | A higher percentage of your return tends to come from income than from capital gains.
00:03:15.800 | That's not always a good thing,
00:03:17.360 | especially if you don't need the income.
00:03:18.920 | But it can be useful for decumulation years,
00:03:21.760 | and also for replacing earned income during the working years.
00:03:25.280 | Another great thing about real estate is that it's a little bit easier to add value.
00:03:29.920 | You're extremely unlikely to add value to your portfolio by studying and picking stocks.
00:03:34.640 | If you have not learned that yet,
00:03:35.840 | you will learn it this weekend.
00:03:37.760 | But all real estate is local.
00:03:40.720 | An active management has the potential to work better with real estate than it does with stocks.
00:03:45.320 | You can also boost returns,
00:03:47.040 | aka earn money by doing the work yourself when something needs to be done.
00:03:51.800 | That introduces some aspects of a second job,
00:03:54.120 | which a lot of people find not very attractive about real estate investing.
00:03:58.200 | But it is an opportunity to add some value.
00:04:00.720 | Another awesome thing about real estate are some tax advantages,
00:04:04.520 | which frankly are unfair.
00:04:06.360 | They're unfair tax advantages.
00:04:08.000 | For example, if you sell your home,
00:04:09.720 | and it's appreciated less than $250,000 since you've been in it,
00:04:13.640 | all that capital gain,
00:04:14.920 | you don't have to pay capital gains taxes on.
00:04:16.680 | If you're married, it doubles.
00:04:18.640 | Depreciation. Basically, the government says your house is going to be worthless in 27.5 years.
00:04:24.160 | The truth is your house isn't going to be worthless in 27.5 years.
00:04:27.880 | It's overly generous.
00:04:29.520 | Even for businesses, it's like 39 years.
00:04:31.880 | Still overly generous.
00:04:33.120 | That warehouse is not going to wear out completely in 39 years.
00:04:36.720 | Then when that depreciation is recaptured at a sale,
00:04:39.280 | it's only recaptured at 25 percent.
00:04:41.240 | For those of us in the highest tax brackets, that's a great deal.
00:04:44.280 | Take the break at 37 percent, pay it back at 25 percent.
00:04:48.600 | If you get real estate professional status,
00:04:50.800 | which admittedly is not all that easy to get,
00:04:53.000 | or you take advantage if you're doing short-term rentals,
00:04:55.680 | the short-term rental loophole,
00:04:57.480 | you can use passive losses to offset your earned income.
00:05:01.320 | I know doctors, high-powered surgeons,
00:05:04.840 | whose spouse qualifies as a real estate professional,
00:05:07.400 | who pay no taxes on their clinical income because of depreciation from rental properties.
00:05:13.320 | Mutual funds, unfortunately, can't pass through their capital losses,
00:05:16.480 | but a partnership investing in a real estate property can do so.
00:05:21.160 | Those depreciation losses, they're really only losses on paper,
00:05:24.640 | but they can pass them through to you.
00:05:26.320 | Opportunity zone funds are another excellent way that real estate offers some tax advantages.
00:05:31.760 | Basically, allows you to pay less on capital gains that you get from that real estate.
00:05:36.920 | But the very most tax-efficient way to invest in real estate,
00:05:40.480 | is to invest directly in properties that you buy,
00:05:44.000 | depreciate, and exchange rather than sell into another property,
00:05:48.480 | a bigger property usually,
00:05:49.720 | and then depreciate some more,
00:05:51.320 | exchange it into a bigger property,
00:05:53.280 | and finally you die without ever selling anything.
00:05:56.240 | Well, if you never sell anything,
00:05:57.440 | you never pay capital gains taxes.
00:05:59.040 | Your heirs get to step up and basis a debt.
00:06:01.280 | It's incredibly tax-efficient.
00:06:03.240 | All that depreciation sheltered income,
00:06:05.600 | and then nobody ever pays the capital gains taxes.
00:06:07.880 | So that's one of the cases for real estate,
00:06:09.920 | these unfair tax advantages.
00:06:12.160 | Okay. So we're talking about the case for overweighting real estate,
00:06:16.040 | because most of you own real estate investment property whether you like it or not.
00:06:20.480 | The total stock market index at Vanguard owns three to four percent real estate.
00:06:26.040 | Three to four percent of it is composed of
00:06:27.840 | these publicly traded real estate investment trusts.
00:06:31.920 | However, 90 percent of real estate by dollar value is not publicly traded.
00:06:37.920 | It's not on the stock markets.
00:06:39.720 | It turns out investors only purchase about 22 percent of single family homes,
00:06:43.840 | and only three percent of those are purchased by large institutions.
00:06:46.840 | They're not on the markets.
00:06:48.160 | It's a completely separate economy from what we're investing in,
00:06:51.640 | in Vanguard index funds.
00:06:53.520 | If you compare that to non-real estate businesses,
00:06:56.240 | you'll see that there's a few thousand publicly traded businesses in the country,
00:07:00.200 | but there's 27 million total businesses.
00:07:02.760 | However, the truth is almost all of those are one-person businesses.
00:07:06.880 | Twenty-one million of those only have one employee.
00:07:09.920 | Eighty percent of profits,
00:07:11.600 | when you look at non-real estate businesses,
00:07:13.680 | 80 percent of profits in the country are coming
00:07:16.000 | from those publicly traded businesses from stocks.
00:07:18.840 | That's not the case in real estate.
00:07:20.720 | So the idea is that if you overweight real estate in your portfolio,
00:07:24.440 | more than a total stock market index does,
00:07:26.760 | that's a little more representative of the real economy and real wealth in the country.
00:07:32.080 | Okay. So enough about real estate in general.
00:07:35.120 | Let's talk now about private real estate.
00:07:37.800 | Okay. What is the case for private real estate as compared to
00:07:41.160 | just investing in real estate investment trusts that are publicly traded on the stock market?
00:07:45.920 | Well, you still get high returns.
00:07:47.800 | They might not be higher returns,
00:07:49.880 | as we'll discuss momentarily.
00:07:51.680 | You get lower correlation and perhaps better risk-adjusted returns.
00:07:56.600 | You may collect an illiquidity premium.
00:07:59.240 | You certainly should by theory,
00:08:00.960 | whether you do or not is a different question.
00:08:03.760 | You may get lower expenses.
00:08:05.520 | A lot of these, there's a lot of
00:08:07.200 | regulation when you are publicly traded on the stock market.
00:08:09.640 | It costs a lot to comply with all those regulations.
00:08:12.840 | However, when you're involved in these smaller properties, syndications, etc.,
00:08:17.320 | you can have those regulated according to regulation D,
00:08:20.120 | which is a much lower barrier.
00:08:21.760 | It has its upsides and downsides.
00:08:23.680 | There's fewer regulators looking at it,
00:08:25.680 | but it costs less to comply with it.
00:08:27.760 | So you may have lower expenses in that regard.
00:08:30.520 | You're also often investing in smaller properties.
00:08:34.160 | A duplex just isn't going to fit into a publicly traded REIT.
00:08:39.000 | It's too big. It needs to invest too much money.
00:08:40.960 | It's not going to buy the duplex down the street from you.
00:08:43.120 | That might not be the case with private real estate.
00:08:45.640 | It tends to be a less analyzed market,
00:08:47.720 | fewer people picking through it,
00:08:48.880 | fewer analysts looking at it.
00:08:50.440 | Of course, in these sorts of partnerships or whether you own it directly,
00:08:53.960 | the depreciation is passed through right to your tax return.
00:08:57.480 | Okay, but here is where the rubber meets the road.
00:09:00.720 | 2022 is not a great year for most of us.
00:09:03.240 | These are my actual portfolio returns from 2022.
00:09:05.960 | If you look at my overall return is about minus 10 percent.
00:09:09.400 | US stocks were down about 16 percent.
00:09:11.520 | Small value did a little better.
00:09:13.200 | International did about the same.
00:09:14.760 | Small international did even worse.
00:09:16.840 | Bonds did not have an awesome year in 2022 either.
00:09:20.520 | I bonds were like one of those rare bright spots.
00:09:23.440 | Well, if I look at my private real estate
00:09:25.440 | compared to my public real estate that year,
00:09:27.160 | my public real estate got hammered right along with the stock market,
00:09:30.080 | did even worse, minus 23 percent.
00:09:32.920 | But my equity real estate did about nine percent.
00:09:36.240 | On the debt side, I did a little bit better than that, nine and a half percent.
00:09:40.840 | To me, that goes, "Hey, there's something here.
00:09:44.200 | Maybe we ought to be looking at this a little bit more closely."
00:09:46.760 | Those are various hand-selected investments and how they did in that year.
00:09:51.320 | Some of them did quite well.
00:09:53.120 | But on average, about nine percent that year.
00:09:56.200 | So, are private returns actually higher?
00:09:59.600 | This is a good question.
00:10:01.000 | The answer is it depends.
00:10:02.680 | I think the best answer is probably not on average.
00:10:07.120 | But the risk-adjusted returns probably are a little bit better,
00:10:11.760 | because they have lower correlation with stocks and bonds.
00:10:14.240 | Once you incorporate it into a portfolio, it may do better.
00:10:18.480 | But the returns don't actually have to be
00:10:20.400 | higher for it still to make sense to invest there.
00:10:23.920 | So, here is a comparison in four sectors of the real estate investing space.
00:10:30.160 | Retail, and US office,
00:10:32.320 | and industrial, and apartments.
00:10:34.640 | We're comparing private and public.
00:10:37.640 | So, the red line is the REITs,
00:10:39.760 | the publicly traded real estate.
00:10:41.640 | The blue line is the private.
00:10:43.760 | As you can see, it varies a little bit by sector,
00:10:46.240 | but more or less, it's about the same.
00:10:49.600 | However, when they look at these things more specifically in studies,
00:10:53.520 | you'll see a lot of studies that come back with data like this.
00:10:56.560 | You'll see here, the second thing down there are these publicly traded REITs,
00:11:01.360 | and they did pretty darn well over this time period,
00:11:04.000 | which is about 20-year time period.
00:11:05.760 | It's up there 10.5, 11 percentage.
00:11:08.200 | If you go down about halfway,
00:11:09.600 | you'll see unlisted real estate.
00:11:11.080 | This is the private real estate.
00:11:12.480 | It did not do nearly as well.
00:11:13.800 | It's about, what, eight percent.
00:11:15.480 | So, it was higher in that study for the publicly traded real estate.
00:11:20.840 | Numerous other studies have basically shown the same thing.
00:11:24.240 | Time periods are all a little bit different,
00:11:26.400 | but it's basically the same thing.
00:11:27.800 | You'll see that the public real estate did better than the private.
00:11:31.840 | But then you start looking at studies where they look at
00:11:34.640 | incorporating into a portfolio to take
00:11:36.800 | advantage of the fact that the correlation is lower.
00:11:40.000 | This study from Yutahi et al concluded that the optimal portfolios had
00:11:45.040 | higher weightings of direct real estate investments as opposed to REITs,
00:11:48.840 | and that the optimal portfolios containing REITs are outperformed by
00:11:51.720 | those containing direct real estate investments.
00:11:54.480 | So, it's not all about returns.
00:11:57.640 | If you look at the Sharpe ratio,
00:12:00.640 | private real estate, according to Black Creek anyway,
00:12:03.360 | has delivered better risk-adjusted returns for
00:12:05.320 | investors over the last 20 years once you adjust it for risk.
00:12:09.320 | By risk, they mean primarily volatility.
00:12:12.720 | The reason why is the correlation is just much lower.
00:12:15.960 | You see over the last 20 years compared to the 10 years before that,
00:12:19.640 | the correlation of the stock market with publicly traded REITs has gone way up.
00:12:24.680 | It's gone up a little bit for the overall real estate market,
00:12:27.800 | but not nearly as much.
00:12:29.160 | So, it's just much lower correlation.
00:12:32.200 | This is interesting data too when you look at this.
00:12:35.400 | You'll see there's a little bit of a lag.
00:12:37.280 | Because the stock market is marked to market daily,
00:12:40.640 | it goes down first.
00:12:42.840 | Likewise, publicly traded REITs go down first,
00:12:46.400 | and then the private stuff follows it.
00:12:48.200 | So, there's a little bit of a lag there.
00:12:50.320 | If only private real estate didn't have
00:12:52.880 | such high transaction costs and such illiquidity,
00:12:55.520 | you might even be able to take advantage of that.
00:12:57.920 | This is interesting too.
00:12:59.720 | Once the stock market gets pounded,
00:13:01.400 | once publicly traded REITs go down more than
00:13:04.080 | 20 percent compared to their net asset value,
00:13:08.440 | then they do much better than private real estate over the next one to three years.
00:13:12.800 | That's what this graph is showing.
00:13:14.160 | So, something to keep in mind there.
00:13:16.600 | All right. Enough about private real estate.
00:13:19.280 | Let's talk about the most important slide in this presentation,
00:13:22.840 | the real estate continuum.
00:13:25.000 | This is what it looks like.
00:13:27.360 | On the left side, you will see people who are basically real estate developers.
00:13:31.800 | They go to the city, they get a permit,
00:13:33.760 | they break the ground, they dig the hole,
00:13:35.560 | they build the building.
00:13:37.320 | It's ground up construction.
00:13:39.720 | Then you move along to the next category.
00:13:41.720 | This is fix and flip.
00:13:42.640 | You buy a place, it's like the shows on TV.
00:13:44.760 | You fix it up, you renovate it, and then you sell it.
00:13:47.320 | Coming next on the spectrum is short-term rentals.
00:13:51.040 | You're running a hotel business here.
00:13:53.400 | This is Airbnb, this is Vrbo.
00:13:55.680 | People are renting your house for three days or seven days, something like that.
00:13:59.560 | Next to that comes long-term rentals.
00:14:01.520 | You still own the whole thing,
00:14:02.760 | but you're now renting by the month or by the year.
00:14:05.600 | After that is a turnkey property.
00:14:07.960 | Basically, you still own the whole property,
00:14:09.920 | but you're not doing any of the work.
00:14:11.240 | You've hired it all out.
00:14:12.240 | Somebody else finds it, they put the tenant in it,
00:14:14.120 | they manage it, they repair it,
00:14:15.840 | they sell it, they're doing everything.
00:14:17.360 | All you do is own it. After that,
00:14:19.760 | we're getting into the more passive types of real estate investing.
00:14:22.760 | The next couple are available only to accredited investors,
00:14:25.640 | meaning an income of at least 200,000 for each of the last two years,
00:14:29.280 | 300,000 as a couple,
00:14:31.000 | or a million dollars in investable assets.
00:14:33.680 | We're talking about syndicated properties.
00:14:35.680 | So the idea here is,
00:14:37.600 | 99 investors go in together and they buy a 200-door apartment complex,
00:14:43.000 | because none of them can afford it on their own, number one.
00:14:45.120 | Number two, you get some sharing of expenses a little bit,
00:14:49.960 | and you get professional management.
00:14:51.480 | None of those 99 investors are being called when the toilets clog.
00:14:54.760 | It's a passive investment to them.
00:14:56.480 | It's mailbox money that comes in every quarter.
00:14:59.080 | But you own the property directly and it's a partnership,
00:15:02.080 | and so the depreciation is still passed to you.
00:15:04.560 | A private fund, often now structured as a REIT,
00:15:07.840 | even though it's still private,
00:15:09.480 | is just 15 or 20 of these.
00:15:12.240 | You put 15 or 20 of these apartment buildings into one fund,
00:15:15.240 | and that's what a private fund is.
00:15:16.880 | Then of course, at the far end are
00:15:18.920 | the publicly traded REITs that show up in your total stock market index.
00:15:22.760 | As you move from left to right along the spectrum,
00:15:26.160 | you will see that you will require less experience,
00:15:28.920 | you will have less hassle,
00:15:30.480 | you will get more diversification,
00:15:32.560 | and as a general rule,
00:15:33.840 | you'll get more liquidity.
00:15:35.480 | However, you're giving up control,
00:15:37.920 | you're giving up tax benefits,
00:15:39.880 | you are paying more layers of fees,
00:15:42.160 | and you probably, if all of this is done well,
00:15:45.520 | have lower returns because of that.
00:15:48.160 | So there's not actually a right or wrong way to invest in real estate,
00:15:52.480 | but there is a right way and a wrong way for you to invest in real estate.
00:15:57.600 | You've got to match yourself up on that continuum with what makes sense to you.
00:16:01.640 | If your goal is you hate your job and you want out as soon as you can,
00:16:05.360 | and you'll do anything to do it,
00:16:06.960 | the answer might be building an empire of short-term rentals.
00:16:10.480 | On the other hand, if you're like,
00:16:12.080 | "I'm a retiree and I want to play golf for 12 hours a day,
00:16:14.600 | and I don't want to do any of this real estate stuff."
00:16:16.600 | The right answer for you might be,
00:16:18.280 | "I'll just take the real estate that's in the total stock market index,
00:16:21.080 | or maybe I'll just add a little bit of the Vanguard REIT index fund."
00:16:24.120 | That sort of a thing. Everyone else has got to match
00:16:26.600 | themselves along that spectrum somewhere.
00:16:29.040 | Real estate, of course, is not mandatory.
00:16:31.280 | You already own it, whether you want to or not.
00:16:33.840 | Okay. So what we've talked about.
00:16:35.800 | Real estate, while optional,
00:16:38.240 | is a great asset class and often the first alternative that gets added to a portfolio.
00:16:43.280 | Private real estate may not have higher returns than public real estate,
00:16:47.360 | but it does have some other advantages.
00:16:49.520 | There are lots of different ways to invest in real estate.
00:16:52.280 | You don't need and you certainly don't want to do all of them, I promise you.
00:16:57.280 | Make an honest assessment of what you
00:16:59.480 | want from your real estate investment before making it.
00:17:02.800 | But you can invest in real estate without getting toilet calls.
00:17:06.400 | It is not always a second job.
00:17:08.360 | If you look at that spectrum,
00:17:09.840 | all of our real estate investments,
00:17:11.440 | my wife and mine, are on the far right side of that spectrum.
00:17:14.560 | Some of them are private and some of them are public,
00:17:16.800 | but nobody calls us for toilets, I assure you.
00:17:20.520 | That is not the only way to invest in real estate.
00:17:23.280 | Real estate investing should not be a get-rich-quick scheme,
00:17:26.280 | but it can be a get-rich-quicker scheme.
00:17:29.640 | It's still going to take years,
00:17:31.360 | but using some hard work, some leverage,
00:17:34.060 | you actually can reach financial independence earlier,
00:17:36.920 | most likely doing that.
00:17:39.080 | Of course, passive income is a great term.
00:17:42.560 | It is often not nearly as passive as it looks.
00:17:45.960 | All right. Thank you for your attention.
00:17:47.920 | Let me.
00:17:49.440 | [APPLAUSE]
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