Choosing to sell bonds to invest in real estate can be a simpler decision than selling stocks for the same purpose. This is because real estate and bonds share more similarities than real estate and stocks. Real estate can be seen as a ‘bond plus’ investment, meaning it’s like a bond but with more potential for gains and less risk of losses. However, nothing is certain in the world of investments, hence the term ‘potential’.
This information is useful for those who are:
- Trying to understand the relationship between investing in real estate and bonds.
- Considering selling bonds to invest in real estate, or vice versa.
- Looking to structure their net worth based on their risk tolerance.
- Seeking ways to achieve financial independence sooner with more risk than bonds.
- Believing in the value of real estate as a tangible asset that generates income and provides utility.
Real estate and bonds behave similarly in response to interest rate changes. When interest rates decrease, the value of both bonds and real estate tends to increase. Conversely, when interest rates rise, their values tend to decrease. Therefore, if you sell bonds after a rise in interest rates to buy real estate, you might be swapping one losing investment for another.
In a bull market, real estate usually provides higher returns than bonds. This is where the ‘plus’ in ‘bond plus’ comes in. Due to leverage, real estate often has a higher cash-on-cash return. Additionally, because real estate holdings usually have a larger dollar value than bonds, the absolute return from real estate tends to be greater.
Real estate can also outperform bonds in a bear market. For instance, when interest rates rose sharply in 2022 and 2023, bond funds took a hit. However, real estate performed better because the median home price in America only declined by about 8% in 2022.
Real estate investors can take proactive steps to protect against downside risk. These actions can include refinancing, finding higher-paying tenants, and remodeling. Bond investors, on the other hand, have fewer options to hedge against downside risk.
Real estate also offers more benefits during extreme hardships. For example, in a hyperinflation scenario, government bonds will lose value, while real estate values will likely inflate. Similarly, if your country goes to war, government bonds may lose value due to capital flight. However, as long as your home isn’t destroyed, it provides shelter and retains some value.
The type of bond also matters for relative performance. For example, if you bought $1 million worth of one-year Treasury bonds yielding 4.5% before interest rates started rising, and sold the entire position nine months later to buy real estate, you likely didn’t lose any principal. Instead, you probably made a 3.375% return after nine months instead of a 4.5% return after twelve months.
Before selling individual Treasury bonds to pay cash for a new house, consider the following:
- Will you lose money if you sell before maturity?
- How much risk-free interest income will you forgo a month if you sell before maturity?
- How much in federal ordinary income taxes will you have to pay on Treasury bond income?
- What would the composition of your net worth and investment portfolio look like if you sell Treasury bonds to buy a new house?
In conclusion, real estate acts similarly to bonds in response to interest rate changes, can offer higher returns than bonds during good times, and can lose less than bonds during bad times. Selling bonds to pay cash for a home is easier than selling stocks to pay cash for a home. Your down payment fund should hold short-duration individual Treasury bonds versus Treasury bond funds or riskier bond types.
Real estate is a favorite asset class for many people to build wealth. It generates income, provides shelter, offers diversification, can be improved upon, usually benefits from inflation, and has a positive historical return. Bonds are fine and have a historical average return of about 5%. But given you can’t enjoy your bonds or improve your bonds, bonds are simply not an enticing enough investment to make when compared to real estate.
What are your thoughts on holding bonds if you already own real estate? Do you view real estate as a bond plus investment as well? When does owning bonds outweigh the benefits of owning real estate?
