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WHITE PAPER A TIMELY ALTERNATIVE REAL ESTATE INVESTMENT: Land for Residential Development and Its Place in a Balanced Portfolio Sponsored by The True Life Companies (TTLC) WHITE PAPER ALTERNATIVE INVESTMENTS are commonly defined by what they are not. They’re not one of the three traditional asset classes of stocks, bonds, and cash. Instead, alternative investments include a wide array of nontraditional assets, from fine art to financial derivatives. Gold, oil, commodities, REITs, hedge funds, real estate, and private equity are all types of alternative investments. Mark Twain’s famous advice is now more compelling than ever. Scarcity is driving increasing demand by homebuilders for entitled homesites—ready-to-build land for single-family residential development. Major demand drivers are population growth, household formation, and—perhaps most important—a shrinking supply of land ready to build on. Alternative investments are typically used in a balanced portfolio to meet specific investment goals such as preserving capital, dampening volatility, defending against inflation, adding yield, capital appreciation and asset growth. POPULATION PRESSURE After US population growth peaked in the post-war ‘50s at 18.5%, growth slowed but still has maintained an impressive pace: 13.2% or 32.7 million people during the ‘90s, and 9.7% or 27.3 million people from 2000 to 2010.i Population growth is the number one driver for new home demand and thus is the number one driver of housing starts (the number of new homes for which construction has begun). From 1990 to 2006, housing starts roughly paralleled population growth. Starting in 2007 however, housing starts fell behind while population growth continued its upward trajectory. Housing starts hit their pre-recession peak of 2.1 million in 2005the highest on record since record-keeping began in 1959 – then plummeted to a low of 554,000 in 2009. This white paper examines a particularly timely alternative investment in real estate: land targeted for approved residential development. This niche alternative asset class complements traditional and alternative investments to contribute to a balanced portfolio. LAND AND LOTS MAPPED AND APPROVED FOR HOMEBUILDING—A TIMELY NICHE INVESTMENT “ BUY LAND. THEY ARE NOT MAKING IT ANYMORE. ” – Mark Twain Over the past 60 years, housing starts generally followed an average trend of 1.47 million annually, however since 2008 the number of housing starts fell to its lowest level since recording began, and has struggled to recover, finally reaching just over 1 million in 2014. WHITE PAPER Housing Starts and Population Growth 330 310 2,400 290 270 1,900 250 230 1,400 210 190 900 170 HOUSING STARTS AVERAGE: 1.47 MILLION/YEAR 150 400 9 95 1 2 96 1 5 96 1 1 8 96 1 1 97 1 4 97 1 7 97 1 0 98 3 98 1 1 6 98 1 9 98 2 99 1 1 5 99 1 8 99 2 1 00 2 4 00 2 7 00 0 01 2 3 01 2 4 01 2 Source: U.S. Census, http://www.census.gov/construction/nrc/historical_data HOUSEHOLD FORMATION Household formation is another key factor in the increase in housing starts and is a natural result of population growth. The chart below shows that household formation slowed dramatically during the Great Recession and housing starts followed. As household formation recovered in 2011 housing starts began to recover although they have not caught up. According to the New York Times on January 21, 2015, housing starts surged to their highest level since early 2008. The National Association of Homebuilders forecasts that housing starts will reach 1.16 million in 2015, continuing the upward trajectory. For information on other major factors affecting the demand for land for residential development, view our previous white paper detailing the 10 Economic and Demographic Drivers Behind the Demand for Homesites. 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 19601970 1980 1990 20002010 Household Formation Over the Decade Total Housing Starts Over the Decade Sources: U.S. Census, http://www.census.gov/construction/nrc/historical_data ; U.S. Census Bureau, Demographic Trends in the 20th Century; 2010 Census Briefs, Households and Families: 2010. Total U.S. Population Housing Starts (000s) DECEMBER 2014 POPULATION: 319.9 MILLION WHITE PAPER “A I s ANOTHER TIME-HONORED REAL ESTATE TRUISM: LOCATION, LOCATION, LOCATION The growing demand for homesites is national, yet more intense in certain locations. Population growth has been greatest in the South and West, so those areas have experienced the greatest growth in housing as well. A prime example is the San Francisco Bay Area, where the technology industry employs a growing number of high earning workers who can afford to pay top dollar for housing. One example of how inflation impacts demand: the San Jose Mercury News reported that from December 2013 to December 2014, Bay Area median home prices increased 10.2%, compared to 8.2% nationally. Similar housing demand patterns are evident in other Western cities, such as Phoenix, Los Angeles, San Diego, Seattle, and Denver. The South also experienced a robust upturn in housing demand, while the Northeast and Midwest had slower growth. Clearly, when it comes to homesites as with other real estate, where you buy can be just as important as what you buy. Location, location, location. PORTFOLIO ROLE Investment in land to be mapped for real estate subdivisions (entitled homesites) in the right locations can help achieve several key investment goals within a portfolio. It becomes a defense against inflation, boosts capital preservation and of course contributes asset appreciation, adding value through the process of obtaining a final approved subdivision map on the property. evaluate a range of possible investments for clients in the current environment, I believe that residential real estate looks attractive, both for diversification and for return enhancement potential. – Rick Holbrook, Holbrook Global Strategies ” In today’s real estate markets, land entitled as homesites can provide double-digit short-term return potential. TWO OTHER PROMINENT ALTERNATIVE INVESTMENTS GOLD: THE ETERNAL ALLURE Gold holds a special place in human history for its aesthetic, symbolic, and economic values. Today, investors can add gold to their portfolios by purchasing bars and coins, exchange-traded funds, futures contracts, or mining company stocks. IT’S AS “GOOD AS GOLD” Many investors are drawn to gold because it’s a tangible asset with intrinsic value. It’s an almost universal medium of exchange. And the supply is limited and growing even more slowly than in the past. According to Rob McEwen, chairman and chief owner of McEwen Mining Inc. as reported in Forbes, “The supply of gold has been curtailed both through cutbacks and development projects — so there’s going to be a gap in production that could be three to five years long before it’s properly addressed.” In contrast, the supply of paper currency is easily expanded by a government printing press. Gold’s value remains undiluted while the world’s currencies can fluctuate dramatically. Thus gold is seen as a safe haven, protection against economic crises, and a hedge against inflation. WHITE PAPER BUT IS IT INVESTMENT-WORTHY? Warren Buffet doesn’t think so. By his definition, gold is a non-productive asset: it doesn’t create a product. In contrast, most common stocks are issued by companies that produce goods and services people will buy: food, goods, homes, all the things that a population wants or needs. Mr. Buffet’s opinion, as quoted in Forbes, “People will forever exchange what they produce for what others produce.” The result is a compounding growth rate for productive assets. In 1972 the DOW closed over 1,000 for the first time in its history, and on December 23, 2014 the DOW closed at 18,069, its record high.ii Evidence that supports Buffet’s assertion that “ . . . over any extended period of time [productive assets] will prove to be the runaway winner . . . More important, [they] will be by far the safest.” VOLATILITY RISKS Some investors mistakenly think of gold as an inert asset—solid, stable, immune to market whims. But gold is fungible. With no investment dynamics other than supply and demand to influence its price, gold is a natural target for speculation that can drive prices up or down dramatically. Gold price volatility is also influenced by the actions of central banks and government fiscal policies. Political turmoil can often push gold prices up temporarily—or bring it down. According to CNN Money, when there were concerns about Greece and Europe in 2010, gold prices spiked above $1,900 an ounce but then subsided to $1,210 an ounce, nearly 40% below its all-time high. It’s not uncommon for gold prices to rise or fall as much as 15% in a 12-month period.iii Gold prices, in fact, can be more volatile than commodities. PORTFOLIO ROLE Gold is one of the leading alternative investments—as an inflation hedge. Limited long term growth prospects and high volatility argue against expanding that role. OIL: IT’S BEEN BUMPY ROAD Crude oil is the most commonly traded of all commodities, and arguably the most important. Oil can be added to a portfolio as an alternative asset several ways, including the purchase of futures contracts or exchangetraded funds. After hovering around $100 a barrel for the first half of 2014, oil prices per barrel dropped dramatically, over 42% off the highs in June, and under $70 in January 2015.iv National average prices at the pump fell to under $3.00 per gallon after pushing the $4.00 per gallon threshold earlier in the year. WHITE PAPER TOO MUCH OF A GOOD THING Falling oil prices are great for consumers and for the overall economy on the premise that consumers will use their energy savings to buy other goods and services.v But low prices don’t bring smiles to oil producers. The problem is excess worldwide supply. American fracking and horizontal drilling have contributed to that.vi These techniques to extract oil from shale now produce four million barrels a day— from practically zero in 2008. As a result, the US is now the world’s largest oil producer as well as being its largest oil consumer. Adding to the surplus, Saudi Arabia and OPEC have not cut back on their production in an effort to hold onto their market share.vii With the growing glut of oil, cities like Midland, Texas, which burgeoned with the boom and saw its population grow from 108,000 in 2010 to 140,000 in December 2014, is now feeling the pinch. As prices fell producers in the surrounding Permian Basin cut back their rig count from 570 in September 2014 to below 490, with the expectation that it would fall to 300 unless prices go up.viii While supply continues upward, demand is on a downward trend, due in part to the general economic global slowdown and deflation in Europe. The International Energy Agency doesn’t foresee an upturn in the demand curve anytime in 2015. IEA Forecast of World Oil Demand (year-over-year change in million barrels a day) Latest June July Sep. Oct. 1.8 1.6 1.4 1.2 1.0 0. 8 0. 6 0. 4 0.2 Source: International Energy Agency. 15 4Q 20 15 3Q 20 15 20 2Q 1Q 20 15 14 4Q 20 14 3Q 20 14 2Q 20 14 20 1Q 4Q 20 13 3Q 20 13 2Q 20 13 20 1Q 13 0 WHITE PAPER $ PORTFOLIO ROLE The primary motive for investing in oil is asset appreciation. But for those considering oil as alternative investment in today’s environment, the word is “uncertainty.” This at least is the view expressed in the International Monetary Fund’s global economy forum of December 2014: We find both supply and demand factors have played a role in the sharp price decline since June. Futures markets suggest that oil prices will rebound but remain below the level of recent years. There is however substantial uncertainty about the evolution of supply and demand factors as the story unfolds. THE TRADITIONAL ASSETS BONDS: STILL A SAFE BET? Bonds, whether corporate, treasury, or municipal, have traditionally been added to a portfolio for two reasons: 1 To provide a reliable fixed income stream. 1 2 To keep a part of the portfolio in a safe 2 place for capital preservation. 5.5 Both reasons are generally valid still, with a caveat or two. BONDS SAFE BET? VALUE IS BASED ON YIELD Investors purchase bonds primarily for income and bond prices are driven by their yield—the income they generate. That’s because lower yield means lower income. Lower income means lower value to the bond holder. Moody’s, the bond rating service, reported an average corporate yield in December 2014 of 4.17%.ix The 30-year treasury bond rate was 2.44% on January 16, 2015.x As long as inflation rates remain low, those are acceptable income sources. However, if inflation rises to 4% or more—as it did in 2008, for example—the yields after inflation from those bonds is at best break even. Factor in taxes and fees, and bond income loses ground. As the chart below demonstrates, xi just because the yield is low to begin with doesn’t mean it can’t go lower. Historical Treasury Rates 5.4 4.5 Rate (%) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 .5 0 200520062007 20082009 2010 2011 2012 2013 2014 2015 http://www.freddiemac.com/pmms/pmms30.htm Time Period STILL A WHITE PAPER THE LIQUIDITY RISK Bonds do have liquidity. But remember that the market value of a bond is based on its yield. If a bond’s yield rises, the bond’s price declines. To liquidate bonds that are “under water,” the price has to fall to increase the bond’s relative yield. In a thin market, such bonds will go begging until their prices are cut severely. KNOW THE ISSUER There’s also the default risk—that the bond issuer will not be able to continue its payments to you. This risk is slight for large, well-established corporate issuers except in times of dire economic crisis. But beware of junk bonds that promise exceptional yields and are issued by little known entities. If they go south, you’re left holding a worthless piece of paper. PORTFOLIO ROLE Current income and capital preservation are the main reasons to invest in bonds, making bonds especially suitable for a retirement portfolio. Investors must remain mindful that bonds are relatively safe, but not risk free. STOCKS: THE TRADITIONAL MAINSTAY Equities—common stocks and mutual funds traded on the New York Stock Exchange or Nasdaq—are the backbone of most portfolios. And for good reason. Equities have demonstrated persistent growth for over a century, based on Dow Jones Industrial Averages and are thus considered the soundest long-term investment. They’re also one of the most liquid of all asset classes. However, picking stocks is a highly sophisticated skill. So is knowing when to buy and when to sell. “Market timing”— attempting to predict the market’s direction— is very chancy and requires constant monitoring plus expert knowledge. It’s not advised for the average investor. Nor is “day trading”—buying and selling stocks in a short time frame to try to capitalize on minute-tominute price changes. It’s a full-time job. THE ADVANTAGES ADD UP Besides growing value, investing in stocks can also produce current income from dividendpaying stocks like Apple, Coca Cola, and Wal-Mart. Stocks offer the flexibility and range of options to create customized solutions to meet the goals of most portfolios. Their liquidity makes stocks’ value readily accessible with a phone call to a broker or a few clicks on an online trading site. A portfolio of stocks in several different economic sectors can provide balance and diversity as protection against economic downturns in individual sectors. HOW LONG CAN THE BULLS KEEP RUNNING? Stocks had their steepest annual decline since the Great Depression in 2008. They bounced back strongly and have since continued to grow in value despite continued problems elsewhere in the US economy. Recent numbers are evidence of this growth. The Dow Jones Industrial Average opened at 16,572 on January 1, 2014 and peaked at 18,069 on December 23. On December 31, it closed the year at 17,983,xii setting a new year-end record high. The DJIA had the largest calendar year point gain in 2013 rising over 26%. WHITE PAPER PORTFOLIO ROLE Stocks and mutual funds merit their prominent role in the American investment portfolio, for their long-term growth potential, access to liquidity, current dividend income, and ability to preserve capital in a balanced asset allocation. In the short term stocks are very difficult to predict and manage because of their volatility. SUMMARY - THE BALANCING ACT It’s a well-known fact that diversity is the key to a balanced portfolio. Different asset classes can be selected to meet different goals. Traditional assets—stocks and bonds— typically are considered to meet long-term goals while commodities like oil offer shortterm returns. An investment in entitled residential land can fill in the gaps to create a more balanced portfolio. They offer both defensive and offensive attributes: capital preservation and inflation protection as well as asset appreciation. Careful selection of value-added residential land in prime locations offers the potential for double-digit short-term returns. Current trends in housing, particularly western US markets, support the timelines of an investment in entitled homesites. Sponsored by The True Life Companies, real estate investment specialists operating in California, Arizona, and Colorado. For more information on our company and investment opportunities, please visit our website: http://thetruelifecompanies.com/ partnership/ or call Joe Fraser at 925.824.4303. Please contact us if you have comments on this white paper or wish to order reprints. SOURCES The following organizations, documents, and websites (in alphabetical order) provided material for this white paper. Please see next page (Endnotes) for specific references in order of appearance. •1stock1.com/1stock1_139.htm •about.com/money •bankrate.com • Board of Governors of the Federal Reserve System •Bonds.About.com •Bondbuilders.co •CNBC • CNN Money • The Economist • Financial Times • FRED: Federal Reserve Economic Data • Forbes Magazine • Forest Investment Associates • Fortune Magazine •goldprice.org US Department of Census New York Times and Yahoo Money iii bankrate.com iv CNBC v Forbes • The New York Times • Market Realist •MarketWatch •Moody’s • National Association of Homebuilders • National Association of Insurance Commissioners • National Association of Realtors • TradeWeb Data Point • US Department of Census • Yahoo Money •ycharts.com • US Department of Treasury • US Energy Information Administration • US News & World Report CNN Money and The Economist CNN Money and The Economist viii The New York Times ix National Association of Insurance Commissioners ycharts.com US Treasury Department Resource Center xii Yahoo Money i vi x ii vii xi Copyright ©2015, The True Life Companies, All Rights Reserved.