Thursday, December 15, 2016

Rethinking my property allocation

I’ve been historically heavy on equities as the overall focus in my portfolio. More recently I’ve been thinking about giving property greater prominence.

Equity investment has been a major part of my journey towards financial independence. I like the asset class for number of different reasons. I find businesses easier to analyze and understand. It’s more self-evident to me to work out the reasons why a business performs in the way it does based on its competitive strengths, its revenue growth and the returns it derives for its shareholders equity. Frankly it’s also a lot easier to move into and out of equities given transaction costs are relatively low.
It’s never been as easy for me to understand the dynamics behind property investment. I struggle to work out what really drives the price appreciation of property in a given area versus another area. Sure some basics such as proximity to services, transportation and school districts no doubt account for a larger amount of why a given property is valued in the way it is. However what explains property growth and appreciation beyond that has been harder for me to understand.

However I’ve come to the point in my investment journey where I think I’ve reached a natural ceiling as far as my equity investment is concerned.
Equity allocation now comes to dominate my overall investment strategy. When looked at across all our holdings, including our collective 401(k)s, dividend investments, growth investments and indexed funds almost 75% of our investment holdings excluding the primary residence happen to be in equities.
In my view there’s certainly a lot of merit for property to have a more dominant place in one’s asset allocation and part of the reason is as much psychological if nothing else.
One of the beauties of property investment I feel is the ability to comfortably take a highly leveraged long-term position on a given property and its prospects for price appreciation.  One of the things that I’m finding with equity investment is that the average tenure of a business on the S&P 500 is steadily decreasing with time.
The disruption from rapidly advancing technology not only impacts technologically based businesses but is steadily disrupting many businesses in many fields technology. Disruption has steadily made its way into banking, insurance oil and gas and other more traditional fields.
It’s getting increasingly harder to buy confidently and with conviction and hold for the long-term (decades as opposed to just years). This multi decade holding period is necessary to really enjoy significant wealth creation.
Warren Buffett and others definitely had advantage in being able to invest in an era when technology facilitated disruption was relatively low and competitive strengths endured far greater periods of time.
I’ve become more suspect about the ability to confidently buy-and-hold for periods of 20 or more years. The beauty with property investment on the other hand is that a piece of land tends to retain its enduring characteristics over long periods of time provided the area in which you invest doesn’t go through dramatic economic or structural declines.
That piece of property that you own is likely to only continue to appreciate in value over long periods of time.  You can’t change location if you bought close to transportation links or the waterfront or within close proximity to major metropolitan area. These structural advantages will continue to endure for long periods of time.
Property also has the comforting psychological feeling of not being quoted back to you on a daily or hourly basis. You don’t see that $300,000 house being listed as a public ticker and fluctuating price on a daily or hourly basis.
With property it literally is easier to buy as if the market is closed for the next 10 years and just periodically check in. Perversely the same transaction costs that make it so easy to jump in and out of stocks make it prohibitively more expensive to buy and sell property on an ad hoc basis, which tends to foster more of a long-term buy and hold approach.
Ownership of property is also not affected by periodic shorting attacks and dramatic plunges for no rhyme or reason and flash crashes that can take the price of an investment down 10 or 15% over night and restore that value within a weeks’ time.
Of course while that presents the savvy investor with great opportunities, such volatility can be damaging to one’s psyche to see such gyrations in the marketplace of the short periods of time. The very nature of the structure of property almost requires the investor to be content to hold the asset for long periods of time.
I recently read an intriguing book, the subject of which was about hundred bagger stocks. I will distill some of the lessons from this book in a future post but there was a very interesting story in the book that I am mindful of. The author recounts the story of a friend happen to purchase a piece of art which was then hung on his walls for a period of time. The artwork was almost forgotten about until 15 years later the friend casually happen to taking that piece of art and have it assessed he was shocked to hear that the piece of art was more than 20 times what he had paid.
The fact that this piece of artwork didn’t have a ticker that constantly displayed its changing price and value no doubt provided the opportunity for this individual to simply have the artwork just sit and do nothing but appreciate in value over time. That’s seldom the case with stocks.
After a period of about 5 to 7 years I eventually plan to transition most of my individually held stock portfolio to indexed based asset allocation. In the near-term we will see a significant inflow of cash over the next two years as the kids get older and some of our expenses start to fall away. In addition our passive income will start becoming materially more noticeable as some of our debt obligations are reduced and dividend income and rental income continue to roll in free of any encumbrances.
Ideally in addition to our current rental investment I’d like to acquire another one or two rental properties to add to the collection which will also overtime generate significant passive income once loans against those properties have been extinguished. Look for an update to this over the course of 2017
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