On the risk of investing in real estate for the long run

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unemployable
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Re: On the risk of investing in real estate for the long run

Post by unemployable » Mon Aug 12, 2019 12:05 pm

7Wannabe5 wrote:
Mon Aug 12, 2019 11:44 am
Does anybody know how detailed the grid on real estate derivatives is these days? I'm wondering because it came up in a futuristic novel, "New York 2140" I just finished reading. In the novel, one of the main characters has created an Index which tracks the value of post-global-climate-change-water-level Intertidal Property.
There are analytics out there that can drill down to the FICO scores of individual borrowers and stuff such as what day of the month they typically pay their mortgage on. Have been since at least 2008, and I haven't been in the business for a decade, so by now they probably track what you buy at Home Depot. I met with some of the hedge funds that traded them. Mortgage derivatives are crazy. I liked to quip that every time I discussed them I learned about some new twist on them. I think it cost me the job when I said that in an interview once however, as it implied I didn't know what the hell I was doing. Which was probably right.

Also, we have weather derivatives already. Hell, corn futures swing around based on whether a big storm moves through downstate Illinois, and have since the CBOT opened.
Kind of apples and oranges to compare real estate to index fund, because you are paying somebody else a little bit of money to trade for you exactly like everybody else is trading with an index fund, whereas the real estate holding situation is imagined as static with the market moving around it.
Actually most people do pay others to "manage" at least part of their real estate. Hiring painters, installers for the new water heater, lawyers to dispute their latest property tax increase, listing fees to AirBnB and the like.

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Re: On the risk of investing in real estate for the long run

Post by rube » Mon Aug 12, 2019 1:18 pm

RE is, as mentioned before, local. I am also astonished by the high tax and buying/selling cost in some locations.
The risk of RE can IMO not generalized, just like it can't for 'stocks' or 'commodities'.

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Re: On the risk of investing in real estate for the long run

Post by 7Wannabe5 » Mon Aug 12, 2019 1:35 pm

unemployable wrote:There are analytics out there that can drill down to the FICO scores of individual borrowers and stuff such as what day of the month they typically pay their mortgage on. Have been since at least 2008, and I haven't been in the business for a decade, so by now they probably track what you buy at Home Depot.
Interesting. I think it may be the case that secondary credit market tracks stuff like what you studied in college and whether you ever ordered a pizza on your credit card to be delivered to home of multi-millionaire where you were couch-surfing (GRE Score X Sugar Baby Index?) OTOH, I recently read "The Signal and the Noise" and I was like (hindsight being 20/20) "Wow! Even I can do probability better than those pre-crash bundlers." Anyways, I was wondering more about zip-code or block by block granularity; like betting on Zillow movement.
Actually most people do pay others to "manage" at least part of their real estate. Hiring painters, installers for the new water heater, lawyers to dispute their latest property tax increase, listing fees to AirBnB and the like.
True. Any endeavor can be out-sourced down to virtual passivity. However, there's a difference between running an "as if" passive simulation and actually tucking yourself in for a long Rip Van Winkle-esque nap. Like the best method for waking up and finding yourself a millionaire would be to put $1000 in an index fund today and then pay somebody minimal fee to konk you out and keep you on IV drip for the next 40 years.

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Re: On the risk of investing in real estate for the long run

Post by unemployable » Mon Aug 12, 2019 1:58 pm

7Wannabe5 wrote:
Mon Aug 12, 2019 1:35 pm
Interesting. I think it may be the case that secondary credit market tracks stuff like what you studied in college and whether you ever ordered a pizza on your credit card to be delivered to home of multi-millionaire where you were couch-surfing (GRE Score X Sugar Baby Index?) OTOH, I recently read "The Signal and the Noise" and I was like (hindsight being 20/20) "Wow! Even I can do probability better than those pre-crash bundlers." Anyways, I was wondering more about zip-code or block by block granularity; like betting on Zillow movement.
The limit to how granular an individual MBS tranche can get is dozens to a couple hundred houses. Larger loans tend to smaller sizes because you simply have fewer of them. A series of tranches usually has some common demographics such as "FICO between 670 and 710" and "primary householder between age 42 and 46" and "loan amount between 215k and 230k" with more senior tranches generally containing the better borrowers, but usually the payments are lumped together to an extent... I said these things get complicated. How they can be chopped up is limited only by the data you have available, and to an extent the supply creates the demand. Collective risk is easier to predict than individual risk is, just as for insurance companies.

In the bubble era the object was just to get stuff sold. Each transaction has a willing buyer and a willing seller, same as the the underlying dwellings did.

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Re: On the risk of investing in real estate for the long run

Post by 7Wannabe5 » Mon Aug 12, 2019 3:16 pm

unemployable wrote:Collective risk is easier to predict than individual risk is, just as for insurance companies.
True, but according to Nate Silver (possibly over-simplification), the problem prior to the bubble-burst wasn't just that sub-prime/risky loans were being made, but that the ratings agencies were granting them stamp of approval based on erroneous notion of independent function. As if an actuary was looking at her screen and calculating negligible likelihood of more than 2 out of 100 16 year old drivers getting into an accident on Junior Midwinter Prom night, but not taking into account weather report of impending blizzard through which they all might end up driving. OTOH, agree that obviously buyer beware applies to rating agencies as well as any other consideration.

So, in the U.S. if you wanted to hedge against a big bet on real estate, MBS derivatives is the best you could do? Just curious. Doesn't matter to me, because I am already anti-fragile (better than hedged) in my real estate investments which are currently literally yielding very small potatoes :lol: ETA: Oops, my ROI was only 600%, because I neglected to consider the fact that I partnered up on half of cash investment = 2/3 of acreage in order to cover ongoing maintenance costs.

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Re: On the risk of investing in real estate for the long run

Post by unemployable » Mon Aug 12, 2019 3:31 pm

7Wannabe5 wrote:
Mon Aug 12, 2019 3:16 pm
True, but according to Nate Silver (possibly over-simplification), the problem prior to the bubble-burst wasn't just that sub-prime/risky loans were being made, but that the ratings agencies were granting them stamp of approval based on erroneous notion of independent function. As if an actuary was looking at her screen and calculating negligible likelihood of more than 2 out of 100 16 year old drivers getting into an accident on Junior Midwinter Prom night, but not taking into account weather report of impending blizzard through which they all might end up driving. OTOH, agree that obviously buyer beware applies to rating agencies as well as any other consideration.
That is the nice way of putting it, rather than attributing it to stupidity or avoidance of career risk. They never failed before, right?

My favorite detail in the literature I've read about the bubble is that people's models would crash if you tried to input a negative number in the "home price appreciation" field. Like every cell displaying #VALUE! in an Excel spreadsheet.
So, in the U.S. if you wanted to hedge against a big bet on real estate, MBS derivatives is the best you could do?
Yes, there were and are credit default swaps on MBSs, and that is what the big funds (Greenlight, Paulson etc) made all their money in.

Nowadays you can trade futures on the Case-Shiller index, including in larger city markets. And where you can trade futures you can trade options.

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Re: On the risk of investing in real estate for the long run

Post by jacob » Mon Aug 12, 2019 3:58 pm

The Big Short (2hr movie + Michael Lewis book) provides a dramatized explanation/examples of various ways people set up their trades. In the movie (and probably in reality too) Michael Burry talked a bank into creating a CDS specifically so he could short the MBS market. Other [smaller] traders realized that the cascading problem meant that it was not just the juniorest CMO tranches that were in play but most of them. They then try to talk bigger fish into backing them. Some of the drama was the good old one about how the market can stay irrational longer than you can stay solvent. Cue the scenes where the shorts go to conferences and CNBC giving their "emperor has no pants"/"you're all idiots" speech.

Another part of it was that if one rating agency refused to rubber stamp some security, the investment/mortgage banker would just go to one of the other agencies who'd then get the fee. It wasn't all stupidity. Some of it was just good bad business practices.

Fun story: Back in 2008 I tried very hard to transition into quant finance (for the first time). I had a connection on LinkedIn (bank economist) who were trying to talk me into applying at Countrywide it being a very successful company, etc. I wasn't too sure about that---"weren't they having some problems?"---but he maintained that a big company like that surely knew what they were doing and had everything under control. So it's not like everybody were just pretending either.

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Re: On the risk of investing in real estate for the long run

Post by shemp » Tue Aug 13, 2019 6:12 am

Riggerjack wrote:
Mon Aug 12, 2019 8:56 am
But what I really wanted to address was shemp's assumptions. As a landlord, getting out of the business, I agree with all he said, with one huge objection.

All of his assumptions are based on the appreciation caused by relatively stable demand that urban markets continue to enjoy.
Actually, my chief assumption is that overpriced real estate remaining overpriced for a very long time. Same as the stock market is still a better investment than bonds even at current very high PEs, provided those PEs remain high. That is a questionable assumption, because long time means like 60 years for real-estate and stocks at current low cap rates and high PEs. Duration increases as real interest rate (inverse of PE) decreases.

As for the local economy issue, that is true, of course, but not too worrisome. Yes, Silicon Valley could turn into Detroit, but unlikely. If this does happen, you have the option of walking away in California (non recourse on first mortgages for owner occupied properties). Which is a great reason for buying the biggest house possible, as I'll discuss more below. Anyway, economic upheavals affect other investments as badly as real estate, including investment in your career.

The consistent mistake I see by too many posters is to treat owner occupied real estate as other than a business, thus ignoring income (imputed income for owner occupants). Significant appreciation/depreciation should never be assumed, just as you should never assume expansion of PE multiples. Real estate is not a perfectly efficient market, but it is efficient enough that people will not sell if they think prices will soon appreciate. And if they do have to sell, then arbitragers (flippers) will step in. Either way, market prices soon reflect expectations for appreciation/depreciation. Buy real estate for income (imputed income for owner occupants) and/or opportunity to renovate (a business in itself).

Buying a small house is fine if you can't tolerate the idea of being a landlord, but it is not the best idea right now in Silicon Valley (among other places). The best idea is buy the biggest house possible, using as much leverage as possible, then rent out rooms. As owner occupant sharing common areas (kitchen), you have tremendous legal rights a regular landlord doesn't have. In particular, you can evict easily, discriminate much more in tenant selection, be very stringent with rules. Plus you get more tax advantages than a regular landlord. If local industry shuts down and rents and housing prices collapse, just walk away and lose only your down payment.

Just about every financial blog comes to the same conclusion: real estate is a far better way to get rich than stocks, assuming you are willing to treat it like a business and have skills to be a part-time landlord: skill at selecting and managing tenants, skill at crunching financial numbers, skill at hiring and managing repairmen, lawyers, and other professionals to do jobs you can't or don't want to do yourself.

I never invested in real estate myself because I was frequently moving while employed. Transaction costs are indeed a killer with real estate. But I have frequently recommended it to younger relatives who are location stable, especially the idea of roommates. OP's example is unnecessarily pessimistic about big houses because he entirely rules out roommates, though that is precisely the direction ERE people should be going.

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Re: On the risk of investing in real estate for the long run

Post by FIRE 2018 » Tue Aug 13, 2019 6:18 am

Buying the most expensive house, renting rooms out, managing the operations, - no thanks , don't need the stress and BS that go along with it. Buying into index mutual funds monthly regardless of share price is proven at least to me to be far exceeding in increasing my net worth in the last 30 years rather than owning homes and managing the soap operas that go along with it. Started investing as a young kid and never looked back. In regards to real estate is better than stocks do the financial "gurus" tell you what to do in an economic downturn?? With owning stocks, you can sell or buy on the dip in prices and accumulate a bigger stock position. Can you dump a house that quickly? Are your renters going to pay on time or even at all when they are short on cash or lose their jobs? And which has better diversification with your hard earned money, real estate or stocks? Owning multiple real estate investments and you sink or swim with that specific investment sector. Being diversified in mutual fund stock investments spreads your net worth and helps you in the long run.

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Re: On the risk of investing in real estate for the long run

Post by bigato » Tue Aug 13, 2019 1:25 pm

I question the notion that real estate is not liquid. You can almost always sell real estate fast if you want. There is always a price that will sell, it's called the liquidation price. It is just that people usually don't want to take the loss and often keep stuck with it for years if not decades.

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Re: On the risk of investing in real estate for the long run

Post by Jason » Tue Aug 13, 2019 4:04 pm

To question whether investing in real estate is a path to wealth is ludicrous. (It is). However, using the terminology "Real Estate Investing" when discussing a primary residence expands the common business practice definition. In my opinion, that use merely describes someone finding creative ways to offset their living expenses via their own home. I would use the base line as how banks differentiate when you apply for a mortgage i.e. is this your primary residence or are you an investor.

There are great stock investors. There are great real estate investors. There are great entrepreneurs. To each their own. People have different comfort zones with different asset classes. There is no better way. There is no right way. There are just ways and each way has its own risks and own rewards. The key is to find the class with which you are most comfortable and then find the way you want to skin the cat in that asset class. Its not a "this vs. that" proposition. That being said, I do not consider someone owning a house and renting out a room a real estate investor. I consider them a homeowner with a tenant.

Edit: Although a sociological study, if you want a why "the hood is good" account of real estate investing, read Matthew Desmond's "Evicted."

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Re: On the risk of investing in real estate for the long run

Post by FIRE 2018 » Tue Aug 13, 2019 4:23 pm

There are always risks in real estate investing and stock investing. Some savvy investors I know in FL do well in both areas. They continue to buy depressed foreclosed or for sale homes and condos, have a team of illegal labor force of hard working guys give the homes a good makeover inside and out, then the investors flip the homes for a profit 6-12 months down the road. With the added money they have earned, they pay the laborers for their work, then investor profits buy into the stock market and look for potential future real estate deals to flip for a profit. It's not rocket science and it's how much do you want it to be successful in your goals.

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Re: On the risk of investing in real estate for the long run

Post by Peanut » Wed Aug 14, 2019 8:10 am

I remember Schiller stating that 2%/yr appreciation was the historical average for housing in the US for the past hundred years prior to the run-up to the '08 bubble, like 1890-1990. His account perfectly fits a place like Pittsburgh, a city that has fallen on hard times and then made a great but not spectacular comeback. I mean, I think it's a nice place to live but it's not the home of the Carnegies of today.

Some other cities have experienced a much faster rate of appreciation post 90s, and buying there may reap rewards in flipping. I agree primary home barely qualifies as some kind of investment, however. To me the issue is always, if you are happy in your house then you do not want to move, perhaps to the very end. And if your house appreciates a lot, it just brings you higher property taxes in the medium-tong term, which seems like a big downside.

The issue of renting vs owning is much more than a financial one, however, I think especially to women and families. And a house is much more than a hedge against renting. It's a lived environment where most people spend a whole lot of their time. It's interesting to me that OP is looking at this particular home from his childhood. It sounds very grand and is the kind of place a lot of people probably dream of as an ideal home for their children. This ideal spurs many people to spend bigly or overspend on their house. But perhaps they get more in return than we think?

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Re: On the risk of investing in real estate for the long run

Post by Ego » Wed Aug 14, 2019 10:23 am

Peanut wrote:
Wed Aug 14, 2019 8:10 am
The issue of renting vs owning is much more than a financial one, however, I think especially to women and families. And a house is much more than a hedge against renting. It's a lived environment where most people spend a whole lot of their time. It's interesting to me that OP is looking at this particular home from his childhood. It sounds very grand and is the kind of place a lot of people probably dream of as an ideal home for their children. This ideal spurs many people to spend bigly or overspend on their house. But perhaps they get more in return than we think?
Must a place be owned to create the feeling of a lived environment? Are people overspending bigly to get something real or are they getting something they've been conditioned to believe is real?

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Re: On the risk of investing in real estate for the long run

Post by IlliniDave » Wed Aug 14, 2019 11:36 am

Ego wrote:
Wed Aug 14, 2019 10:23 am
Must a place be owned to create the feeling of a lived environment? Are people overspending bigly to get something real or are they getting something they've been conditioned to believe is real?
I've rented and owned. Both are acceptable. I prefer to own. When I rent I'm acutely aware that the place isn't mine and that I can be shown the door the day the lease ends (moving is far down my list of things I want to do with my time). Assuming the cost of owning is somewhat higher all else being equal (not sure how good of an assumption that is), the remaining question is whether the benefit to me is worth the additional money spent. I say yes, but someone else might reasonably say no.

No doubt a fair number of people are following the "process" and making themselves house poor along the way. Like anything, for most it is a multidimensional trade space one must navigate. I rented for the first 12 years of my professional life because I didn't feel comfortable taking on that much debt. Once I got over that hum, I've never looked back.

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Re: On the risk of investing in real estate for the long run

Post by Ego » Wed Aug 14, 2019 12:16 pm

IlliniDave wrote:
Wed Aug 14, 2019 11:36 am
When I rent I'm acutely aware that the place isn't mine and that I can be shown the door the day the lease ends
I believe that is somewhat different than the feeling of a 'lived environment' but it is a good point.

Is that awareness (fear?) of the possibility of being shown the door something that is innate or is it learned?

Most young people don't seem to experience much anxiety about that type of thing. Are they ignorant of the consequences? Have they not yet matured into fully responsible, stable adults? Or are they simply more resilient and they know it?

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Re: On the risk of investing in real estate for the long run

Post by 7Wannabe5 » Wed Aug 14, 2019 12:28 pm

I think in the U.S. a good part of the preference for owning is due to the lack of variation in supply of rental units. For instance, I was pretty much forced to buy once my kids were no longer toddlers due to scarcity of 3 bedroom units with reasonable rent.

I also believe that feeling of "home" is more about good practices associated with "home-making" as opposed to home-ownership, but structural differences can serve to make the practices and patterns of good home-making more or less easy to observe.

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Re: On the risk of investing in real estate for the long run

Post by unemployable » Wed Aug 14, 2019 12:32 pm

I've rented my whole adult life. I've been "shown the door" multiple times, when the landlord decided to sell, and am effectively being shown it right now as my rent is rising to a level I no longer am willing to pay.

Every time I've moved (again, as an adult) has resulted in a better living situation. I've always found a place whose combination of cost, location, quality and value appealed more to me than the place I was leaving. If I ended up paying X% more in rent, I received what I felt was a greater than X% improvement in quality of life. A 1br instead of studio, a walk to work instead of a bike ride, Colorado instead of Chicago. For sure, what I consider "quality of life" changes during the course of my tenancy. I've written about all the noise I've had to deal with here in the last year or so, for example.

I'm not wired to live somewhere permanently, not for the time being at least. This is probably partly because my family moved around often as I grew up. But it's also because I'm just curious about living in a lot of different places and exploring stuff there. The "door" rather acts as motivation to go explore some other place. Maybe this makes me a worse person. I'll leave that for others to decide.

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Re: On the risk of investing in real estate for the long run

Post by IlliniDave » Wed Aug 14, 2019 12:52 pm

Ego wrote:
Wed Aug 14, 2019 12:16 pm
I believe that is somewhat different than the feeling of a 'lived environment' but it is a good point.

Is that awareness (fear?) of the possibility of being shown the door something that is innate or is it learned?

Most young people don't seem to experience much anxiety about that type of thing. Are they ignorant of the consequences? Have they not yet matured into fully responsible, stable adults? Or are they simply more resilient and they know it?
I'm too old to remember young, so don't know about younger folks in general. Moving is generally a pain to me (especially when I don't have a vote), so it is something I seek to minimize. For me that aversion was probably learned later in adulthood as I became increasingly established.

I wasn't sure what "lived environment" meant precisely. I'm speaking more to a sense of "this is my spot and worth it to me to invest in". "Invest" is not limited to the financial sense.

Fundamentally, home can be wherever one hangs her/his hat. For some people renting makes the most sense, or is even preferable. That's fine. It's just not what I want for myself, and since I can comfortably afford to have some $$ tied up in owning a home, I do so.

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Re: On the risk of investing in real estate for the long run

Post by Peanut » Thu Aug 15, 2019 9:58 pm

Ego wrote:
Wed Aug 14, 2019 12:16 pm
Must a place be owned to create the feeling of a lived environment? Are people overspending bigly to get something real or are they getting something they've been conditioned to believe is real?

Is that awareness (fear?) of the possibility of being shown the door something that is innate or is it learned?

Most young people don't seem to experience much anxiety about that type of thing. Are they ignorant of the consequences? Have they not yet matured into fully responsible, stable adults? Or are they simply more resilient and they know it?
Great questions.
1: Not necessarily but rented and owned lived environments or let's just call them 'places,' tend to look very different. So much so that it tends to be immediately apparent when you walk into a place. When I've rented I've put in a certain amount of effort but there is a limit to what it seemed reasonable to do. Like, it would be foolish to replace old appliances, etc. What I've observed about rentals, either flats or homes, is that they often look transient, a bit messy, and either without a coherent aesthetic or with an incomplete one. And I think this is fine and even sensible but it's not an achieved ideal the way OP's childhood home may have been. Long-term rentals tend more towards the latter, but I'm guessing financially they make even less sense than overleveraged homes.

2: Ha I would say it is 'taught' to you--by your "jerk" landlord. Ultimately any imminently respectable person can become a jerk to their tenant. I'm not sure how to articulate it and I've never had awful landlords but the power relationship bothers me, on both ends, and when I've considered doing it myself it's always left me uneasy.

3: The consequences just aren't that consequential for them. For an unencumbered young person getting kicked out of a place is not a big deal, nor should it be.

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