The 'Stock' People Love To Buy

Includes: VNQ
by: Tom Bunyavanich

If you were told to find a stock that you really liked and to put a large part of your life savings into it, would you? Plus, the stock price was so high, that to buy just 1 share, you would have to borrow 4 times the cash you put up. Since it is such a huge investment, you would have to buy insurance on it. There's more, the stock could pay you a nice monthly dividend provided you put in the necessary work. You would have to pay taxes every 6 months if you were the stock's registered owner. You also have to incur regular maintenance expense on the stock. There is no liquid standardized market for this stock where you could easily see up-to-date market prices, few bid and ask prices to assess, if any. Transaction fees on buying and selling this stock are also very high.

You might say this is ridiculous. Nobody would ever do this! Why would I get myself into such a high leverage deal? Brokerage accounts don't even allow such high degree of borrowing in a margin account, too risky. Many are suffering the consequences of high leverage today. I wouldn't want to get involved in such an illiquid investment. I may not be able to cash out when I want. Further, there's no diversification, a large part of my money in one asset? This type of investment would be an easy target for financial magazines to write up about as the worst investment.

What I'm referring to is not actually a stock, but buying a house as an investment property. Surely you have been told at least once in your lifetime that buying a house is the finest investment that you could ever make. Reflect on your motivations to own a house as an investment. Do you feel it is part of moving forward in life or an important symbol of wealth? Or is it the walk-in, feel the actual walls emotional feedback? Think it through deeply. Do you have time in your life to find renters, fix leaky sinks and toilets? Things always break and need repair in a house. Do it yourself or incur the extra bills. Also, get more insurance because renters sue landlords.

The big misconception about a house is that it is an appreciating asset. In fact, it is the depreciating asset. You have to continually put money into it simply because things break over time. You always hear the success story of how a person bought a house for $100 and now it's worth 1 million. Yes, high leverage works great when you are right. In a market where investors have difficulty trading, either because open markets do not exist or high costs to trading exist, inefficiencies in pricing can continue for long periods. Therefore, the probability of finding the great real estate deal (as long as you are on the right side) in the market exists even though the average expected return for the entire market may or may not be superior. Many investment properties are bought with a 2nd mortgage, which is often a recourse loan. If you default, aside from damaging your credit score, the lender can still come after you in many states, seeking other assets, like your primary residence.

If you have decided that real estate is the investment for you and/or you think the real estate market is going up, you don't actually have to buy a house. Instead of putting all your eggs in one house, would it be better for you to own 10% of 10 different houses? You would be spreading your risk out. Further, instead of 10 houses, how about different types of real estate, such as houses, multi-family units, office properties, apartment complexes, strip malls, etc., in 10 different cities. Your risk would be further diversified. You could accomplish this today by buying a real estate investment trust, which is basically a corporation that invests in real estate. REITs have been in existence for more than 50 years. Many are listed publicly that you could buy and sell like a stock.

To benefit from diversification even further, consider a basket of REITs rather than one REIT, using exchange traded funds. One example, the Vanguard REIT Index ETF (NYSEARCA:VNQ), designed to track the performance of the MSCI US REIT Index (RMZ), holds over 100 REITs, so it is well diversified. VNQ also has a very low expense ratio. With REITs, investors can directly participate in the returns generated by real estate properties without dealing with high leverage risk, illiquidity, high closing costs, maintenance time, maintenance costs, litigation liability, and real estate taxes. In case something does not go right, your loss is limited too, no banks will come after you. You will also benefit from lower overall portfolio risk with REITs as a component, because of their low correlation to traditional stocks and bonds. And you don't have to go through a credit check to get started.

Disclosure: I am long VNQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Article is for educational purposes only and does not constitute financial advice.