With Gold at record highs, and property falling to unprecedented lows,
where should a consumer put his/her confidence?
An investor, by nature is someone who is seeking an above average return; and is willing to take on a commensurate amount of risk in order to achieve that return. There are those who believe that we need to analyze the past and watch for trends in order to ride waves largely based around consumer sentiment, and there are those who believe that it all boils down to the technical analysis of an investment and what exactly you are getting in exchange for your hard earned money.
While there are a plethora of different investment vehicles out there, I believe only two are worthy of discussing today: Real Property and Gold. Sure there are good buys in equity positions currently, but there is too much unexpected (and frankly unexplained) day-to-day volatility to advise that option. So what is one to do? Gold or Property?
While there are circumstances in which I would advise the other, I strongly believe that property is the superior investment at this time.
A wise man (James Grant) once said “Gold is the reciprocal of the world’s confidence in the likes of Ben Bernanke.” And up until recently there apparently has been no confidence in him at all! That being said, as an investment, gold has been at its all time high for sometime now, and real estate has fallen to record lows. Even if we believe that the US government is not going to pull itself out of the economic trenches anytime soon, by purchasing gold we are putting ourselves at risk of a total loss. What I mean by that is when one purchases gold they pay face value for it, and if it declines they are stuck with it. Conversely, when one purchases property they employ leverage, and acquire the property at a fraction of the face value price.
Leverage, or the use of debt to finance an activity, allows an investor to increase his potential return while limiting his potential loss (in the case of a mtg on a property). To illustrate this lets say that an investor purchased a $500k property with the industry standard down payment of 10% ($50k), and financed the rest through a mortgage. If the next day that property is worth $600k, the investor can sell it, pay off the remaining mortgage ($450k), and after his down payment is subtracted he is left with a 200% return on investment ($100k return on $50k outlay). Now if the investor had purchased $500k in gold, they would have to pay the full $500k upfront (sure you can buy on margin but then you either have to share the profits, or pledge cash as insurance) . Therefore if the next day the gold was worth $600k and the investor decided to sell, he would only have realized a return on investment of 120%.
Not only is the upside potential less, with an investment in gold vs. an investment in property , but the downside potential is much higher. Lets take the same example as above and apply it in a loss situation to better understand this point. If our investor had purchased his $500k property by putting $50k down, and the next day the property was worth $400k, the investor still has not really lost anything more than the $50k he initially put in. How? Simply because he has various options to defer or dispose of the debt, sometimes even without having to sink anymore money into the property. The ethical solution is to continue making your mortgage payments and wait for the market to rebound, but there are other options as well. I am not suggesting the follow as solutions to a bad investment, but I am suggesting them as realistic options that are exercised everyday: the investor can default and allow the property to foreclose, he can file bankruptcy and walk away from the debt, or he could even short sell the property and get out of trouble that way. Given the current economy and recent legislation (see SB 931 & SB 458), you can escape an underwater property relatively easily.
However if our investor had put up the $500k for the gold, and the next day it was worth $400k, he just lost $100k over night. His only options are to either sell it and take the loss, or sit on it and hope that it rebounds. Which while it sounds similar to sitting on a piece of property until the market rebounds, it is not. With property you can rent it out and cover your monthly (loss) payment, while you are waiting for the market to rebound; whereas someone is not going to give you some cash so that they can carry around your gold bar for a month…
Finally, let us not forget the old adage “cash today is better than cash tomorrow”, with the gold investment one would be making an outlay of cash 9x greater than the investment in property. The opportunity cost of purchasing gold, relative to purchasing property, is almost incomparable. For these reasons, I believe property to be the superior investment overall.
Feel free to call us with any questions pertaining to this article, or leave a comment below and I will get back to you.