Those that pay attention to the stock market know that things have been going badly recently. What does this mean for real estate as an alternative asset? Some good things can happen. We don’t know exactly yet but we do have a good idea of what to look for.
Understand What is Spooking the Macroeconomy
Very recently, the S&P 500 slumped nearly 4%, entering a bear market territory, meaning the broad benchmark index has now dropped more than 20% from its most recent high. That’s the definition of a Bear Market and those words strike fear in the minds of stock market investors. The Nasdaq has been there for a while and the Dow Jones Industrial Average isn’t doing any better.
The economic headlines point at skyrocketing energy prices and a crippled supply chain as the chief causes of inflation. Indeed, inflation rose 8.6% in May, the highest since 1981. At a macro level, the higher-than-expected inflation report triggered stock market concerns that the Federal Reserve will need to raise interest rates more aggressively this year and even into next year.
This is all bad news for stock market investors but there can be some upside for real estate as an alternative asset. It might be a couple of more weeks or months for the real estate picture to be completely clear but here are three key points to keep your eye on:
- The best thing that a market dive could do for real estate is to keep the Federal Reserve from raising interest rates so high that mortgages become unattainable. While the Feds want to raise interest rates to lower inflation, there is also pressure not to raise interest rates too much or too fast because it will slow the economy which would bring the threat of a recession. The ideal soft landing spot is about 2% annual inflation. We are not going to hit 2% inflation this year. What the Fed wants to do is slow inflation gently so that it returns to 2% without overshooting the mark in a way that could cause a recession. Look for the June 2022 Fed rate hike to be either 0.5% or 0.75%. A 0.5% rise will make it easier to finance real estate as an alternative asset held in a Solo 401k. A small interest rate rise will also keep the real estate market more affordable for all home buyers which keeps value appreciation on a healthy track.
- A bear market is considered an important barometer of investor pessimism and is symbolic of a deep and sustained market selloff. The S&P 500 entering one sends a powerful warning signal across the economy. Trillions of dollars are invested in index funds made up of S&P 500 stocks. That money has to go somewhere and real estate has long been considered a safe harbor during times of uncertainty.
- The rise in inflation meant workers lost more ground in May, with real wages declining 0.6% from April and 3% on a 12-month basis. Combined with rising interest rates, this makes home buying less affordable. This should slow the sky-rocketing rise in appreciation which would make real estate as an alternative asset more affordable for investors. Additionally, everyone needs somewhere to live which would be good for rental revenues. As inflation and interest rates get sorted out over time, the demand to purchase homes will again increase, causing a resurgence in future appreciating values.
When stocks are tanking, money-wise buyers start turning towards safer harbors.
Real Estate as an Alternative Asset During Stock Market Down Turns
Real estate as an alternative asset is already seen as a conservative purchase and may be seen as even more of a wise investment as stocks continue to plunge. If you are in the stock market, what’s particularly scary is that no one knows how long it will take for stocks to recover from this major downturn or how long the plunge will go on. Even if it is just a “correction,” corrections tend to happen frequently. A stock market correction is a drop of between 10% and 20% in a major market index. Since 1950, the common count is that there have been 36 double-digit corrections, 10 bear markets, and 6 crashes.
Sometimes it’s an outside crisis, such as the pandemic in 2020. Other times, a particular industry or economic sector collapses which affects the entire market, as with the bursting of the dot-com bubble in 2000 or the financial crisis in 2008. In the middle of June 2022, the name being attached to the downturn is simply “Bear Market.” It is now a confirmed bear market for the first time since March 2020, fueled by worries over sky-high inflation, a hawkish Federal Reserve, and slow or no near-term economic growth.
On the other hand, the spring 2022 real estate market has been red hot. In December 2021, Zillow predicted house price growth would decline. That was before the stock markets soured. By January, it predicted that 2022 would finish with a 12-month house price growth rate of 16.4%. As the stock markets continue souring, the year-over-year price growth expectation became a peak of 21.6% by midyear with a 2022 close at 17.3%. Owning real estate as an alternative asset remains a terrific way to generate passive and consistent income.
Real Estate as an Alternative Asset When Market Fears Differ From Real Estate Reality
While no one can say with absolute certainty, the signs don’t point to a real estate slowdown in 2022. Millennial population demographics, a decade-long shortage of new construction homes, and the state of the U.S. economy are all present factors pointing to a healthy and sustainable real estate market. Fannie Mae is calling for 5.6 million existing homes to be sold in 2022 and home prices are also expected to rise.
Additionally, the chance of a real estate crash caused by foreclosures is low because tighter lending requirements have increased home equity. That makes the risk of over-supply due to defaults extremely low. Although there has been a slight increase in the last few months, housing inventory remains tremendously low, especially compared to historical trends. We are almost four million houses short of meeting demand, according to Freddie Mac analysts.
Here are some tried, trusted, and rewarding benefits to expect by holding real estate as an alternative asset in a Solo 401k.
- Security of Returns. Unlike fluctuating stock market performance, real estate returns have minimal variance and as the value increases over time, real estate provides a source of stable and consistent income.
- Inflation Hedge. Inflation erodes the wealth of investors over time. One of the primary objectives of investors is to protect their wealth against the negative effects of inflation, especially for long-term investors. Real estate provides a hedge against inflation as the value of the assets grows in tandem or higher than the inflation rate. Rents can be adjusted over time in response to movements in inflation rates.
- Leverage to Build Equity and Wealth. Real estate can be leveraged to acquire itself, thereby building equity. Additionally, the income enables investors to buy more properties to increase cash flow and wealth.
- High Returns. This will vary depending on individual decisions and circumstances but the long-term average rate of return on a rental property is around 10% and the average ROI on commercial real estate is 9.5%.
When well planned for, real estate as an alternative asset could lead to great returns for any investor through net operating income, equity build-up, and/or capital appreciation.
Real Estate as an Alternative Asset During Rising Interest Rates
Because real estate is a hard asset that provides utility and produces income, real estate generally outperforms during times of uncertainty. The market will likely balance out between a buyer’s and seller’s market. Inventory is still low enough for homeowners to confidently put their homes on the market with expectations of selling at a fair price. This will improve conditions for investors that have struggled recently to find worthwhile real estate as an alternative asset.
The Federal Reserve doesn’t set mortgage rates, but it does affect mortgage rates indirectly.
Interest rates are not heading into unreasonable territory. So far this year, the Fed has enacted two rate increases totaling 75 basis points. A basis point equals 0.01%. Keep in mind that we are coming off historically low-interest rates.
Too much emphasis is probably being placed on modestly rising interest rates. During the pandemic, mortgage rates hit historic lows that dipped as low as 2.65% in January 2021. Many people remember the 18% mortgage rates of the 1980s — or even an 8% during the 1990s. We didn’t even see 6% 30-year mortgages until 2002. Historically, people would probably say today’s 5% is a good mortgage rate. However, someone who bought a home last year at 2.65% might not think 5% is a good rate today. Mortgage rates need to be kept in perspective rather than overreacting as they come off historic lows.
The Federal Reserve raised the target federal funds rate by 0.5% on May 4, 2022, to a range of 0.75% to 1%. Multiple increases are expected in 2022 according to the committee’s projections. The Fed does a lot of work using its signaling function to indicate the direction of interest rates, long before the Fed follows through. That’s what happened in the first four months of 2022. Although the Federal Reserve will adjust going forward, much of what is expected has already been factored into today’s interest rates. The expected result is that mortgage rates should not balloon to some disastrous level.
Hiking The Real Estate Rise To A Hidden Plateau
Most Fed officials estimate the “neutral” level of their benchmark borrowing rate to be around 2.5%. With it already between 0.75% and 1%, whatever the size of the June rate hike, the Fed will be close to 1.875% after the July meeting. It does not have much further to go up and much of that is likely already priced in via Fed signaling since the benchmark 30-year mortgage rate rose from 3.3% to 5.36% during the first four months of 2022.
Also, although the Fed’s actions are putting upward pressure on mortgage rates, other factors are dragging them down. Rates for fixed mortgages are also influenced by supply and demand. When mortgage lenders have too much business, they raise rates to decrease demand. When business is light, they tend to cut rates to attract more customers. Less demand in today’s market creates pressure to keep mortgage rates lower. The secondary market where investors buy mortgage-backed securities plays a role, too. Most lenders bundle the mortgages they underwrite and sell them in the secondary marketplace to investors. When investors aren’t buying, rates rise to attract buyers. When investor demand is high, mortgage rates trend a little lower. Expect downward pressure on mortgage rates because real estate as an alternative asset is an attractive and secure investment when the stock market is down.
Why Investing in Real Estate Is Better Than Stocks
Investing in real estate as an alternative asset is a tried-and-true practice for building wealth with a Solo 401k retirement account. Real estate is a physical asset, which makes it a safe investment. Even during dips in the economy or crashes in the stock market, the property retains value. Ultimately, when it comes to growing your wealth, real estate tends to offer more long-term stability with lower risk over time. If your financial goals are to provide financial stability and security throughout your adulthood while building a nest egg that you can cash in on for retirement, real estate is a clear winner. It can provide you with all of that and more.
Set Up Your Solo 401k for Tax-Advantaged Real Estate Investing
You can invest your Solo 401k funds into houses, condos, land, mortgage notes, and more! Let the gains, rents, and profits go back into your Solo 401k without taxation. Our Unlimited® platform gives you the freedom to invest in virtually any real estate deal, whether it be a rental home, a bargain at the foreclosure auction, or a syndicated “insider” real estate development.
Real Estate has long been the darling of the self-directed investing industry.
Opening your Solo 401k involves very little work for a ton of benefits.