Bond/Annuity Bubble?
Investors in real estate investment securities often have interest in other income investments. It is worth looking at the "hot" income investment products of today; bonds and annuities. However, the question arises: Are they the new "bubble"?
Remember when investors paid $1,000 for each $50 of real estate income? Looking back we all call it the real estate bubble. Yet today bond investors only get $30-$40 income for their $1,000 invested, while investment grade property easily pays $70.
One is forced to wonder where the investment bubble is today? Bonds and annuities are purchases of income streams – write the check and get the income. If the issuer (that's the company or government that guarantees the income) is strong, investors pay more for the income. Certainty of payment is important and investors pay higher prices for that strength. That is why in troubled times investors will accept under 3% for ten year government treasuries – Even less for tax free municipals.
The dangerous issue with high prices and the resultant low yield is when overall interest rates rise, not only is the old, lower, rate less attractive; but the bonds lose value. No one will pay $1,000 for $30 of income when new bonds pay $50. Let's look at it another way. One can buy $30 of income for $600; and, for the sake of simplicity, that is what the old $1000 bond is worth – $600. (Trading prices will reflect the term of the bond and complicated yield adjustment formulas are employed)
The other bond value is the value of the bond when held to maturity. In that case, the investor gets the face value of the bond. While that has the appearance of security the purchase power of that face value may be substantially less. Even with low inflation of 3% after ten years the inflation adjusted value of bond investment is substantially less... another unanticipated blow to the investor. Should inflation rates rise substantially due to huge government deficits the effect on bond values held to maturity is devastating.
Another factor affecting bond and annuity values is the performance of alternative income investments such as net income real estate related securities. Currently it is commonplace to find real estate securities producing income streams of 7% or more. Many of these securities contain provisions providing for value increases should the underlying assets increase in value.
The real estate investment securities are perceived by many as risky due to the hangover from the bursting of the real estate bubble. That fear is an important element propping up bond and annuity values. If that fear is not justified then the bubble nature of the bonds becomes even more dangerous. Investors thinking they are buying safety through bonds and annuities may end up owning a time bomb.
(Note while many bonds and real estate securities have tax advantages the principles determining risk and value remain).
Remember when investors paid $1,000 for each $50 of real estate income? Looking back we all call it the real estate bubble. Yet today bond investors only get $30-$40 income for their $1,000 invested, while investment grade property easily pays $70.
One is forced to wonder where the investment bubble is today? Bonds and annuities are purchases of income streams – write the check and get the income. If the issuer (that's the company or government that guarantees the income) is strong, investors pay more for the income. Certainty of payment is important and investors pay higher prices for that strength. That is why in troubled times investors will accept under 3% for ten year government treasuries – Even less for tax free municipals.
The dangerous issue with high prices and the resultant low yield is when overall interest rates rise, not only is the old, lower, rate less attractive; but the bonds lose value. No one will pay $1,000 for $30 of income when new bonds pay $50. Let's look at it another way. One can buy $30 of income for $600; and, for the sake of simplicity, that is what the old $1000 bond is worth – $600. (Trading prices will reflect the term of the bond and complicated yield adjustment formulas are employed)
The other bond value is the value of the bond when held to maturity. In that case, the investor gets the face value of the bond. While that has the appearance of security the purchase power of that face value may be substantially less. Even with low inflation of 3% after ten years the inflation adjusted value of bond investment is substantially less... another unanticipated blow to the investor. Should inflation rates rise substantially due to huge government deficits the effect on bond values held to maturity is devastating.
Another factor affecting bond and annuity values is the performance of alternative income investments such as net income real estate related securities. Currently it is commonplace to find real estate securities producing income streams of 7% or more. Many of these securities contain provisions providing for value increases should the underlying assets increase in value.
The real estate investment securities are perceived by many as risky due to the hangover from the bursting of the real estate bubble. That fear is an important element propping up bond and annuity values. If that fear is not justified then the bubble nature of the bonds becomes even more dangerous. Investors thinking they are buying safety through bonds and annuities may end up owning a time bomb.
(Note while many bonds and real estate securities have tax advantages the principles determining risk and value remain).
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