Sunday, July 09, 2006

>Gold or Real Estate?

Gold pays no interest. At least properties pay you rent. Therefore you should own properties…

That’s the conventional wisdom.

Yes the first two statements are true. But we need to be careful about drawing the conclusion that you should own rental properties. Now is one of those rare times in history where – even after collecting rent – holding real estate will cost you more than holding gold.

Let me explain…

Yes, gold pays no interest. It’s one of the many knocks against gold. But don’t forget, the cost of owning gold is darn near zero.

Meanwhile, Marc Faber gave an example of a typical home speculator in his newsletter last month, concluding that, right now: “a home buyer / speculator has a negative cash flow of more than 5%.

The assumptions Faber used to come up with that negative five percent cash flow figure were conservative … For example, maintenance costs were assumed to be 1% of the value of the home (sounds low to me). And annual property taxes were assumed to be 1.1% (mine are nearly twice that).

If you can earn a rent yield of 8% or more of a home’s value, these numbers aren’t so bad. But you can’t get that kind of rent anymore…

Steve Leuthold, a legendary investment analyst, looked at rental yields over the last 45 years (as long as he has data). He found that rental yields are lower now than at any time in history – by a wide margin.

Steve puts the current level of rental yield (after expenses) as a percentage of the home price, at about 2.5%. That’s abysmal.

I’m not sure, but I think that figure does NOT include property taxes (which are about two percent where I live), or insurance (which eats up the rest of the yield). Also, importantly, that figure does NOT cover interest on a mortgage. Lastly, this figure does NOT take into account the high cost of buying and selling a house.

If Leuthold is right, and landlords are willing to accept rent (after maintenance costs) of just 2.5% of the value of a home, then most rental property owners are losing money… And lots of it, if they’ve got big mortgages on these properties.

So let’s go back to the question at the start… Which real asset would you rather own right now? You’ve got gold - which pays no interest, but has virtually no cost of ownership. Or you have real estate - which pays 2.5% interest (after home maintenance costs) but loses money when you add up the cost of ownership…

Everyone owns real estate. Nobody owns gold.

Sure, you can earn rent in real estate. But right now, according to some great analysts, all that rent and then some is eaten up, leaving you with a negative cash flow.

I prefer to own assets that nobody owns, like gold. And it’s more attractive than real estate, on a yield basis.

You sure don’t get that opportunity every day.

Note: You would have to do your own rental yield and your cost like insurance, repair, property tax etc to get your own figures.

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