Real Estate

The latest tycoonery in the FIRE movement is real estate. Everybody wants to lock up their capital in a illiquid asset for 30 years, mumble some mumbo jumbo about tax breaks and how people will need a place to live, you know sing a narrative. They speak of tales of the brave and charmed Ulysses on the real estate trail slaying monsters right and left and see themselves buckling into that swash.

My latest passion is to discover inflection points. An inflection point is when the second derivative of a growth curve in a local region of the curve changes sign. The second derivative is denoted by d^2x/dt^2 and is best known to our experience as a change in sign in acceleration. Step on the gas and the second goes positive, let off the gas and it goes negative. If you’re a long only investor that means you pour in the dough when when things are accelerating and sell when deceleration commences. If your a buy and holder it means your accelerometer is busted and you can’t tell the difference between acceleration and deceleration.

Markets run in broad macro cycles. If you look at interest rates the cycle lasts about 30 years. Stocks cycle much more frequently maybe 5 – 10 times in a 30 year period depending on how you define a cycle. FIRE investors are mostly stock types used to rapid cycle boom bust cycles. Bond holders obtain diversity by mixing short cycle duration and long cycle duration and that’s how they control risk and return. Both stocks and bonds are quite liquid. Very different investing styles to be sure, but if you know what you’re doing bond trading can hit as large a home run as stock trading. Last year I bought EDV which is a long duration zero coupon ETF, and saw a 26% year over year increase in that aspect of my portfolio. VTI has only a 21% YoY increase. Both bonds and stocks are priced for perfection. Bonds are limited by 0% interest and stocks are limited by deviation from the mean, and stocks have soared not by increases in productivity but through financial engineering because of the huge amount of money at virtually zero cost that has been pumped into the system by the FED. A dollar is pumped in, it eventually gets sucked up as corporate debt which is used to buy back stock shares which causes equity prices to soar without a concomitant increase in corporate productivity, so stocks and bonds are expensive both in terms of increased price and increased risk.

I’ve looked at getting into real estate wondering if that’s a silver lining. I’ve been in a couple real estate deals that definitely left a dyspepsic taste in my mouth. That’s called a berf aka a baby barf, but who knows? I think real estate like its cousin asset classes are priced for perfection as well. Free money and foreign money has raised the price likely to an unsustainable level. People don’t think of real estate as a particularly risky asset because it, like long bonds and unlike stocks has a long period to its cycling.

I think there are a lot of head winds as well. Boomers were quite happy to sink their fortunes into 2M houses under the delusion the prices effectively always rise. Part of that is based on free money and part based on a lack of history. If you live in a time when housing virtually sky rocketed because of demand and an economy of one time improvement in productivity the local experience looks much different than the historical reality. In 1970’s woman’s lib, a feature of the baby boom generation became a thing. In 1960 the average house could be purchased by a single average wage earner. By 1980 2 handed bread winners had multiplied to 4 hands and the first thing mama wanted with her new found work wealth was a bigger house, and prices soared. This was the time of the baby boomer so a glut of boomers aka a glut of demand entered the system. The demand was so great and the improved productivity so great house loans were able to sustain 19% interest rates. Today millennial’s can’t sustain that price increase. They are not productive enough. Not a knock on them, there just isn’t a double in the number of hands in the household from 4 to 8, and the demand will soon be replaced by a glut in supply as boomers try to cash in and no buyers appear, despite nearly free money. Real estate is a market and same as any market price is set by supply and demand. You may have 2M in your joint but if the market says 1M, 1M it is. Real estate investors also are at risk. Yes people need housing but not at any price. If you buy a building for 2M and the economy dumps, your 1500/mo apartment may drop to 500/mo because your renters have no jobs, and your 2M investment may be worth 1M, and good luck on selling that mess. Buffet owns a ton of cash, not a ton of real estate. Sam Zell is buying trailer parks not condo’s. My impression is the second derivative is negative.

Worth a watch