December 9, 2021
Joe Fairless

JF2655: The Lost Decade and How to Avoid 0% Returns on Your Investments | Actively Passive Investing Show with Travis Watts


 
 

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TRANSCRIPTION

Travis Watts: Hey, everybody. Welcome back to another episode of The Actively Passive Investing Show. I’m your host, Travis watts. I have a very interesting topic to share with you today. What we’re talking about as the lost decade and how to avoid 0% returns. Allow me to elaborate. I was doing a webinar here recently to a group of physicians and medical professionals, and I added this as a subsection to my presentation, because I just thought it was interesting. I was going through some data, and for anybody who’s, let’s say, 40 years old or older, I’m sure you remember this painful period of time in the stock market. If you were in the stock market, whether that was through your IRA, 401k, brokerage account, or basically any vehicle tied to the performance of the stock market, for those not so familiar with the lost decade, this is around January of the year 2000 through December of 2009. Basically, the reason they call it the last decade is if you had invested in January of 2000 in, say, the S&P 500 index, or the stock market broadly, you would have ended up with nearly a 0% return over about a 10-year period. The reason why is we were at the top of a market cycle. We had the dot-com bust, so the markets trickled down for several years after the year 2000. Then we had a recovery and the market started coming up almost back to breakeven, and then we hit the great recession, and the markets took a nosedive once again. Everyone would have been at a loss, had you invested back in 2000. Then we had a recovery, of course, post-2009. But the bottom line is that 10 years went by with very little to no cash flow, and very little to no net worth change or valuation in your portfolio. So the reason this happened – not the economic reasons and the policy reasons, but the reason from a high-level that this would have been the outcome for you or I is because we were using a buy low/sell high investing mentality.

I’m not suggesting that there’s anything wrong with that in particular, but raise your hand if that’s how you were taught about investing… Whether that was through school, colleagues, friends, parents, whatever. It was this idea that “Oh, yeah. I understand investing. I buy a stock at 10, I hope it goes to 15. If and when it does, I sell it, and boom. I made a profit.” This is how a lot of people think of investing, this is why so many people are speculating on the crypto space because they think, they predict, that they’re going to buy today and that one day, it’s going to be a 10x return, because historically, that has happened in that space. But it doesn’t always happen. Sometimes people buy into Bitcoin at 60k and then it goes to 30k. You can go the other direction with it. But long story short, that’s why, and I want to share with you an alternative way of thinking. What if you would, instead of doing the whole stock market thing in index funds, you would have invested in multifamily apartments.

Here’s a couple of interesting stats to consider. I want to be as fair and unbiased as possible. Check this out. Multifamily real estate investments have provided an average annualized return of about 9.75% from 1992 to 2018 according to CBRE research. That’s the data that they chose for that. We know in 2019, ’20, and ’21 multifamily has continued performing great so I’m sure that wouldn’t change too much if we had that data in that statistic. Equally so, the S&P 500 for the past 90 years, because we have a lot more research on that, was around 9.8% annualized return all things considered. So you would look at these numbers potentially and say, “Well, there’s not a lot of difference there. So why not just invest in the stock market?” In other words, what’s the advantage of investing in multifamily? Volatility. We’ve talked about it a lot on the show, but I can’t say it enough. Volatility is probably the number one thing that sets stocks apart from private real estate. Again, according to CBRE, the standard deviation for multifamily returns is around 7.75%. And according to Seeking Alpha research, the standard deviation of the S&P 500 is around 19.7%.

Let’s break that down. If you’re not familiar with standard deviation, I want to define that in my definition. Get on Google and you can go read paragraphs and paragraphs and paragraphs about what standard deviation means, what it is, and how it’s calculated, but here’s the bottom line – it’s a measure of volatility. It’s the amount of variation from an asset’s true value. In other words, if the book value of a stock is let’s say $10 per share, but it’s currently trading at $20 per share or $8 per share, this is the deviation away from its actual value. With those two stats in mind, you can see that stocks have twice –actually a little bit more than twice– the standard deviation of private multifamily real estate. So the prices fluctuate more, they crash harder, they boom bigger. All of that is summed up and could be categorized as general volatility.

Break: [00:06:01][00:07:34]

Travis Watts: Something to keep in mind is that stocks, statistically speaking, when we’ve had recessions in the US – they’ve lost about 33% of their value during times of recession. Which means they may not be the best vehicle for preserving your capital. There’s been a lot of news and headlines for years that maybe we’re at the top of a market cycle. The truth is that nobody really knows that, and there are so many things out of our hands with policies, government, the Fed, stimulus, and all these things that you are I have no control over, neither do the talking heads on TV nor any guru in the space. That doesn’t stop people from making their predictions. But I’ll be the first to tell you, I don’t have a crystal ball and I have no predictions for you. So I say “Who knows.” That’s my best guess at the future. But it’s crazy, you guys. Something like 80% of fund managers in the public markets and Wall Street licensed professionals, this is what they do, day in day out, full-time for careers – 80% underperform the S&P 500 index over a five-year timeframe. That’s insane. That tells you that if true professionals can’t time the markets accurately or choose which investments will outperform or be best, then what chance do you or I have? I don’t know. You may feel differently about it. I used to feel differently about it when it came to syndications. I used to think this individual deal is going to outperform that deal, so I’m going to go heavier on it. And it turns out, I wasn’t always correct on that.

And I love this saying — a lot of people get coined as originating the saying. I don’t know who the originator is, but “Time in the market beats timing the market.” Something to think about and consider as you go through your investing journey.

So the heart of this conversation – why focus on cash flow? Or what if you focused on cash flow and passive income, and not buy low sell high in capital gains, and trying to flip things, and all of that. As we talked about in the last decade, you would have had basically a 0% return more or less over a 10-year period investing that way. Consider this. Let’s say you or I, for example purposes, invested –just making up numbers here– $100,000 in the year 2000 in multifamily apartments, generally speaking. It doesn’t have to be one deal, it could be your whole portfolio of different deals, whatever. Now, I want to paint this picture as conservatively as I can. So let’s say that the cash flow that was distributed to investors, you and I, was only 6% per year.

By the way, if anyone knows the statistics and the facts of multifamily during those timeframes, it was much higher, generally speaking. But I’m going to keep it conservative. That means that we would be collecting $6,000 per year in cash flow off our $100,000 investment, times 10 years. So at the end of 10 years, you and I would have effectively $60,000 collected from cash flow on our investment, regardless of the price fluctuations in the market; regardless of the stock market, first of all, regardless of whether we had bought into an apartment building at 20 million, now it’s 25 million, or we bought in at 20 million, and now it’s 15 million. But I want to paint a couple of examples here of what advantage multifamily has over single-family, because more people are familiar with single-family investing, which I did for many, many years, and then I transitioned over to multifamily.

So here’s the unfortunate truth about single-family. I could go out and buy an amazing property in an amazing location, single-family, and put the world’s best renter in there; and this renter, they take care of my place, they’re upgrading my place, they’re paying above-market rents in my place, I’m able to raise my rents 5% a year every single year with them.

Alright, things are great. But guess what? If all my neighbors have foreclosures and short sales, and they’re selling below market values for whatever reason, as we saw in the Great Recession, I lose money on the deal overall. In other words, if I want to exit my deal, the lenders and the appraisers of the world when it comes to single-family can care less about my tenant or how much rent I’m collecting off my property. It really would make no difference, because they go off of comps, comparable sales, in the surrounding area. So single-family investing as a strategy, generally speaking, is buy low, sell high. That’s true for wholesaling properties, that’s true for fix and flipping properties; that’s even true, in my opinion, for buy and hold. Because again, if you ever need to exit or get out, it’s all going to be based on the comps. And even though you collected a great cash flow, if you’ve got to exit and take a loss, it was a buy low, sell high strategy.

Break: [00:12:58][00:15:46]

Travis Watts: Multifamily, on the other hand, is treated much more like a professional business, like a commercial company. They look at net operating income as the primary factor in the valuation of the property. A few reasons for this. One, what if there are no comps in the area that could be supported off the price that you’re asking? For example, you’re investing in a brand-new built luxury high rise, built in 2021, 30 stories high, 400 units, in an old section of some downtown sector. Where all your comps are one in two-level buildings, they’re 80 units, and they were built in 1930. That’s not a comp; so there may not be any 2021, 30 story buildings to go look at. Instead, they’re going to say “What are you getting in rents, in income, and what are your expenses?” and someone’s going to come in and buy that from you at a multiple of what your net operating income is. So said another way, the rents and the cash flow in the passive income are the primary factor and focus to multifamily investing. With single-family, it’s more about buy low, sell high and what the property is worth, and the cash flow and passive income is a secondary consideration. That is probably the biggest difference between the two strategies.

The key to buying multifamily or investing in multifamily properties is to know that you can at least maintain your rents… By the way, on a side note, talking about maintaining rents. Did you guys know that, statistically, multifamily rents during the Great Recession, during this huge real estate collapse and downturn, went from a national average of 1350 a month leading up to the recession, that’s per unit rent, to 1250? That was the big collapse, $100 per month on a multifamily property. Just keep that in mind for perspective. Back to what I was saying. To successfully invest or buy multifamily real estate, you want to make sure that you can be cashflow positive, even if you’re not able to push the rents, and hopefully there’s even some margin if rents go down or soften up. But generally speaking, rents will go up. I think the national average is about 3.5% a year. But generally speaking, they go up as much if not a little higher than inflation. Right now, we’re seeing about 5% national inflation, that’s running a bit hot. Historically speaking, the Fed’s goal is to keep it around 2%.

But regardless, if rents go up 2% to 5% a year, multifamily valuations go up as well, even if the single-family home market softens and then we start seeing 20% discounts on single-family homes. That is secondary to investing in multifamily apartments. The same thing is true with the stock market. The publicly-traded REITs in the stock market, in general, fell 30% give or take in March of 2020 when COVID was just outrageous and crazy. Well, guess what guys? Private multifamily deals was not transacting at 30% discounts during the same timeframe. The volatility was not there. That was market volatility in the public markets, not in the private sector. What I encourage you guys to think about is just this idea that if I invest for passive income or cash flow, I don’t have to worry so much about what exactly the valuation, or the comps, or the comparables, are at any given time, if you’re just sole focus on creating passive income streams. I’ve asked this question before on social media, I may have mentioned it here on the show as well. Would you rather have $5 million in cash in the bank and no investments? Or would you rather have $30,000 per month coming in in passive income, but a $0 net worth?

Everyone’s going to have a different take, and again, I’m not telling anyone what’s right or wrong or what to do. I would choose the cash flow and that means that I put a lot less emphasis on net worth in that situation. But we’re all different. What’s right for you isn’t necessarily right for me, and vice versa. I’m not a financial planner or strategist so please always seek licensed professional advice. But with that, I really thought this extraction was worth sharing here on the show. I hope you guys found some value in it and learned a couple of new things. Again, my goal is just to share what I see as a mindset. Several people reach out every episode, and I love hearing from you guys. You can reach me at joefairless.com or travis@ashcroftcapital.com, or a lot of people reach out on LinkedIn. I’d love to get your thoughts. Leave a comment below. Happy to share, happy to be a resource. I’m no guru in the space, I don’t know what you would call me, I’m a thought leader, I’m one opinion out there. And if any of this resonates with you, I’d love to hear about it. Thank you, guys, for tuning in. We’ll see you next time on The Actively Passive Investing Show. Take care. Have a Best Ever week.

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