Why gentlemen prefer real estate

Becoming rich from real estate is not that easy. Don’t get blindsided by confirmation bias and the recency effect.

Anecdotally, one could easily argue that the average wealthy individual has created a disproportionate amount of his wealth via property investments. There are of course, stories of average investors that made millions on single-stock investments, but they are few and far between.

Meanwhile, it is not difficult to establish that an investor with disposable capital looking to invest some of it is much more willing to deploy that capital in real estate, rather than seek to become a fractional owner in a business traded on the stock market. The latter holds true no matter the type of business, whether high-risk to low-risk.

But why do investors feel safer buying real estate? Real estate is a highly illiquid asset class, it is a perfectly immovable asset (it has no flexibility as it can’t be moved), it is fragile to economic swings, damage, wear and tear, it is fragile to secular changes in specific industries and long-term economic trends like working from home, co-working, population swings, regulation and policy, tax etc. The range of outcomes is practically infinite.

Real estate is mostly predictable in the short-term, but mostly unpredictable in the long-term. Even with that being true, investors tend to go for the more seemingly “safe” real estate assets because they don’t want to feel that they are taking on risk. They want the “sure” investment. To achieve this, they don’t mind paying a hefty price for the asset.

Another reason why investors are so willing to jump on real estate is because the asset class has been appreciating steadily and with very good rates for a very long time. Investors believe that “property only goes up”.

Nassim Nicholas Taleb once said that, “the payoff of a human venture is, generally, inversely proportional to what it is expected to be.”

Using the above as a prologue I argue: If real estate has appreciated so much in value during the past few decades, what would happen to it if some of its tailwinds now started to work as headwinds?

The opening up of the world’s economies under globalisation, together with the ascent of megacities, advances in productivity and the steady lowering of the cost of money (the interest rate) via concerted intervention from global central banks has created a lot of value for real estate.

A piece of land that had no use suddenly became a site to develop residential or commercial space. A seaside property that was up to now not in demand, is suddenly sought out by wealthy Asian buyers looking to park some of their wealth away from their home countries. An out of the city large piece of land that was sitting dormant for 30 years becomes the new headquarters of a foreign business. A residential property that exchanged hands at a 7% rental yield, is now selling for a petty 3%, while the numerator on the rental yield calculation has also moved up in absolute terms. The examples are endless.

All of the above, together with the strong and persistent trend of inflation has supported real estate prices for decades.

Finally, it takes much less work to study a real estate investment than a business trading on the stock market. What’s the rental yield? How much can it appreciate going forward? How much money can I borrow from the bank to buy this asset? The three questions above seem to be the primary deciding factors an investor looks at before buying real estate. When the answers to the above three questions abruptly change, property owners start to experience problems.

Even if on the face of it, it seems that the only way to make money is by buying real estate, the truth is that the real creators of wealth are good businesses bought at reasonable prices.

If equities are so great then why does the average investor shy away from them? And when he does buy equities, he is only looking to make a trade and not an investment?

The average investor seems to believe that equities have higher risk because they have a quoted priced on a stock exchange. He seems to believe that because property does not have a price that changes every day, it does not have any risk. There is absolutely no truth to this, it’s just investor psychology.

Adding to the above, corporate failures receive much more exposure in the news than property- related failures – and this scares off investors. Caveat: property deals fail too, property companies go bankrupt too.

Due to all this, the average investor looks at the stock market as a casino where one can make money quickly by buying something to flip it, and then disappear. It requires a solid investment mindset to be able to look at the stock market as a venue for becoming a fractional business owner for the long-term.

Summing it all up:

Psychological forces like survivorship (they only remember the big real estate successes) and recency (they remember a recent corporate failure somewhere) bias,

The illusion that somehow one can control the range of outcomes on a property investment but that investing in equities is completely random.

As well as the massive headwinds that real estate benefited from in the previous decades, has biased investors towards real estate investments.

Focusing on the price of a security as it moves up and down every day, week or month and not focusing on the business as it adds or destroys value over time keeps the average investors trying to guess where the market will go in the short-term; rather than what a business will look like over the long-term.

The question these gentlemen should ask themselves now is, are they right in preferring real estate over equities? When investing in any asset whether it be real estate, equities or bonds, a strong focus on fundamentals and value considerations should be taken. Fundamentals should be assessed and analysed before making a decision. Past performance is not indicative of future results.