Real Estate - Is The Party Over?

We have been looking at real estate hard ever since we told our clients in September 2016 that we would be implementing a four pronged approach to expanding opportunities for them to profit.  This new approach included looking harder for new opportunities, a continued focus on preservation and growth of capital, a renewed focus on planning and finally a increased desire to be an innovator for our clients.

This approach came after a firm-wide review of everything we were doing including the way we managed money.  It also resulted in the shelving of several investment strategies and the introduction of new, longer biased solutions.

Since that time, unbeknownst to our clients, we have spent countless hours pouring over real estate, private equity, venture capital, private note and a whole host of other deals.

We have consistently found the same things (in general) in our searches.  This economic cycle is likely near an end and therefore investment risk has increased while corresponding return possibilities have declined.  In other words, the incremental return for the risk being taken is just not there.

One area we have particularly looked hard at is residential real estate.

A Review of Residential Real Estate

I have to admit I am still learning all the numerous ways to approach residential real estate.  My most significant experience in this space had been my 70+ year old house, that seems to monopolize a lot of my free time with constant maintenance projects.

In my quest to help clients look at this possible avenue for investment, I have read half a dozen books on subject.  I joined the Tampa Bay Real Estate Investors Association (TBREIA) and started regularly attending their meetings.  I have networked with investors in this space who owned hundreds or even thousands of residential properties.

I don't know if I am completely there yet and probably won't be until I personally own more residential units, but I have come a long ways!

So what did I learn?

First, its apparent that real estate in local.  My analysis of the Tampa residential real estate market will likely not play in De Moines, Iowa or even New York City.

Second, real estate is cyclical.  Many claim that real estate follows an eighteen year cycle of boom and bust like below.

Third, while there may be a bigger 18 year cycle to real estate, it also tends to follow the overall economic cycle.  So within the larger 18 year cycle, we still have smaller boom and bust cycles (a cycle within a cycle) in that follow the economic cycle.

​That market cycle tends to follow the same progression every time.

Fourth, I learned some geographic markets are more stable than others.  My market, Tampa, is anything but stable.  In fact, this market appears to be more of a boom, bust market than most!

When times are tough, the market drops like a rock.  When times are good, prices rise to the moon.  Much of this has to do with the growth this market experiences from people moving into the state when times are good.  This trend seems to reverse when there is excess hurricane activity that effects the state or tough economic times as much of the workforce is service driven and transient.

So you may be asking how does this nice little lesson on real estate affects us?

The answer is that it may not, but I did want to share some of our insights on the Tampa market that may be applicable to other markets.

Let's start first with this chart of historical residential sales prices per square foot in the Tampa market taken from 100 random homes that are currently listed for sale.  So that would mean the 2017 price per square foot data is based on list price, not a sale price. Price per square foot data before 2017 are based on actual sales prices.

So again this is price divided by the square footage of the unit sold.  So we have attempted to compare apples with apples.

What you notice is that price per square foot in current listings is at bubble top levels. This does not in itself mean the top is in just that it's possible.

I also must disclaim that sales data prior to 2001 is very sparse and it could be misleading.  If we just focus on 2001 through January 2017 that chart looks like this:

It doesn't really change the picture any but is does eliminate the less robust data that may be distorting the picture.

​So next I wondered if we took three year smoothed price per square foot data from 1998 and then increased that data by the historical Consumer Price Index on an annual basis where should the price per square foot be based on that 1998 - 2000 smoothed data.

You see the results below.

The Conclusion

So what can we conclude from this data?

I believe its quite possible that we are in another bubble and now well beyond where prices should be on a price per square foot basis.  As I drove down a local street yesterday, I noticed For Sale signs every 8-10 houses.  I can tell you that the shear number of such For Sale signs has literally multiplied in the last few weeks.

CNBC also reported that in some parts of the country homeowners were receiving 60 offers on one home (http://www.cnbc.com/2017/02/28/spring-housing-already-overheating-think-60-offers-on-one-house.html).  This is crazy, if true.

I also believe the moral of the story is that you must either plan to buy and hold for a very long time or you must be very nimble at these levels.

Since the big money is real estate is made from buying low and selling higher and I don't want to be a flipper, I would believe the only play left is the public market play via real estate ETFs and funds where I can quickly press the SELL button when it appears the gig is finally up here.  

Otherwise this is just a much larger, grown up version of musical chairs and we already know there are not enough chairs for everyone when the music finally stops.

Let me know your thoughts.  Am I missing the mark?  Leave your comments below.