Does Wall Street understand real estate?
This perennial question has returned. It was likely prompted by the billions of dollars being invested in FinTech and iBuying with low to no returns, heightened by Zillow Offers collapse. This question is separate from those about Wall Street’s understanding of the equity value in residential brokerages or any business based on investing in and managing real estate as an asset class.
Is the disconnect structural or is it a mindset?
Remember the fateful frog and the scorpion? After the scorpion convinces the frog to ferry him across a stream, he fatally stings the frog. The reluctant frog feared this outcome, but the scorpion assured him it was not in the scorpion’s best interest. The dying frog asks why only to hear, “that to sting is just in my nature!“ I propose this is the case with Wall Street and their exchange-traded asset worldview.
Wealth managers and investible assets
The divide first begins with an asset-centric mindset based on education and licensing. Wall Street is heavily regulated. Wealth managers are rigorously educated in promotion and trading rules, exchanges and brokerage responsibility. Licenses and fee structures are restricted to either sales commissions or management fees. Owning or investing in real estate competes with the investible funds a typical retail investor can invest in traded assets.
Then, there’s self-interest: Why would a licensed broker direct a client to own real estate when there’s no commission paid? Traded real estate investment trusts or funds excepted. This is just investing in shares in real estate enterprises.
This asset centricity is not exclusive to exchange-based brokers. Real estate brokers and licensed agents have the same license (and commission) centricity too. “Buy a house, versus buy stock!”
As a side note, it’s important to comment that this arbitrary license divide and asset-centric view does not reflect the investment life of the average retail consumer/investor who is desperately in need of wise, holistic portfolio advice!
Single family residential as an asset class
In 2004, after selling a company publishing NASDAQ and day trading traded-asset magazines, I launched a newsstand magazine for residential small investors, called “Personal Real Estate Investor Magazine.” I soon understood I had completely underestimated how vast and vital this market is. I asked Steve Murray of RealTrends why real estate sales did not serve small real estate investors.
He suggested we poll for an empirical answer. We hired Harris Interactive to poll and analyze home sale data to search for market size. We published the “Invaluable Investor Study” in 2008. This pegged residential sales by Realtors/brokerages with intentional investment as a goal, at anywhere from 12% to 28% of all single-family residential sales in an average year. These sales are to repeat clients who represent predictable recurring revenue.
In 2008, there was little institutional (Wall Street) interest in this market. The Great Financial Crisis of 2008 and 2009 changed this. Home prices were compressed compared to rental income ratios. When we repeated this study in 2012, leading fund managers and institutions had awoken to the huge upside in returns in residential rentals. Note: These institutional leaders knew how to find generous returns in distressed companies, funds and depressed assets. SFR rentals was that asset.
In the U. S., investors in housing have been perceived as hobbyists at best, predators and bottom feeders at worst. Elsewhere in the world, successful home investing is held up as a highly respected “national sport.”
Why does the U. S. have this jaded view of real estate investments and investors? First, there’s the loud and effective “Wall Street voice,” the regulators, institutions and media. Nothing similar exists for real estate. This is because SFR sales and management is practiced by local franchisees and individual contractors. The National Association of Realtors, as formidable as it is for Realtor interests, does not articulate the value of real estate as an alternative asset to traded assets.
Well-managed rental homes can demonstrate better returns even with “tenants and toilets,” just ask Blackstone. It’s just not their mission, and it bumps into the highly regulated area of investments, unsurprisingly heavily influenced by Wall Street.
The second is the focus of the wealth management industry. Yes, commissions can be earned from selling clients on REITs or securitized real estate, such as SFR rentals or mortgage-backed securities. This is not direct-ownership real estate, but shares in an asset management company allegedly understanding real estate. Writing today, “Zillow Offers” clearly illustrates why relevant management skill is critical.
Real estate as an under-appreciated asset class
Licensing, education and income channels are just the first reasons. Wall Street generally does not embrace real estate as an asset class. Why? There’s work to understand and implement wise accounting with the income, appreciation and tax advantages possible.
Comparing the performance of income real estate to traded asset returns, the benefits are clear. Next question is why are U. S. real estate brokerages undervalued? It’s often because mature companies unknowingly deliver partial ownership and investment experiences for clients and stakeholders, hence limit their value upside.
There are a number of avenues around appreciating real estate as the center of an industry. The initial conclusion is this lack of understanding of real estate as an asset class is not limited to Wall Street but also much of the real estate industry.