The stock market has been a good place to be in recent years, hitting new highs seemingly daily. Even for those who are not active retail investors or Reddit-fueled speculators have benefitted handsomely from steadily growing returns that have transcended economic downturns and even the sharp shock of the 2020 pandemic.
Many financial advisors have concluded there are only so many places money can go to grow, and in a low interest rate environment it is only natural that investors will rely heavily on equities in their quest for any kind of appreciable yield. But there are risks, not least that too many investors are both leaving significant money on the table as well as making themselves vulnerable to a dramatic market adjustment which has happened all too often in the past.
There is a way to avoid this trap. Careful real estate investing can provide superior yields while also mitigating the effects of stock market volatility.
The Complacency of the Bull Market
It is easy to see why many investors overlook the power of real restate investing. Traditional market investors have lived for many years now in a bull market environment, accompanied by very low levels of consumer price inflation and zero-bound interest rates. However, it is important to be mindful of the saying “past is not prologue.” The long duration of good returns from a traditional market investing approach has fueled a considerable level of overconfidence bias in equities, especially among financial advisors.
Overconfidence bias is the natural egotistical tendency to think we are better at something than we really are. We stop relying on the data and evidence, and we start becoming blind to historical and current macroeconomic or empirical trends.
The danger of overconfidence bias is it leads to bad choices in investing. Overconfidence tends to make us less cautious and less reality-based in our investment decisions than we should be. Many of these mistakes stem from an illusion of knowledge and an illusion of control.
Just before the 2008 financial crisis, a leading global equities strategy group conducted a survey of 300 professional fund managers, asking if they believe themselves above average in their ability. Some 74% of fund managers responded in the affirmative. 74% believed they were above average at investing. And of the remaining 26%, most thought they were average. In short, virtually no one thought they were below average. These figures represent a statistical impossibility.1
A major study by McKinsey identified this trend several years ago. In the study, researchers found that financial analysts, as a group, have been persistently overoptimistic for the past 25 years, with estimates ranging from 10 to 12 percent growth a year compared with actual average earnings growth of 6 percent. Over this time frame, actual earnings growth surpassed forecasts in only two instances, both during the earnings recovery following recessions. On average, analysts’ forecasts have been almost 100 percent too high.2
Despite recent market highs, some financial advisors continue to see the stock market as the place to be, even abandoning their traditional 60/40 equities/fixed income strategies for a more energetic jump into shares. We have seen this exuberance before, although not since the 2000s. As one recent research report cites:
“We studied EPS forecasts with the S&P 500 price index in the 7-year period leading up to March 2000. Back then, the excitement of new technologies combined with growing confidence in the Fed had expectations running high. Wall Street EPS forecasts were rising healthily. Prices, unfortunately, moved even faster, in fact 69% faster. This, as you know, did not end well.
Today history is rhyming. The new business model narratives are compelling – high growth, asset-light, network effects, high switching costs, “disruptors”, etc. Wall Street EPS forecasts are rising healthily. The problem is that prices are again growing 70% faster. This, as you suspect, cannot end well.”3
1 James Montier, Behaving Badly. DrKW (now Klienwort Hambros) Macro Research, Feb 2, 2006. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=890563.
2 McKinsey & Company. Marc H. Goedhart, Rishi Raj, and Abhishek Saxena. Equity Analysts: Still Too Bullish, McKinsey Quarterly, Spring 2010. https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/equity-analysts-still-too-bullish
3 Asset Allocation Team, There are No Bad Assets, Just Bad Prices. GMO Insights, Jun. 7, 2021.
Where to Turn Now
The billionaire investor Seth Klarman famously said, “the stock market is the story of cycles – and of the human behavior that is responsible for overreactions in both directions.”1 If the bull market is inevitably heading for a correction, and if the interest rate environment continues to weigh on any prospect for rewarding fixed income yields, where should investors turn?
Reducing volatility is a fundamental pillar in constructing a wealth-building strategy. Savvy investors have traditionally seen real estate as a foundational part of building wealth, but even the experts often overlook the extent to which real estate investing is a both a generator of yield and, at a more profound level, a true store of value that, in the right hands, is less risky and far less volatile than equities.
Over time, stock market volatility leads to less price appreciation than real estate. This is especially true in Ballard’s core investment markets of Austin, Miami and Denver. This steady appreciation is even true of Ballard’s multifamily real estate investments. While this is perhaps surprising, the facts reveal that careful real estate investing in empirically solid, growing markets will consistently be less volatile than the market. When considering the broader multifamily market nationally, the segment still has three to four times fewer down years than the stock market and represents a much-lower volatility asset class.2 This type of real estate investing reduces overall portfolio risk, mitigates the impact of market volatility, and adds a stable and growing source of actual wealth.
A successful real estate investment strategy requires a high level of expertise, although no more so than investing in any other asset class. Working with a trusted partner is critical, as real estate investing depends on a deep, hyper-local understanding of high-growth geographical markets and their demographics, economics, sociocultural considerations, and developmental patterns. Ballard, for its part, focuses on Austin, Miami and Denver because these three markets, in dramatically different parts of the country, offer both a consistency of economic dynamism – all three are among the fastest growing metro markets in America – as well as a diversity of population groups, in-migration patterns, and key industries fueling growth.
In the same way market investors will balance high-growth shares in, say, technology firms with great future prospects alongside more traditional blue chip stocks that provide steady returns, a sophisticated real estate investment strategy is built upon a balancing of residential with relevant commercial real estate categories such as warehousing/logistics, multi-family residential and, in Ballard’s core markets, even selected retail properties in the fastest-growing parts of the three metropolitan areas.
Austin, for example, is a hub for out-of-state corporate relocations, especially for technology companies looking to escape high-cost, high-tax jurisdictions such as California or the Pacific Northwest. The city has become the number one destination in the United States for potential commercial real estate investment.
Mike McDonald, vice chairman at Cushman & Wakefield, who represents pension funds, insurance companies and real estate investment trusts, recently told The New York Times that “Austin is the hottest market in the country right now. Millennials are moving to the Sun Belt, and companies are following the millennials. Investors are following the companies.”3
Both Miami and Denver have seen similarly robust commercial real estate growth. Of course, people follow the labor market, so rapid and unprecedented in-migration has been a catalyst for some of the fastest residential housing price appreciation in the country.
Even in these exceptionally strong real estate markets, investments must be made with considerable acuity and deep market knowledge. Not every street, neighborhood, suburb, exurb or “development of the future” is going to prove to be tomorrow’s goldmine.
Many factors must be considered in what makes a real estate investment a solid growth prospect. Physical factors, for example, include things like location, natural resources, soil conditions, climate, topography, water and power access, quality of surrounding roads, close-by amenities such as shops and restaurants, and even noise and pollution levels. A multifamily residential project alongside a freeway or rail line will be approached differently than one in a park-like setting next to several corporate offices.
More obviously, economic and demographic considerations are vital, but related to that are the intentions and longer-term plans of various levels of local government. What major infrastructure projects are planned? How is access to mass transit? On a related note, local and regional tax policies, recent construction and redevelopment permits, and a million and one other details will have a direct impact on the bottom line and feed into investment decisions.
Like other asset classes, the past and expected future financial performance of real estate properties to be acquired or, if newly constructed, to be expected based upon similar properties in the same areas, is weighed into all the other consideration to ensure the expected trajectory of returns can be confidently forecast.
In other words, real estate investing is, above all else, a serious form of investing that offers all the benefits of high-quality equities investing but arguably builds on a higher level of market intelligence and, consequently, far lower levels of volatility and risk.
1 Seth Klarman, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. Harper Collins, 1991.
2 Murray Coleman, Dalbar QAIB: Investors are Still Their Own Worst Enemies, Index Fund Advisors, Apr. 19, 2021.
3 David Montgomery, Bucking the Pandemic, Austin Is ‘the Hottest Market in the Country’, New York Times, Aug. 31, 2021. https://www.nytimes.com/2021/03/23/business/austin-real-estate-rebound.html.