Trillions of dollars in wealth

Here are the facts: (a) over 200,000 houses were built in Jamaica over the past two decades, (b) the average value per house is at least $10 million. Here’s what this means: the 200,000 houses at this $10 million dollar average value translate into at least $10 trillion in wealth. That’s a lot of money.

This $10 trillion in real estate wealth is not likely to lose value over the next 30 years; in fact it’s more likely (notwithstanding the current state of the economy) that the value will outpace the inflation rate during this period.

What this means is that when the last of these mortgages are paid off in the next 30 years, there will be tremendous wealth held by a group of Jamaicans that just a few generations ago were working 18-hour days as slaves. The significance of this is often ignored.

The sharp increase in real estate wealth in the past two decades is important for another reason. With the birth rate tumbling over the same period, the average family size is less than four persons per household. This means that there are fewer people in each family who are likely to lay claim to this new wealth.

This real estate wealth may not translate into cash, but it means is that there is now significant ability to access capital through the use of the real estate as collateral .

The discussion then, about economic crisis, job losses, the rising foreign exchange rate and the high price of oil while important, fails to notice one very important fact: there is now significant wealth in the hands of the average Jamaican.

For a people that have not known financial wealth in centuries, this is both a significant reality and a significant challenge. For one, it’s of crucial importance that this wealth be preserved during this current economic downturn with large-scale re-possessions to be avoided at all cost.

In addition, it is important to ensure that this wealth is passed to the other generation in an organized and structured manner through the use of proper wills, provisions being made for the payment of transfer taxes and due thought given to how the houses will be held (by individuals or through trust funds etc.)

Much has been said about the stock market with its billion of dollars in market value and approximately 50,000 investors. This is obviously commendable, but so too is the newly created real estate wealth with close to 200,000 families and more than $10 trillion in value. There needs to be a shift in the dialogue.

Rethinking Retirement

Let's say that you do exactly as told: you do a sensible budget; live within your means; save a significant portion of your monthly income and invest in stocks in your youth and gradually shifted your portfolio toward bonds as you grew older. Let's say you did all of this for 40 years until age 65; it would be reasonable after all this sacrifice and discipline to expect at least a comfortable retirement.

It would be a reasonable expectation but it if the 40 years were the ones up to 2008, then you may be in for a great surprise. During this period, Jamaica's inflation averaged 17% per annum a rate that eclipsed the yield of most investment options. Let's put this in perspective: an annual inflation rate of 17% over a 40 year period means that on average, prices would have surged more than 53,000% (yes, this is a real number) over the four decades. An annual average inflation rate of 17% over a 40 year period would leave investors hard-pressed to earn real returns. An item that cost $100 in year 1 would end up costing more than $53,000 at the end of the 40 years.

Financial Analysts define a Real Return on an investment as a rate of return that is greater than the inflation rate. Therefore, if your investments earned an average of 17% per annum over the past 40 years then your real rate of return would have been 0%. This may not be as bad as it sounds as almost no form of investment earned an average annual return of 17% over the past 40 years.

For one, fixed income investments have not yielded this kind of return, but then, no one real expects fixed income investments to yield superior returns. No, for that eyes tend to gaze expectantly at the stock market. There is good reason for this. Since its inception in 1969, the stock market index has skyrocketed from 100 points to its current level of approximately 82,000 points. This is remarkable when it is remembered that at current levels, the index is well off its peak of a just a few years ago.

The only problem with this though is that most investors do not invest in the index (though there are investment vehicles that allow this). Instead, they invest in individual stocks and the results of this have been far more checkered than investing in the performance of the market as a whole. Furthermore, stock prices can be particularly volatile.

There has been an undisputed saving grace during this 40 year period though: real estate. Here’s an example: a 2-bedroom, 1-bathroom house in Portmore went for $20,000 in 1980. The same house (unimproved) now sells for at least $6 million. This an average increase of over 1000% per annum over the 28 years period. Of course this gain only becomes available if the home is sold and therein lies the problem: the wealth cannot be truly unlocked unless the home is sold. In many instances, this is the residence of the owner and sale is not a viable option.

The next best option is therefore rental. While rental income has not grown in the way that property value has, the gain has still been remarkable. Take this example: a studio flat in Mona Heights rented for $500 per month in 1989. The same flat would rent for at least $25,000 today. This is an annual gain of 245% over the 20 year period. Not as dramatic as the surge in property value but enough to provide a significant cushion against inflation , with more than enough left over to fund retirement.

This is not to say that real estate is the only good long term investment option. No, the point is that when planning your retirement funding strategy, real estate and its ability to tame the effects of inflation should not be far from your thoughts.