Wednesday, June 5, 2013

Misplaced Blame: Money Management and the Real Estate Recovery

Misplaced Blame:  Money Management and the Real Estate Recovery

Over the past several years, a glut of residential real estate has burdened many local markets.  Many of the areas that experienced the biggest boom in real estate prices suffered through the most painful bust.  Two years ago it was hard to envision how these markets would recover.  Today many of these areas, such as Las Vegas and Phoenix, are rebounding.  While prices are still well below peak levels, this should come as no surprise.   Banks aren’t willing to extend huge amounts of credit.   Moreover, potential homeowners have neither the capital for a down payment nor the annual incomes to support those peak home values.

The Decision (1997)

Although I am a critic of the money management industry, they are playing an important role in stabilizing residential markets.  Real estate managers have raised substantial amounts of capital from pension funds and endowments for the express purpose of buying depressed real estate assets.   Yesterday, The New York Times ran a story that raised questions about the role of institutional money in the local housing market.  The article first suggested that Wall Street was driving up housing prices and then switched its focus to infer that the Street is preparing to sell and thereby depress prices.[1]

The article provides a distorted picture of what is happening.  First, Wall Street (investment banks) isn’t the primary driver in buying up houses.  Rather, as I suggested earlier, it’s real estate managers deploying money raised from institutional investors who are behind this phenomena.  Some local investors and individuals are being shoved aside by the ability of these funds to buy en masse. However, massive buying power is a good way to absorb the excess supply of housing. Real estate funds played a similar role in 1993-1994 when they soaked up depressed real estate created by the Savings and Loan crisis.

Most real estate managers are turning these houses into rental units.  I know the American Dream is supposed to include home ownership.  However, I believe the virtues of home ownership have been oversold.   The country’s goal should be safe and affordable housing.  For some families the best strategy will be ownership and for others it will be rental.  Moreover, the idea that home ownership leads to retirement security or riches is deeply flawed and has destroyed the credit of a generation of Americans.

Undoubtedly, those real estate managers who started buying homes three or four years ago will want to monetize their investments.  That of course is the nature of managing a real estate fund with a finite life.  Pensions and endowments want their money back, so the managers will have to look for exits.  However, the selling will be orderly and occur over time, so it’s not going to extinguish the real estate recovery.

In short, money management is playing a constructive role in this part of the real estate cycle.   These managers are not saints.  Many of them poured capital into the real estate markets in 2007 and 2008, which helped to inflate the credit bubble. Moreover, real estate managers will continue to raise funds even as the market becomes overvalued at some point in the future.  After all, their business model requires them to continually generate fees and the occasional slug of carried interest.  Money management is not a virtuous activity.  

While the entry of institutional money management into residential real estate is to be welcomed, it also comes with a significant side effect, which brings us back to Wall Street.  Goldman Sachs, Bank of America, and the other behemoths stand to make huge fees advising, merging, and selling real estate assets as money managers build and dispose of their portfolios.  There’s something fundamentally unjust when the people who brought us the great recession are getting rich on the recovery. 


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