Over Valued?

Research on Safe Withdrawal Rates

Moderator: hocus2004

JWR1945
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Post by JWR1945 »

Delawaredave wrote:Does any one have any experience/websites on SWR's for rental real estate ? Though I read somewhere that rents average 1%/month of property value.

That's 12% per year - sounds high. If one did the property management themselves and some repairs, is that a more reliable way to get a 6-7% SWR than equities ?
This is the wrong way to phrase it.

Here is the rule of thumb. You should not pay any more than 100 times the monthly rental income. That way, monthly rental income is at least 1% of the property value (gross).

These days, it is difficult to purchase such properties anywhere except in slums. Being a slumlord requires a unique personality.

There are ways to make money with lower rents. Leverage is what makes real estate investments special. Typically, a return that is only a small percentage of a property's price is magnified into a large percentage of the initial investment (down payment plus fees).

There are special concerns such as being able to pay your bills when you have a vacancy.

Here are two important rules that many (but not all) successful residential real estate investors follow:
1) Always maintain a positive cash flow.
2) Always make your capital gains when you buy. That is, buy low enough (including making ridiculously low bids) to assure yourself of a nice gain later on.

I do not know for sure where you live. But guessing from your name, my guess is that you are close enough to Washington DC to have a continually high demand. That is FMO's situation.

In the northeast and in the western seaboard, residential real estate prices have become highly volatile and extremely expensive right now. Those markets are dangerous. You can lose big. In addition, many (or most?) areas along the west coast restrict development which artificially inflates real estate prices. You are at the mercy of politicians.

[Quite often, you hear high sounding motivations attached to such restrictions such as maintaining the quality of life among all income groups. In reality, the economic effect is to increase prices and drive lower income people out of the area.]

My impression is that Mike comes from an area along the west coast with such artificial restrictions.

Have fun.

John R.
Delawaredave
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Post by Delawaredave »

Thanks for above. My estimated required SWR was net of inflation (I can never remember if that's "real" or "nominal"....

The above posts, especially below quote, certainly signify "where I want to be"
semi-retirement, where you retire to opportunity, personal development and satisfaction instead of simply retiring away from gainful employment.
I'll keep browsing past threads - lot of good information and views.
JWR1945
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Post by JWR1945 »

My estimated required SWR was net of inflation (I can never remember if that's "real" or "nominal"....
Real includes an adjustment for inflation. That is what you are talking about.

Nominal does not include any adjustment for inflation. It is nominal in terms of dollars but not in terms of buying power.

You will want to read this thread started by Bookm on the FIRE board:
Pros and cons of being a landlord dated Fri Dec 10, 2004.
http://www.nofeeboards.com/boards/viewtopic.php?t=3164
I provided several links to early FMO real estate posts.
http://www.nofeeboards.com/boards/viewt ... 345#p25345

Have fun.

John R.
JWR1945
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Post by JWR1945 »

Delawaredave wrote:Does any one have any experience/websites on SWR's for rental real estate ? Though I read somewhere that rents average 1%/month of property value.

That's 12% per year - sounds high. If one did the property management themselves and some repairs, is that a more reliable way to get a 6-7% SWR than equities?
I forgot to answer this part.

YES. Usually, it is much more reliable and it is obtainable.

Ben Solar and ElSupremo are enthusiastic about real estate these days. At least, when compared with the stock market.

Some people are quick to point out that what you are talking about involves work.

Keep in mind that there are situations in which you cannot make money in real estate. This happens when the market gets flooded with new investors. It happens when politicians come up with short-term solutions that ultimately destroy markets such as rent controls.

Have fun.

John R.
hocus2004
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Post by hocus2004 »

"I'll keep browsing past threads - lot of good information and views."

Thanks for those kind words, DelawareDave.

Here's a link to a thread titled "Concrete Actions to Take In Today's Valuation Environment."

http://nofeeboards.com/boards/viewtopic.php?t=2613
hocus2004
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Post by hocus2004 »

"Ben Solar and ElSupremo are enthusiastic about real estate these days. At least, when compared with the stock market. Some people are quick to point out that what you are talking about involves work."

Which just makes it that much more appealing to those of us who see work as one of the great joys of life. My personal assessment is that BenSolar, ElSupremo and JWR1945 all are more properly included in that camp than in the camp being slyly refered to in the words above by JWR1945, the camp that sings the song about how "Work Is Just Another Four-Letter Word."
Delawaredave
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Post by Delawaredave »

Does everyone agree that PE10 is the best measure ?

Seems to me like averaging earnings over 10 years is too long - that's a couple of business cycles. I agree that earnings swing too much - and should be averaged.

But if they're averaged over too long a period they distort the current trend - correct ?

I'm concerned that by averaging in earnings back during last downturn one is understating today's true earnings - and therefore overstating valuation excess ?

I should do some math to confirm, but are we in a spot where the S&P:
- "regular" PE is 18, and
- averaged P/E10 is 23 ?

I guess you should compare "regular" PE's to "regular PE averages" and
PE10's to PE10 averages.

I'm new to PE10's -- just seems to compare current pricing to too much past earnings.

More confused each day,
DelawareDave
JWR1945
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Post by JWR1945 »

Delawaredave wrote:Does everyone agree that PE10 is the best measure ?

Seems to me like averaging earnings over 10 years is too long - that's a couple of business cycles. I agree that earnings swing too much - and should be averaged.

But if they're averaged over too long a period they distort the current trend - correct ?
..
I'm new to PE10's -- just seems to compare current pricing to too much past earnings.

More confused each day,
DelawareDave
P/E10 is our best indicator so far in terms of Safe Withdrawal Rate research.

I have applied several indicators to the historical record to predict the order of Historical Surviving Withdrawal Rates. I have looked at many indicators including the single year P/E and a variety of combinations. P/E10 is the best so far. Tobin's Q is second.

P/E10 does a good job of estimating intermediate-term returns. The intermediate-term, especially at 10-15 years, turns out to be the most important for retirement portfolios. By then, the portfolio has grown enough to assure continued success or it has already shown signs of being in trouble.

Professor Robert Shiller of Yale, who wrote Irrational Exuberance, came up with P/E10 and he includes it in his (free) S&P500 database. This is the database used in historical sequence calculators. Benjamin Graham came up with the recommendation to average 5-10 years of earnings. Professor Shiller applied it to the S&P500 index.

Professor Shiller has shown credible evidence that P/E10 successfully predicts future stock market performance. His first paper looked at P/E30. P/E10 was a refinement.

The long-term earnings growth of the S&P500 has been remarkably stable when averaged over 10 years.

You have too many reading references at this moment. You might visit Professor Shiller's site in a few weeks to see his comments.

Home page:
http://www.econ.yale.edu/~shiller/
Here is the data.
http://www.econ.yale.edu/~shiller/data.htm
This is a List of Online Papers
http://www.econ.yale.edu/~shiller/online.htm

These papers show that P/E10 is a good predictor of future performance.
Original Paper by Shiller, which is easier to read.
http://www.econ.yale.edu/~shiller/data/peratio.html
Federal Reserve Paper by Shiller and Campbell, which is more thorough.
http://www.econ.yale.edu/~shiller/online/jpmalt.pdf

Again, you are better off delaying this part of your investigations. You already have plenty to look at.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

Delawaredave wrote:I should do some math to confirm, but are we in a spot where the S&P:
- "regular" PE is 18, and
- averaged P/E10 is 23 ?

I guess you should compare "regular" PE's to "regular PE averages" and
PE10's to PE10 averages.
When earnings are growing steadily, P/E10 will be higher than the single year P/E. This is because the average of the previous ten years of earnings is less than the latest year of earnings when there is a steadily upward trend.

Of course, there are years in which earnings (almost) disappear. Most of the time, however, P/E10 is bigger than P/E.

Here is an additional point. The earnings in P/E10 are in real (i.e., inflation adjusted) dollars to make each year comparable with the others. This means that the price (or index value) has to be in real dollars when making calculations.

Have fun.

John R.
JWR1945
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Post by JWR1945 »

Mark Hulbert may be stealing our material. [Warning: Subtle Joke.]

Mark Hulbert's column today is Stocks are not cheap:
http://cbs.marketwatch.com/news/story.a ... mktw&dist=
Quote:
These higher valuations might be more justified if companies' quality had been steadily rising over the years. But that does not appear to have been the case over the past two decades: Valuations have risen as quality has declined.

Why aren't more investors focusing on this dangerous divergence? I suspect that it is because they are constantly being told that today's valuations are not out of line with historical norms.
..
The problem with this currently-popular argument, they say, is that it compares P/E ratios that are calculated in significantly different ways. The S&P 500's current P/E ratio is as low as 16 only if it is calculated using projected earnings for the coming year. But the S&P 500's long-term average P/E ratio is not as high as the mid-teens unless it is calculated using earnings actually reported over the trailing 12 months.

Since P/E ratios based on projected earnings will almost always be lower than P/E ratios based on trailing earnings, the current belief that the S&P's P/E ratio is not above average depends on a comparison of apples to oranges. To come up with a true historical comparison, it is crucial to use the same definition when calculating today's ratio as well as the historical average.

Have fun.

John R.
Mike
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Post by Mike »

Quality down, valuation up. Now if he would only explain why.
JWR1945
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Post by JWR1945 »

This is earlier in Mark Hulbert's column. Keep in mind that Hulbert's specialty is evaluating investment newsletters. This time, his comments were based on S&P's Outlook.
The chart..shows the number of companies that, as of the end of each of the past 20 years, earned S&P's highest quality rating, an "A+." Though the formulae that S&P uses to calculate this rating are proprietary, it does say that the rating takes into account the growth and stability of earnings and dividends.
The number of firms earning an A+ rating was above 200 in the early 1980s..It fell to below 100 in the early 1990s..at the end of 2002 [it] had fallen to what so far has been an all-time low -- just 76 companies.

Despite the economic recovery since 2002, furthermore, the number of firms earning S&P's highest quality rating has barely budged. As of this past Dec. 31, it stood at just 80.

Quality is reported as lower as a result of Standard & Poor's estimates of the growth and stability of earnings and dividends.

Let me add another factor. It is speculation on my part.

I suspect that Standard & Poor's uses greater caution these days because of accounting scandals such as at Enron. S&P rates bond. If I recall correctly (IIRC), they got caught with some of their higher quality bonds going directly into default. Moody did too.

If I am correct, all companies are having their quality ratings diminished because of this.

Have fun.

John R.
Mike
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Post by Mike »

Less stable earnings, and a bit more caution. I suppose S&P earnings dropping in half in the post 2000 period does give one pause.
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