Reality is the great antidote of hope. Whenever my colleagues and friends ask me for my global economic outlook, by the time I’m done, they always provide a cheeky response about the depressing nature of my outlook. However, the outlook doesn’t have to be depressing at all for those willing to face reality and take a proactive stance. As a realist, if the outlook calls for great pessimism, then great pessimism is what I will necessarily convey, even if it is not what the people want to hear. Though I’m an optimist at heart (as any entrepreneur will tell you, one has to be an optimist to survive as an entrepreneur), I separate this inherent personality trait of mine from the realism of my wealth-consulting persona. When providing wealth management consultations, anything but realism will harm your clients. The wealth management industry is full of optimists, not realists. An optimist will tell you that the market outlook is the best in a decade (in any market) when reality calls for a mildly optimistic outlook, and that the market outlook is recovering and provides great value when reality calls for a pessimistic, or even a strongly pessimistic, outlook. A pessimist will tell you that the market is long overdue for a correction in the middle of a long rally when fundamentals point to sustainability, and that a crash is around the corner when fundamentals are slightly negative. However, a realist will be pessimistic when conditions justify pessimism and optimistic when conditions justify optimism.
Hope is a dangerous drug to willingly ingest in the investment world or any type of world for that matter. Remember the below wildly popular 2008 campaign ad? What has hope done for Americans since then?
Given that hope is the most counter-productive emotion of all next to greed and fear when it comes to investing, I’m amazed by how many people are still clinging to the fragile, umbilical cord of hope, rather than facing reality, when it comes to real estate markets in the United States. Since 2008, economists and politicians in the US have been injecting false hope into the veins of both residential and commercial real estate investors with nary a single dose of realism. As recently as just last month, I’ve spoken to real estate investors that refuse to sell their residential and/or commercial real estate properties now in the hope that the US real estate market has bottomed and will now rebound strongly. When I’ve probed the reasons that RE investors refuse to sell out of their investment properties now, I seem to receive the same two answers:
(1) Their properties have declined so much in price now that they can’t bear to sell into a depressed market now; and
(2) An unyielding hope the US real estate market has bottomed and will now begin to rise in price.
However, the last three months yielded the lowest three months of demand in nine years of residential housing sales dating back to 2001 despite the Federal Reserve’s QE measures. This is not a good sign. The reality of the situation points to the strong possibility that we are still perhaps several years away from the housing bottom. Furthermore, even if we are not several years away from the housing bottom as I suspect we are, the recovery mode in the US housing market will likely be very sluggish, contributing to the very real possibility that RE investors will not recoup their lost equity for a decade or longer. If we look at the US commercial real estate industry, provided that we look at the industry through the lens of realism, the outlook is just as bleak if not bleaker. According to debt-analysis company Trep LLC, more than half of the $1.4 trillion US commercial real estate mortgages coming due by 2014 are under water.
Consequently, some of the largest US commercial real estate companies have finally come to terms with the reality of the market and have started to walk away from properties in their portfolio. Vornado, one of the largest owners of offices and malls, stopped payments on, and walked away from an $18 million mortgage on the Cannery at Del Monte Square mixed-use development in San Francisco; Simon Property Group stopped payments on the Palm Beach Mall mortgage in the wealthy community of West Palm Beach, Florida; and Macerich stopped payments on a $135 million mortgage on Dallas’s Valley View Center mall. Deutsche Bank AG’s RREEF, which manages $56 billion in real-estate investments, explained the decision of these large US commercial real estate companies as follows: Better to divert payments away from losing projects with dismal outlooks into more lucrative projects or other uses with better returns on the investment. Though commercial mortgages are easier to walk away from than residential mortgages because they are typically nonrecourse, perhaps individual investors can learn from the behavior of these large US commercial real estate companies by also diverting money away from their private real estate portfolios into more productive assets.
The psychological pain of a loss is often an enormous barrier to overcome when convincing an investor to sell a losing asset. Thus, if I encountered a US RE investor that purchased a portfolio of $6 million RE properties that was now worth $4 million, the following are the two questions I would ask him or her to get her to move in the right direction:
“If you had $4 million in cash in your bank account instead of a $4 million RE property, would you go out today and buy the exact same portfolio of properties that you own today?”
The only way they could honestly answer yes to the above question is if they believe that the investment will be profitable in the near future. If they answered yes to this first question, then I would ask the follow-up question.
“Do you believe that there is no other investment today that will provide a better return in less amount of time than your current RE portfolio?”
If they answer no to either question, the task of convincing such a person that selling today, even at a loss, is the best possible choice, becomes exponentially easier.
In the chart above, I’ve shown that in 2002, 3,952 troy ounces of gold could buy a single $1,000,000 home. By August of 2010, with the rise in the price of gold, that EXACT same 3,952 troy ounces of gold could buy FOUR $1,000,000 homes and ONE $500,000 home. This trend of the appreciation in gold outpacing the depreciation/appreciation in US real estate by leaps and bounds will likely accelerate over the next ten years. Even if someone believes that the US real estate market has bottomed, if he or she believes that another asset class will rise more quickly than the rebound in real estate, then it makes zero sense to remain invested in real estate today. Simply put, though the gold market will likely experience another short-term very moderate dip again soon, sell your US real estate and accept your lumps. And with the proceeds, buy physical gold and silver.
About the author: JS Kim is the President & Chief Investment Strategist of maalamalama, a fiercely independent wealth and investment research consulting company. Since the launch of his Crisis Investment Opportunities newsletter in June, 2007, a $1,000,000 investment in the CIO newsletter would have grown to more than $2,206,200 as of September, 2010, while $1,000,000 invested in the US S&P 500 would have shrunk to $682,700.
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