To paraphrase an observation made by Amazon's (AMZN) Founder and CEO Jeff Bezos: People who are "right a lot" are people who often changed their minds. Simple words. Such profound wisdom. Particularly for investors.
How many times have we clung to an investment philosophy for dear life, only to end up being dead wrong? And, in the process, we either lost (lots) of money or missed out on (lots) of profits. It's not your fault. Blame your genes. As I've noted before, we're prone to confirmatory bias. That is, we seek out information congruent with our own beliefs with much more fervor than contradictory data. So don't worry. I'm not here today to beat you up for your past investing sins. I've got plenty of my own. Instead, I'm sounding the alarm bells, because it's time to overcome nature. Otherwise, you're going to miss out on the tremendous profits in residential real estate.
Please note: If the mere mention of investing in real estate makes you cringe, you're precisely the type of investor I'm targeting today.
For over a year now, the average investor has been reluctant to jump back into the real estate market. How can I be so sure? Because every time I bring it up, my inbox overflows with colorful comments on why now is precisely the wrong time.
At first, people pointed out that the overwhelming supply of distressed properties flooding the market would put an end to the fledgling recovery. So I pointed out that distressed home sales were dwindling as a percentage of total sales. My critics then moved on to the argument that we weren't in a true recovery because prices weren't increasing. And when prices began to tick higher? They said it wasn't a genuine increase in demand. It was merely a temporary phenomenon, sparked by the Fed's suppression of mortgage rates.
In response, I proved that demand was, indeed, increasing as a result of new household formation. Again, critics ignored the data, claiming those households couldn't qualify for a mortgage to buy a house. I'm sorry, folks, but from my vantage point, there's a clear pattern at work here. Time after time, investors have clung tight to their original beliefs and the lies being spread by the mainstream financial press -- despite the contradictory data. As a result, they've missed out on profits.
But the past is the past. What matters now is that investors learn their lesson and (finally) accept that the real estate recovery is charging full steam ahead. Sadly, though, they're still clinging to lies. Lately they're claiming that Wall Street investment firms like Blackstone Group are driving the U.S. housing recovery, not actual buyers. Absolutely not. And all I need to prove it is a fifth grader with remedial math skills.
Breaking Down the Buying
I'll be the first to concede that Wall Street firms love residential real estate right now:
- Exhibit A: Blackstone spent more than $4 billion on roughly 24,000 single-family homes in the last year.
- Exhibit B: Private equity funds raised $22.6 billion in the fourth quarter, specifically earmarked for real estate investments, according to research firm Preqin.
But Wall Street institutions didn't get the nickname "the smart money" by accident. They recognize a bargain when they see one. And housing certainly qualifies, as prices remain well below their peak levels in almost every major market.
Or, as Jonathan Gray of Blackstone says, "We believe the current environment provides a highly attractive opportunity to generate favorable returns." I concur. Just because Wall Street is overly bullish, though, doesn't mean they're literally driving the market higher with all their buying.
If we take the time to perform some basic calculations, we can easily debunk this widely circulated myth. Let's say that private equity funds put all their new capital to work in the coming months. I know $22 billion sounds like a lot. But when we put it into perspective with the entire housing market, it's actually not.
Based on the latest median home price ($184,300), Wall Street can afford to buy 122,626 homes. Yet the latest existing home sales data reveals that we're on pace for 4.92 million sales this year. Do the math, and Wall Street would only account for 2.5% of the buying. Sorry, but that's not even remotely big enough to say they're driving the market.
Of course, some holdouts are bound to argue that Wall Street never pays full price. Fair enough. So let's use Blackstone's average purchase price and redo our calculations. As I revealed earlier, Blackstone has acquired roughly 24,000 properties in the last year for $4 billion. That works out to an average price of $166,667, equal to a 9.6% discount to the current median home price.
At that price, Wall Street's capital would go a little further. But not much. More specifically, they could afford to buy 135,600 homes, which would amount to about 2.8% of all existing-home sales. Again, that's hardly big enough to be considered a market driver. For the truly stubborn members in the group, though, let's assume that Wall Street gets the deal of a century on every single house they buy. Instead of paying the median price, say they get a 50% discount. Guess what? Even then, their capital would still only account for about 5% of all buying activity.
Bottom line: As Oliver Chang, co-founder of Sylvan Road Capital, told Bloomberg, "It's possible that [Wall Street] investors are less in the driver's seat and more along for the ride."
"Possible"? I'd say it's definite. Despite all the headlines to the contrary, Wall Street only accounts for a fraction of the buying activity. So the real estate recovery is legitimate. Plain and simple. If you want to be right -- and profitable -- it's time to change your mind about investing in the sector.