Disclaimer: Bryan Church’s Real Estate Corner is not presented or intended to be used as investment, legal, tax, or as any other advice and should not be used as a basis for any type of decision.  Consult a professional before making any decisions.  

Wealth Preservation and Long-Term Tangible Investments

July 22, 2016

Successful long-term investments sometimes have more to do with avoiding losses than capturing gains.  Many investors are in a "wealth preservation" mode at this time and looking to keep what they have—rather than increasing their net worth.  Many investors have started looking at tangible wealth over intangible wealth. 

 

Tangible assets have become popular as a means of diversifying investments into something that exists as a "physical thing," rather than remain in cyberspace and exist as a "virtual thing."  Many investors have converted securities, bank accounts, and U.S. dollars held in cold hard cash into hard assets, such as real estate, gold, silver, diamonds, and other tangible assets that are expected to hold their value in the future. It all comes down to what future inhabitants believe is intrinsically valuable and will pay labor and/or capital to procure it.   It's as simple as that.

 

Cold Hard Cash aka "Fiat Currency"

With the discontinuance of the gold standard in 1971, the U.S. dollar became what is known as a “fiat currency.”  This is currency that is backed by the “full faith of the U.S. government” and not gold reserves.  Admittedly, the United States economically and militarily has continued to be the strongest nation on earth, so the full faith of the U.S. government has been sufficient to sustain the U.S. dollar as the world reserve currency.  This meant that oil purchases around the world were done with U.S. dollars and foreign banks held U.S. dollars in reserve at their banks.  Approximately, 60% of all U.S. dollars outstanding are electronically or physically located outside the U.S.  The justification for Nixon removing the gold standard was that oil was now the liquid gold of the world.  Whoever controlled the oil controlled the world economy…and there is some truth to that statement.

 

An excellent example of how a fiat currency fares against gold, silver, and gems in the long-term is the recent discovery of Chinese bronze Bainlaing coins, circa 221 B.C. in China.  Tomb raiders had raided the tomb of gold, silver, and jade; however, 100,000 bronze Bainlaing coins were conspicuously left in the tomb.  Another fiat currency bites the dust. 

 

Potential Stock Market Adjustment(s)

Each time the U.S. appears to be on the precipice of a huge stock market adjustment, another country steps in to save the day.  For example, the Chinese stopped buying U.S. Treasuries abruptly during the fourth quarter of 2013, so Belgium (yes, Belgium) stepped in and bought the U.S. Treasuries, thus taking up the slack and making the Chinese ploy a non-event. 

 

Japan has appeared to take up the slack caused by the U.S. Federal Reserve Bank's (FED) ending of its Quantitative Easing program by increasing its own quantitative easing program for the Yen.  In addition, investors have started pricing in the European Central Bank (ECB) instituting a quantitative easing program of their own, but that eventuality is still far from decided in Europe.

 

Japan's quantitative easing program may have potentially extended out the timing of a major stock market adjustment in the U.S.  Many investors have turned to real estate as a tangible asset that will help maintain all or part of their net worth.  There are pros and cons to holding real estate, so let's take a look at some of them in light of other investment vehicles such as precious metals, diamonds and other gems, and other less-likely non-traditional investments.

 

Real Estate

Everyone needs a place to live.  At some price you should be able to rent out a “cheap house located in a bad area.”  If these types of properties decrease in value, they can only go down to zero (I hope).  So, as long as you are receiving cash flow from rents, who cares what the property’s value is anyway?  You should only care about the value of the property when you sell it at the end of your holding period many years down the road.

 

If you buy less expensive homes located in lower socio-economic neighborhoods, you are faced with higher management intensity and more maintenance issues because of the older homes located in these types of neighborhoods.   One ray of hope, however, is that these tenants may be able to afford to continue to pay the rent during tough economic times.  Just make sure your tenant mix is comprised of people employed in somewhat stable job fields.  Otherwise, you will end up with a large number of evictions and subsequent vacancies.

 

Real Estate is Vulnerable to Increased Taxes

Real estate can be easily traced through county tax records and recorded deeds.   Since real estate can be easily found it can also be easily taxed.  Therein lies the risk to real estate investors.  As government continues to grow at an amazing rate, where will the government get the money to pay for its existence?  Taxes.  A government excise tax would be very easy to levy against real estate investments in the U.S. 

 

An excise tax may seem a little far-fetched, but Hawaii already has a Hawaii Excise Tax on all the residential investment real estate in the state.  Property owners who live in their properties have fairly low property taxes; however, real estate investors who own permanent and vacation rentals pay between 4.33% and 10% in excise taxes on their annual gross income.

 

Real Estate is Vulnerable to Increased Capital Gains Taxes

Because of the continuous threat of inflation, the federal government generally does not want to expand the money supply any more than it already has done through buying treasuries and real estate loans.  For this reason, liberating existing equity that has accrued through increases in the stock markets and real estate markets is usually a really bad idea.  This will increase the already over-inflated money supply and compound the Fed’s inflation problems.  In response, Congress usually passes laws to raise capital gains taxes (Bush tax cuts not being renewed is a good example) to a point where investors are not willing to sell their assets and incur huge losses to their equity.  This “greed” factor is what the federal government is banking on to keep the equity in securities and real estate markets and NOT out on the streets where it can really cause inflation trouble. 

 

Real Estate is Vulnerable to Civic Unrest

Residential landlords may escape economic strife better than other real estate investors because people always need a place to live--at some price.  Civic unrest could result in a loss of city services.  This would make rental houses useless until utilities are restored, and minimal rents may be collected during this time period because of habitability issues. Landlords will be forced to help tenants with water, heating, garbage collection, etc. to keep them paying at least some rent until services are restored and the tenants start paying rent again.

 

International Money Continues to Buy New York Real Estate

The economic environment in the European Union is considered weak by investors and does not look like it will improve anytime soon. These investors consider the U.S. to be a stable, transparent, and broad-based economy that will only get better.  They see New York real estate as being more reasonably priced than London and Hong Kong.  They want to make sure that a $30 million dollar building in Manhattan will be worth the same amount or more five years from now.  If you are paying cash for a property, you can handle a momentary dip in the real estate market and still come out well on the other end.  Each of these investors is looking to invest between $70 million to $100 million in New York properties.   

 

Precious Metals

Some of the options guys believe the U.S. dollar is strong against other world currencies because those governments are in worse economic and financial shape than the U.S.   Value of U.S. dollar may not devalue as much as anticipated because of the worldwide exchange rate for U.S dollars against other currencies and the unanticipated movement of foreign investors away from the Euro, British Pound, Chinese Yuan (Ren Min Bi), and other FOREX currencies and into U.S. dollars.  This is the main reason for the recent drop in gold and silver prices.  In other words, the U.S. is the best of a lot of bad choices.  Short-term projections are not good for the price of gold and silver; however, from a long-term perspective gold and silver may become valuable investments.

 

Government Can Outlaw Ownership of Physical Gold

Physical precious metals can be hidden from the government easier than real estate. They are "outside" the system, so they are difficult for governments to track.  One solution is for the government to outlaw the ownership of gold, similar to what President Roosevelt did during The Great Depression in the 1930s. 

 

Gold

Gold is the only precious metal that international banks universally recognize as currency.  It may be able to be synthesized by nuclear means, but the high costs would have to be paid by a state-run government.

 

It cannot be destroyed; does not tarnish, decay, or burn; is not usually diluted by inflation nor destroyed by deflation; and has survived wars, revolutions, and every economic tragedy in the history of the world.  It has been an emotional basis of wealth for centuries

 

It takes up minimal space, so it can be placed in bank safe deposit boxes and other gold depositories. It is good for wealth preservation, but is difficult to insure because it can be stolen.

 

Worldwide Demand for Gold

Asia, India, and the Middle East like gold coins, gold jewelry, and gold bars. Between 3.5 billion and 4 billion people from Asia accept gold as money.  In fact, they prefer gold to paper money.  Over 54% of world gold demand comes from China and India alone. India's population is expected to increase to 1.27 billion people through 2020, and their average age will be 29 years of age.  It appears there may be continued demand for gold in Asia.

 

China has been hoarding gold for years.  It costs approximately $1,200 per oz to mine gold out of the ground. Mining conglomerates—Numont mining is very close to a break-even at $1,200 per oz of gold—are staying in business waiting for gold prices in the commodity markets to go up.

 

There are eighty million ounces of gold produced each year, with six billion ounces existing in the world. The low price of gold results in less investment, less exploration, delayed new projects, people leaving the industry, and the quality of mined gold decreasing.

 

Price of gold tends to correlate with the money supply.  The more money injected into the money supply, the greater the likelihood of inflation and the higher the price of gold.  Except today we are seeing $4 trillion U.S. dollars in circulation and the price of physical gold is dropping.  One of the reasons is the sale of gold ETFs.  People are investing in paper gold, leading to lots of speculation and its resulting volatility.  The Commodities exchange (COMEX) trades 98% paper gold and 2% physical gold. It is highly leveraged with futures markets and controlled prices. 

 

The London bullion market has a gold price fix (aptly named) in the morning and the afternoon of each business day.  Competition has been coming from the Shanghai Gold Exchange, India, Singapore, and Dubai to take away some of London's gold business.  London has been too secretive in its price fixing and needs more transparency, or it may soon be supplanted by these other gold bullion exchanges.  The Chinese government has been hoarding gold mined in China, as well as Africa, Mongolia, and Australia.   They may well bypass the London gold market altogether. 

 

Silver

Physical silver takes up a lot of space (compared to gold), is sold in lower denominations so it is considered easier to sell, trade, and barter. It is generally not recognized as currency (except in Utah), yet Silver American Eagles tend be a popular investment vehicle because they are minted by the U.S. government and this makes them easier to buy and sell due to the amount of silver in the coin being guaranteed by the U.S. government.  Buyers of Silver American Eagles may not be able to recoup the premium paid between the silver spot price (bullion) and the minted silver coin itself. This is usually between $1.50 to $2.50 per Silver American Eagle coin. 

 

Old Silver Coins

A person must be a coin expert to be able to correctly use coins with numismatic value to preserve and maintain wealth.  Silver American Eagles are more suited to investors who are not coin collectors or museum curators.

 

Diamonds and Other Investment Vehicles

Diamonds can be synthesized out of Carbon.  It takes a special microscope to tell the difference between synthesized diamonds and those naturally-occurring in the earth.  A quality certification and/or gemology report is needed to make sure the diamond is investment grade.  Fits easily in a safe deposit box and can be used in jewelry.

 

Some people think whisky is a good investment.  It has a very long shelf life if stored in a cool environment.  I keep trying to stockpile as much Crown Royal as possible…you never know when you might need it.

 

Overall, a diversified portfolio of real estate, gold, silver, and other tangible investments may be a way to protect your net worth during troubling economic times.  Having a real estate license can help you find good quality investment properties, and receive an added bonus of receiving a commission on the purchase price.  This will reduce your investment costs and increase your overall rate of return.