Is Too Much Money Being Invested In Real Estate?

Also, are too many people over-weighted in real estate? Is this healthy and what else should there people invest in? After buying two or three vacation homes, Wall Street types often turn to art or other collectables.

In the current market, I am thinking of reducing my exposure to Manhattan residential but not sure if stock or bond markets make sense as stock market is at all-time high and interest rates are going up.

s+p 5 year return...75%+. Easier , less hassle. Diversification ? thats a fantasy. When stock mkt crashes, so will real estate. If worried about actual crash, then use bonds or gold. If the fear is gradual rising rates in a growing economy, then their is no real worry because a growing econ will support risk assets.

I think you left out the low returns on other "safe" investments (what are CDs, Treasuries, etc. paying these days?). The low rate of return on alternatives make the minuscule cash-on-cash returns returns on buying investment condos seem more acceptable. However I think people fail to take into account the lack of liquidity and huge transaction costs if the market starts to turn and they want to get out quickly.

So, knewbie, is diversification a fantasy because everything is intertwined?

Yes 30, lack of liquidity is one reason to diversify. But how important is it to diversify and when is the time to do so? A lack of diversification ruined a lot of people in the Great Depression. But just as in the Great Recession, people who were able to hold on to their investments eventually made it all back plus more.

Maybe the key is to keep enough in safe assets to keep you going even through the worst of times?

"Why is so much money being invested in residential real estate and is this trend sustainable?"
Are you talking Manhattan or Global? Appreciate any data you may have to support this.

Xi, depends on what you are protecting against. If its that huge correction that comes about every decade, then its the standard gold, treasury bonds/corp bonds which tend to have a low correlation vs risk assets. If it is a garden variety correction, which can occur within a strong economic backdrop, then real estate holds up pretty well. Even in your standard recession, RE is pretty good as the fed tends to lower rates. So sort of depends on what you think is coming around the corner . Your risk tolerance will dictate your recipe. Generally, I think you just have to be more conservative as you get older, because you do not have time to ride out corrections/mkt crashes.

300, don't have the data but am looking for sources. But seems likely that individual investors are more over-weighted in real estate than in previous generations. Lots of different ways to invest and the costs of entry seem to get higher and higher. 2nd and 3rd home ownership is higher I feel sure but I will research this as well.

Problem with data is that much of this type of data is institutional, not personal so maybe not as relevant to the question. Isn't the resi market much bigger overall than the commercial market? Maybe there is a stat that could be a good substitute. I will get back to you. I suspect household stats on property ownership is not as well-researched.

Knewbie, good points but recessions often happen without much notice. Isn't that why diversification is important? Riding out corrections/crashes is tricky at best.

But the critical issue to me is whether households in the U.S. and New York City in particular are over-invested in their homes. Real estate is not as liquid as many other asset classes and is also an asset class often fully leveraged. It does not necessarily take a recession to have people loose their homes. Could happen for personal reasons - job loss, illness, whatever.

NYC clearly has an oversupply for ultra-high end new development -$2500 plus per sq ft - but undersupply of mid-end luxury call it $1500 per sq ft. Overall $ investment is overdone as evident from soft rents. US housing supply can not keep up with the demand in the areas with economic growth except may be NYC.

As others suggested, you can't speak about levels of real estate spending, investment or price growth in general terms. Between the two coasts, real estate prices in most areas have been rather stagnant for a long time. Even in the most prime areas of Chicago, apartments sell below $500/ft, and prices only recently reached pre-recession levels.

Looking at the highest end of the NY market also is no way to think about markets. Especially in NY/London/etc., there are other issues at play in $10MM+ homes and trophy properties. The broader market is built from the bottom up, as in most cases someone buying a $5MM apartment is not buying their first home, but trading out or up. He or she probably deploys less leverage than an average buyer. And, a foreigner buying NY real estate usually is diversifying, that is the point of parking cash here, and buying a dollar denominated asset.

It does not matter if foreigners over-invest in US real estate, except to the extent it pushes up asset values. The Japanese invested heavily in trophy US real estate in the 1980s, and got crushed in the 1990s recession. But if you want to know whether regular old Americans are over-invested in real estate, you need some criteria. For most people, their home is not an investment but a place to live, and whether they are over-exposed, over-indebted or in over their head is a different question than where investors allocate capital. Most Americans have little investments beyond their home and their 401k. I think it is self-evident that, particularly in expensive real estate markets like the NY metro area, middle and upper class folks have way more of their net worth tied up in their primary residence than prior generations, if for no other reason than because real estate prices have risen so rapidly. For generations, housing costs as a percentage of incomes in America were way cheaper than most of the developed world, which partly explains the over-indulgent consumer spending, and Americans had pensions.

If this is confined to the rarefied world of high-end Manhattan real estate, I still think you need to separate out regular old working stiffs who live here from people who are buying properties for investment purposes. If I didn't own my apartment I would be renting something close to it in size and grandeur because I won't be living anywhere else. While in this market renting can be materially cheaper than buying anew, I do not view my apartment as an investment, or at least not one that I think about in terms of comparative risk and return. I could sell, pay capital gains on the probably 300% implied profit on the purchase price, reinvest that after-tax proceeds somewhere else, and then pay a several hundred thousand a year in after-tax dollars in rent. It is hard to make that math work.

Great comments, nyc. Please allow me to add mine:

"Between the two coasts, real estate prices in most areas have been rather stagnant for a long time. Even in the most prime areas of Chicago, apartments sell below $500/ft, and prices only recently reached pre-recession levels."

This is true for Chicago and other cities today but I did a lot of financings in Chicago before the crash and thought it was a poster child for irrational market behavior. Prices at the peak of the boom were so far above anything Chicago had ever achieved before so reaching pre-recession levels there today is quite an achievement. Chicago is a transitional city for many who eventually move to LA or NYC so market timing is critical. No way I would want to be long Chicago real estate.

"Especially in NY/London/etc., there are other issues at play in $10MM+ homes and trophy properties."

If you mean that purchases of trophy homes in NY/London are not based on need than you are helping me make my case that there exists an over-abundance of wealth in the form of excess cash to invest in such assets.

"He or she probably deploys less leverage than an average buyer.".

My point about leverage is that real estate purchases are more leveraged than other investments suck as stocks which are often limited to 50% margins. And stocks are generally far more liquid.

"a foreigner buying NY real estate usually is diversifying, that is the point of parking cash here, and buying a dollar denominated asset."

Excellent point. In many ways, this is diversification but it still implies that foreigners lack interest in other asset types which drives up prices and adds the risk of a market correction if these investors exit the market which appears to be what is happening now.

"For most people, their home is not an investment but a place to live, and whether they are over-exposed, over-indebted or in over their head is a different question than where investors allocate capital. "

Actually, I think it is the same question. True that home ownership is not purely an investment but for sure its a major consideration for many buyers today.

"particularly in expensive real estate markets like the NY metro area, middle and upper class folks have way more of their net worth tied up in their primary residence than prior generations."

I agree with this statement completely. The question I have is whether this is healthy or not.

"For generations, housing costs as a percentage of incomes in America were way cheaper than most of the developed world, which partly explains the over-indulgent consumer spending, and Americans had pensions."

Again, I agree but in the current economy with job security, pensions and social security benefits all at risk, I think people should think twice before having the vast majority of their personal wealth tied up in illiquid, non-income producing assets like homes.

"If I didn't own my apartment I would be renting something close to it in size and grandeur because I won't be living anywhere else. While in this market renting can be materially cheaper than buying anew, I do not view my apartment as an investment, or at least not one that I think about in terms of comparative risk and return. "

This may be the most critical issue. How to look at a home purchase. How many people do their due diligence to know whether their housing purchase will yield a positive long-term return? Alternatively, how many people perform a detailed rent vs. buy analysis to determine whether to buy anything at all? I believe that people have less control over their lives than they think, and are often over-optimistic in their predictions of where they will live or how much they will earn in the future. Don't forget what happened with ARM's.

"I could sell, pay capital gains on the probably 300% implied profit on the purchase price, reinvest that after-tax proceeds somewhere else, and then pay a several hundred thousand a year in after-tax dollars in rent. It is hard to make that math work."

No need to sell if you invested in a home wisely. Maybe the better strategy is to buy only the home that satisfies your needs and nothing more and then use your excess wealth to diversify into investments such as stocks which generate income and have proven on average to out-perform real estate over the long-term.

""I could sell, pay capital gains on the probably 300% implied profit on the purchase price, reinvest that after-tax proceeds somewhere else, and then pay a several hundred thousand a year in after-tax dollars in rent. It is hard to make that math work.""

Don't forget the exemption for capital gains you get on the sale. If after the exemption you only pay 10% on the gain, and the market goes down 30% (and we're not talking going down 30% of the gain, but total price), do you really net more in the end?

Real estate in USA is one of the most efficient forms of wealth transfer due to 1031 tax deferral rules. That's a key driver of its worth IMO.

@ximon

"Actually, I think it is the same question. True that home ownership is not purely an investment but for sure its a major consideration for many buyers today."

"How many people do their due diligence to know whether their housing purchase will yield a positive long-term return? Alternatively, how many people perform a detailed rent vs. buy analysis to determine whether to buy anything at all?"

The statements above are contradictory. Most primary residential real estate purchases are emotional. The bank caps off your stupidity and as they make commissions, it really is the blind leading the blind.

The question is what to do about all this?

For me, I have been diversified across multiple assets, stocks/bonds/PE/HF/VC/RE/legal funding/alternative currencies, etc. For every $1m invested, I can cash flow about $60-100k after taxes. I can rent a much nicer place with that money than what $1m will buy in NYC, particularly when accounting for carrying costs, which could go up with the new plan.

UHNWI, those with over $30m, typically have no more than 20-30% of their entire portfolio in real estate and often their primary residence is 5% or less (the remainder is investment). Given that most "working" buyers are putting down only 10-20% with 30 yr mortgages and very few will likely earn high incomes for 30 yrs, transaction costs are high, and often savings rates are low, many of these are individuals just waiting to get picked off in the next crisis. Prices will then drop, they will be shaken out, rinse and repeat.

anonymous, I think we are agreeing on most of these issues. What you say about UHWNI's is mostly true although there are many such people who are not as savvy with their portfolios.

It is in fact the "working buyer" that I am most worried about as you are correct about their higher exposure to a downturn. If UHNWI's loose 20-30% of their portfolios due to mismanagement of their residential investments, they will still be very rich.

But for those less fortunate individuals, I think it makes more sense for them to be less emotional about how they invest their hard earned wages and savings. So, my advice for these people is to start looking at their homes more as investments. Diversification and financial planning should not just be for the rich.