Bob Toll, Executive Chairman of Toll Brothers (NYSE:TOL), recently told Reuters that home prices are going to jump 20% in 2013 and another 25-30% in 2014. But before you decide to pile into real estate, you might want to think about it for a moment.
It’s not that there’s anything wrong with Mr. Toll, nor even his prediction. He is a seasoned executive in one of the most respected home builders in the country; it’s why he made this prognostication and what he stands to gain from it that bothers me:
- Toll Brothers is one of the most prominent and capable homebuilders in the country. If people believe that real estate will appreciate, they are more likely to buy more of Bob Toll’s product.
- Toll Brothers needs more of the same – big bailouts, big stimulus and low interest rates because that greases the skids in the banking system for big real estate companies like his. Without the extra money floating around, Toll Brothers’ financing options are limited and he can’t build or at least build as much. Worse, if interest rates rise, his cost of capital will increase significantly and negatively impact his margins. Rising property values give companies like Toll Brothers greater collateral and borrowing power, so of course he wants properties to appreciate…a lot.
- Toll is also an outside advisor to President Obama. That means he’s plugged into the White House like other big business leaders and has a vested interest in preserving the status quo rather than shaking up the establishment and really fixing things.
As for the notion that real estate will appreciate 20% next year and as much as 30% the year after, that’s a more nuanced insight. Note, I’m not saying it’s impossible, just that it’s highly unlikely on anything other than an extremely localized basis.
Why Bob Toll is Wrong About Home Prices
When viewed against the longer term lens of history, housing values are still as much as 6-12% overvalued.
You can see that quite clearly in the Case-Shiller Index created by Yale’s Robert Shiller. Take a look:
In case you are not familiar with it, the Case-Shiller Index reflects sales prices of existing homes rather than new construction. As such, the index more cleanly tracks housing values as investments over time.
Most people are surprised to learn that the value of a $100,000 home (adjusted for inflation in today’s dollars) purchased in 1890 would sell for a mere $119,000 today, 122 years later. Using simple math, that’s a paltry 0.15% appreciation per year or 99.25% less than what Toll is proposing.
I bring this up because the other thing the Case-Shiller Index makes abundantly clear is that real estate prices have still not completely reverted to their average of 112.9263. That means real estate prices favor as much as another 6%-12% decline before they come into line with historical figures.
But back to the notion of highly localized real estate investment. Toll told Reuters host Robert Wolf he prefers New York City as the place to build, citing it as his top pick in 2013.
I can’t say I blame him. As long as big banking has a free pass, Wall Street’s lobbyists continue to run amok and government spending continues, Gotham’s real estate conditions will remain conducive to “investment.”
The story is much the same across broader New York State, notes Levi Spire, who is a candidate for the 121 N.Y. State Assembly.
According to Spire, since 1992 New York’s spending has increased by 153% while its GDP has only tacked on 128% and its population has increased a mere 8%. Clearly something is out of whack.
Figure 1: Office of the Comptroller, Leviforassembly.com
Spire says this suggests that New York “spent beyond its value” and is actually “hurting our economy.”
The story is much the same in other functionally bankrupt states like Illinois, California, and Hawaii, where the number of people who live on the government’s dime outnumbers those in the private sector.
It’s also very similar in states like Florida, where government spending is 68.44% of the state’s per capita 2011 Median Household Income. Or Louisiana, where the figure is an appalling 72.16%. (2011 Federal spending per capita $30,115 divided by Median Household Income of $41,734 = 72.16%)
If and when the government ever cuts back on spending (now it’s my turn to indulge in fantasy), you can bet real estate will tank in these areas.
But – and you knew this was coming – companies like Toll Brothers will be long gone, having financed and sold their projects downstream to unsuspecting buyers who glossed over the relationship between Washington and its favored industries — or worse, completely ignored it.
That’s obviously a strong statement but it’s not one I make lightly.
Toll, like many of his peers in various “favored” industries, is not stupid. He is looking to maximize profits any way he can, and investing in markets like New York City that are heavily dependent on government spending as a means of propping up value is just one way he’s tapping into the system.
Bill Gross of Pimco, Jeffrey Immelt of GE (NYSE:GE), Lloyd Blankfein of Goldman Sachs (NYSE:GS)…they’re all doing the same thing. Their actions are little more than gross self-interest offered under the guise of public stewardship. Whether it’s right or wrong, I will leave up to you.
The Best Ways to Invest in Real Estate Now
If you’re tempted to invest in real estate despite what I’ve just shared with you here are a few things to think about:
- If you can’t beat “em, join “em, especially if you can get in at the wholesale level. Whether you agree with Toll or not, the concept of government spending supporting real estate markets is very real, albeit unevenly distributed. Therefore, concentrate on short-term projects that can be flipped quickly before Washington mentions the word “austerity.” My favorites would be mixed usage properties, particularly those related to medical care and insurance because both are being fed with a Federal fire hose at the moment.
- Longer term, consider more stable states like Utah and the Dakotas, where large numbers of private sector employees have created comparatively stable real estate prospects. Stick to housing in unique markets that have either geographical constraints or cater to the demonized uber-wealthy.
- If you can’t tap into either of my first two suggestions, consider something like the Medical Properties Trust (NYSE:MPW) here in the United States or the GT Canada Medical Properties Real Estate Investment Trust (TSX-V:MOB.UN). The former kicks off a healthy 6.9% yield right now while the latter produces an appealing 8.604%. Both pay you handsomely for the risks you’re taking.