Bonds vs. Buildings: A Real Estate Perspective with Brian Keegan

Technology brings today’s investors access to countless investments and an overwhelming amount of information. While an abundance of options can create opportunity, it can also be exhausting to navigate. As someone who is deeply entrenched in the Chicago Real Estate Investment Sales Market, I frequently encounter questions that reflect this dilemma. Recently, one of those questions seems to come up more often than others:

“Why should I buy a building that has 2% or 3% cash flow (today) when I can earn 4%, 5%, or 6% in a seemingly safer Treasury bond?”

The question does not have a straightforward answer, it depends – not all cash flows are created equal. These are some of the things that we think about and ask our clients to think about when we are faced with that question.

Hard Assets: Building Equity Over Time and Property Appreciation

Real Estate Investments have multifaceted returns and cash flow is just a single part of that. Another aspect of owning and managing a real estate investment is using the income it generates to pay down your debt. Debt, generally, has two parts – Principal and Interest. And while interest goes to and stays with the bank, those principal payments reduce the overall amount that you owe on the property. Servicing your debt (making your payments) will not make you more “liquid” today – But Real Estate Investors recognize that this may increase the capital that comes out of the deal in an eventual sale or refinance.

In addition – Demand, improvements in the surrounding area, inflationary pressures, and other economic growth can increase the value of a property tremendously over time. When this happens, the gap between what an investor owes on a property and the market value of that asset also grows. This is another recognized opportunity by Real Estate Investors and is an area where they may realize returns that exceed their annual cash flow.

Hedging Inflation: Barry Bonds Vs. Barry Buildings

“Real Estate can act as a powerful hedge against inflation” – Textbook (and boring), let’s create a situation:

“Barry” has bought many bonds in his life and can explain what happens when he buys them -> So Barry, buys a bond (typically $1,000) and the government pays Barry interest based on the bond’s coupon rate -> we’ll say that rate is 5%. So, in this example, Barry has given away $1,000 and will receive $50 annually until his bond matures, maybe 5 years from now. When his bond matures, he will no longer receive his $50 annually, but he will get his $1,000 back -> and that is what happens, roughly, when Barry buys Bonds!

Now let’s switch gears for a moment and say Barry doesn’t buy bonds, instead, Barry buys buildings and he’s going to explain how he generates his annual return on those investments (Thanks Barry!) -> So Barry buys a building and it generates income, mostly in the form of rent. Every year after Barry pays the building expenses and services his debt, Barry is left (hopefully) with some amount of money and he calls that his cash flow, which he continues to earn on his building until he sells -> Is that the whole picture?

Both Barry Bonds and Barry Buildings represent distinct investors, and aside from the obvious differences in terms of investment management, different economic environments could create wildly different advantages or considerations for either investor. However, in an inflationary environment, like the one we have experienced in recent years, the Federal Government may raise interest rates to mitigate its impact. For Barry Bonds, this could mean a decrease in the purchasing power of the fixed interest payments he receives, potentially eroding the real value of his investment over time. It may also reduce the value of his bond if Barry tries to liquidate it before it matures (Barry’s bond from yesterday is paying a lower rate than new bonds are paying today, nobody wants to buy that back!). On the other hand, Barry Buildings faces a different scenario. Rising interest rates do impact the proceeds that buyers might get if Barry Buildings decides to sell. But Barry Buildings also, more actively, can generate rental income and adjust rents up in response to inflation. Inflation also generally, increases property value over time. While this example simplifies a complex economic landscape, it underscores the importance of considering inflation when evaluating investments. Barry Bonds and Barry Buildings each face a very different options in an inflationary environment.

It’s Not What You Make: It’s What You Keep

“Taxes are simply a tool the government uses to get you to do what they want you to do.” – Robert Kiyosaki

Robert may be a controversial figure for some, and I certainly do not mean to endorse or not endorse him – but I do appreciate this lens when it comes to taxes, our business, and comparing it to other investments. While we are not tax advisors and you should always consult your accountant and attorney about those kinds of things – I think it’s okay to suggest that working with the tax code to be tax efficient is wise, probably for most. Real Estate Investors understand the value of being tax efficient and know that there are various avenues to reduce your tax burden, unique to real estate professionals and property owners, which are mostly unmatched by other industries and other investment vehicles. Not all cash flows are created equal – It is important to consider how much you get to keep.

(One Of) The Essex Realty Group Advantages: Our Perspective

From forging new relationships to nurturing existing ones and addressing the more immediate needs of clients – brokerage is a year-round, full-time endeavor. I know that sentiment is shared by every broker in our office, each of whom is dedicated to delivering the highest level of service. In practice, that means we’re all leveraging our time and committing our full attention, daily, to educating on the market and conversating with investors/operators about how they’re navigating the various complexities and challenges in our industry. At the heart of it all is a genuine desire to continue to self-educate and to share the knowledge and perspective we have with you, our clients, and partners.