Don’t rely on the strong stock market returns of the past, warns a new set of economic forecasts. Economists have cut forecasts for corporate profits. In light of this unsettling information, investors in the stock market may turn their attention to private equity real estate and its potential for rapid wealth creation.
However, property values might still fluctuate due to market forces. Total returns, which include profits, dividends, and capital gains, can help investors achieve their long-term goals, but they must first be aware of the dangers of blindly following tactics that have worked in the past.
Slower Growth Lowers Equity Earnings Prospects
The stock market’s long-term prognosis is muted because of the economy’s slowdown after a decade of growth. While U.S. shares have earned an annualized return of 10.6 percent over the past 30 years, Vanguard Group predicts a far lower return of 3 to 5 percent in 2019. Vanguard’s chief investment officer, Greg Davis, admits, “Our expectations have clearly come down.” Morningstar, the largest U.S. mutual fund manager, projects a 3.7% return on U.S. stocks, while J.P. Morgan projects a 5.2% return.
It’s not a secret that things seem bleak in the future. Both the company’s growth potential and the stock price, which reflects the present value of the future earnings stream, are considered by Vanguard and other fund managers when making investment decisions.
The price-earnings ratio is more relevant than the stock price for determining stock value, and P/E ratios haven’t been this high since the.com bubble of 2000. Standard & Poor’s 500 companies are currently selling for 21 times earnings. According to the metric used by economist Robert Shiller in his book Irrational Exuberance, stocks are trading for 30 times earnings.
After ten years of growth, Vanguard is concerned that the current P/E ratio has reached “alarming” levels. However, they might become the norm during a decade of slow growth. It cannot maintain earnings at past levels if the economy remains weak. When a company’s ability to create cash flow decreases, dividends also experience resistance. With stock prices near their peak, there is less room for improvement in the total return an investor can earn from the stock market.
Real Estate Generates Wealth
On the other hand, one of the primary benefits of investing in real estate is the possibility of increasing one’s wealth through dividends and appreciation. Property is a tangible asset that has the potential to increase in value. This decade has seen a general downward trend in interest rates, which has led many high-net-worth professionals to reallocate a larger share of their investment portfolios.
Although, commercial real estate will face the same challenges as the stock market during a recession. Passive income streams can be affected in a recession even if owners take precautions with their assets. Real estate is expected to outperform other asset classes. People will always need a place to live. Thus, fortress real estate asset types like multi-family housing should do well in any economy.
As a result of this conservative outlook, our acquisitions team has modified their underwriting assumptions. Previously, we might have anticipated a 16% IRR from the same risks; now, we aim for 14%. We want to under-promise and over-deliver on the internal rate of return, and some properties should still outperform the market. However, given the state of the economy, taking on additional risk is the only option to get the same total return.
Some financial advisors routinely engage in such behavior. They’ll make deals for foreclosed properties, borrow significantly, hand over management to partners, or reduce marketing for new tenants—all strategies that could enhance results if things go right but cause real concerns if things go wrong. Investors must undertake due diligence, examine the fund manager’s intentions and assumptions, and insist on regular portfolio updates because not all such movements will be clear.
Present Day Real Estate Investment Yields Have Expanded Benefits
The advantages of real estate, when managed properly, over stocks include passive income streams, appreciation, and longer set terms of ownership, all of which contribute to decreased volatility. Real estate investment trusts (REITs) have routinely outperformed the S&P 500 due to their stable rental revenue and favorable tax treatment. The benefits of real estate investment through private equity and direct ownership are the same.
On the other hand, private real estate should command a higher price than liquid investments. In this new low-return world, the return premium for private real estate is disproportionately large if the predicted returns on equities are only 5% to 6% going forward and real estate offers returns of 9% to 11%.
More importantly, increased total returns are not contingent on income alone. Even though market prices fluctuate, the underlying worth of land remains the same. As the equities market landscape transforms, real estate is a safe bet thanks to the dual benefits of income and appreciation.
******************************
Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.