2013-03-14

It Will Always Be Real Estate

Part One: The "Housing Is A Bad Investment" Crowd
Robert Shiller is a bear on the housing market. He considers housing investments to be a fad. As he puts it, "Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there's technical progress in housing. So, new ones are better."

Shiller has been beating this drum for a few years now. Frankly, he's made a name for himself this way. He's been quoted and lauded by Stiglitz and Schiff alike (no small feat, considering how opposite those two viewpoints are). Nancy Grace, the Ludwig von Mises Institute, Suze Orman, Oprah... everyone wants to participate in the flogging of the real estate "myth."

Lucky for you, you're a faithful Stationary Waves reader, so you already know about The First Stationary Waves Principle Of Coming Out On Top: When you see a crowd of people all going one direction, that's your queue to go the opposite direction.

Part Two: A Ten-Year Vision
Simon Grey has more, and as usual, his thoughts reflect a higher degree of rationality than the mainstream media's soundbite culture is capable of generating. Grey's response is:
If you want to remodel your kitchen because you want something prettier or more functional, or more spacious, or whatever; then remodel your kitchen because you want to.  But don’t pretend that remodeling your kitchen is somehow an investment in your home.  That’s just bullshit that salesmen use to get you to spend lots of money on upgrades.
If you want a nice, comfortable place live that you can customize to your exact preferences and specifications, more power to you.  But don’t lie to yourself and pretend that modifying your home to your specs is somehow a reasonable business investment.  It simply is not.
And if you want to invest in real estate, either buy rental property or buy development property, or some other property that you can flip in short amount of time.  That’s investing in real estate.  Remodeling your home is not.
The bottom line is that, at some point, people developed the idea that "flipping" houses was a good way to invest. Or did they? Flipping houses is, by definition, market speculation. I am not convinced that the idea ever took hold that flipping houses was a way to invest money.

I remember when day trading first became a fad. Because buying and selling stocks has long been part of savvy investors' overall investment strategy, I think people somehow started using the word "invest" interchangeably with the phrase "buy something and make money when you sell it." To be sure, that phrase probably qualifies as some sort of extremely crude definition of the word "investment," but it seems to me that there is more to it than that.

In a more traditional sense, investment connotes a long-term strategy, a policy of choosing purchases that will yield a large payoff far into the future. Those with extremely lengthy cognitive time-horizons will excel at this sort of thing. Those who see any kind of investment as a bit of a gamble will never do very well, because they don't have very long cognitive time-horizons. They fail to see the long-run connections between A and B, and so to them when prices become volatile, the best explanation available to them is one that involves "luck" and "risk" and "gambling." But the only people who think this way are bad investors and people too afraid to invest in anything at all.

So Grey is correct to point out a few things that seem obvious when we shine the light of longer cognitive time-horizons on the issues: (1) Buying a home isn't automatically an investment; (2) Remodeling your home isn't an investment at all; (3) If you want to make money buying houses, then buy income or development property. I approve of this advice because it demonstrates the savvy and rationality associated with about a decade-long cognitive time-horizon, perhaps even two decades.

Part Three: Seeing Across Many Milennia
For most people, it is wise enough to adopt Grey's strategy. That is good enough to make them wealthy. We have to add the usual caveats about developing an eye for good real estate location and potential land value appreciation. It wouldn't hurt to develop good relationships with local contractors and the good folks at the Title Registry. The more you do it, the better you get at it.

Nevertheless, there is a very important, eons-long game at work in real estate that I think it is extremely useful to keep in mind when thinking about the housing market.

There is a reason, after all, that real estate is the most reliable form of loan collateral for an underwriter. There is a reason real estate can be leveraged more highly than other assets. There is a reason there was a "housing bubble" in the first place. And yes, that reason involves government intervention, but that "explanation" really just kicks the can down the road, and begs the question: Why did the government promote real estate so much in the early 2000s?

The Ludwig von Mises Institute crowd seems to believe in something they call "the myth of the American Dream," or "the myth of Home Ownership" or whatever else. To hear them tell it, the government just magically decided one day to promote the myth that we could all own houses, thereby saddling us all with debt and skewing the American economy toward debt and debt management. I suppose their explanation involves some attempt to seize power through the financial and banking sectors. This explanation is ironic, considering Ludwig von Mises' own views on the demonization of bankers*.

To properly understand economics and real estate, one has to recognize the crucial role real estate has played in human history with respect to the structure of power.

In the days before the Enlightenment, land ownership made all the difference between a lord and a serf. To procure land from a king or queen meant to either gain access to the corridors of power through favor and insinuation, or to fight for that land to the death. Nearly all battles fought across Europe during antiquity were wars waged for the conquest of land and territory. Those ancient people had no concept of modern land utilization economics. They did not seek to acquire land in order to build factories and housing developments. They sought only power, and land was the ticket to that power. With land, one gained control of the denizens living on top of it, whom you could now tax, conscript, and otherwise exploit. Money was in sufficient to gain this kind of power. Being a member of the king's court was insufficient. Only land ownership could suffice to grant that kind of power.

When the New World was discovered and the Enlightenment unfolded, people gained an understanding that being free to produce and trade is what lead to prosperity. Those who were most passionate about these ideas found many ingenious ways to gain access to the New World, where existing property rights were not yet established. There, they could homestead a patch of land free themselves from the burdens of taxation and conscription. Instead, they could leave peaceful and productive lives trading with one another. Power transferred out of the hands of kings and into the hands of democracy, and land was the vehicle through which this occurred.

Yet, those in control of the American government never lost sight of the value of land as it pertains to power. The Lousiana Purchase was made by America's second president, the author of the Declaration of Independence, a man who had the good sense to know that America's prosperity and the gateway to the ascension of its people was through the acquisition of more real estate. Thus was born the idea of Manifest Destiny, which Americans used to justify a mad dash toward gathering up all the empty land they could get their hands on.

Those who made it to the West coast profited most. California turned out to be a literal gold mind, and a silver mine, an agrarian paradise, and a fabulous well of oil and natural gas. Anyone who managed to acquire this land during the 19th Century must surely have guaranteed the wealth and power of several generations of his progeny.

But this was only the beginning. Even the sparsely populated American midwest is dominated by the few old families who have descended from the initial inhabitants who took advantage of the wide and unwanted expanse of land by setting up their homesteads on tracts so wide they extended further than the eye could see. For one hundred years, they existed in modest poverty, king of a domain no one was interested in. But in the 21st Century, those unable to compete with the prevailing power structures in New York, California, Pennsylvania, and so on, are gradually migrating inland, into the midwest, where land is comparatively cheap and plentiful.

Don't kid yourselves: The folks who managed to gobble this land up in the first place will make the first millions, or billions. It is the land that gives them the money and the power here. And it always will be.

Finally, people in the United States and Canada are taking notice of the many foreign real estate investors who are making a long-term play in North America. The media is replete with stories of Arabian, East Asian, and South Asian millionaires who are excitedly buying up real estate here at prices that we locals consider to be insane.

Are these foreign millionaire's stupidly buying into the Federal Reserve's lies or the long-standing myth of the American Dream? No. They simply understand that even high prices here are a bargain when it comes to a long-run vision of acquiring wealth and power. Throughout the ages, it has only ever been land that has provided men with access to wealth and power, and it only ever will be.

It will always be real estate.

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* Cf. Mises, Ludwig von, The Causes of the Economic Crisis, Chapter 5, Section 1. Remember, folks, there is more to Ludwig von Mises than just freedom and gold standards. Just because we reach the correct conclusions doesn't always mean we reached them for the correct reasons!