A few real estate investors made a lot of money in 2009 and 2010, but they didn't do it because prices rebounded quickly from a low. (In the U.S., prices peaked in 2005 and went into a six-year downtrend.)
They did it by buying houses at large discounts of 30% to 50% + repairs.
There is momentum in real estate like in everything else: trends from last year tend to continue.
But even where we do see mean-reversion (one-month time frames in individual stocks), it takes a portfolio of hundreds of positions to capitalize on this statistically weak effect.
I don't know of any trading strategy that can generate reliable returns by trading a single, individual asset (one stock, one house, etc.) using its past price data.
Real estate investors get around the lack of diversification by getting huge discounts.
Once you've taken the discount into account, additional profits are subject to predictions about price movements (e.g. momentum) and valuations (e.g. cap rates) that are not statistically reliable unless you diversify noise away in a large, geographically spread-out portfolio.
Since the discount is the only statistically reliable return driver for 1 house, a small investor should try to reduce other factors:
* Hedge away the beta
* Turn the portfolio over to buy more discounted properties
* Avoid market predictions
* Add diversification (risk parity)
You may think that a fixed-rate loan buys time for a house's price to "come back" after a crash, but the actual tendency (momentum) is for the price to keep crashing.
You're also paying interest on a loan that may be larger than the value of the house itself; that is costly.
The benefit of avoiding margin calls isn't mainly for the price to quickly "come back" (this tendency only exists for a few assets, like individual stocks, and is statistically weak).
The main benefit is in avoiding drawdowns, which lead to negative compounding.
If you have a 75% drawdown, you still need to make 300% to get back to even regardless of whether you get a margin call.
The assets that can make you this 300% may not be the same assets that generated the margin call. You probably need a *different* mix (rebalancing needs).
The best thing to do is to plan ahead and avoid the drawdown in the first place.
A fixed-rate loan will not avoid drawdowns, just margin calls. Default happens with loans too, just in a different way.
Drawdowns are avoided by diversification + tail hedging, not loan terms.
The fixed-rate loan may even exacerbate drawdowns because of the nature of selling an illiquid asset into a market when there is a demand for liquidity.
When a house has to be sold fast, you typically have to accept a 20% to 40% discount.
That's more painful than a margin call, but you may have a bit more control over the timing.
That control is only helpful if you have a statistically powerful way to predict a price comeback. For a single house (and given the existence of momentum), this is unlikely.
This brings us full-circle: an investor that can avoid drawdowns and has liquid capital (which means capital not tied down in private real estate) is able to take the other side of the trades in which other investors are selling at those 20% to 40% discounts.
It's not a price comeback that generates profits during real estate recessions. It's having money available during those tail events to buy at large discounts. This means you want cash at those points rather than previously leveraged property.
If the return driver is mostly from buying at a discount, it makes sense to turn your properties over every year or two in order to get capital to buy again.
Sitting on houses for years waiting for them to come back means not being able to buy when the opportunities are best.
It's true that a margin call reduces your leverage, making it less likely to get the 300% return you need to get back to even in the short term. But the leverage would also have dramatically increased your risk of ruin and lowered your long-term geometric return to zero.
Total return volatility (considering dividend & rental yields), Kelly, & risk of ruin matters for all assets, but being close to ruin is psychologically easier for a house b/c the cost is interest on a loan higher than the value of the house rather than a forced margin call.
It's probably true that the lack of MTM & illiquidity can help you avoid panic selling. But they can also create a false sense of complacency when you do need to de-risk.
Even if your portfolio doesn't go to zero, having too much risk will reduce your compounding rate.
If you consistently buy at 30% discounts, you get a higher return by turning the portfolio over. Noise in home values reduces your confidence that you will successfully get that alpha.
You WILL capture this noise with the high turnover you need to maximize your compounding rate.
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1/ Robust Beauty of Improper Linear Models in Decision-Making (Dawes)
"Even improper linear models are superior to clinical intuition when predicting a numerical criterion from numerical predictors. In fact, unit (i.e., equal) weighting is quite robust."
2/ "In proper linear models, predictor variables are weighted such that the resulting linear composite optimally predicts some criterion of interest; examples of proper linear models are standard regression analysis, discriminant function analysis, and ridge regression analysis.
3/ "Research summarized in Paul Meehl's book on clinical vs. statistical prediction—and a plethora of research—indicate that when a numerical criterion (e.g., graduate GPA) is to be predicted from numerical predictor variables, proper linear models outperform clinical intuition.
1/ US Inflation and Global Asset Returns (Dai, Medhat)
"While average real returns were lower in years with higher inflation for most assets, many of the differences are not statistically reliable, especially among non-bond assets & in more recent times." papers.ssrn.com/sol3/papers.cf…
2/ "Our conclusion that most asset classes have limited inflation-hedging abilities is consistent with the literature. Bodie (1976), Fama & Schwert (1977), & Fama (1981), among others, find that nominal stock returns are negatively related to expected & unexpected U.S. inflation.
3/ "Gultekin (1983) & Beckers (1991), among others, find similar evidence outside the US. Fama & Schwert (1977) also find (i) that nominal returns to government bonds and bills are only positively related to expected inflation and
1/ Betting Against Quant: Examining the Factor Exposures of Thematic Indices (Blitz)
"Investors in thematic indices trade against quants, who prefer stocks that are currently cheap & profitable. Negative factor exposures imply low expected returns."
2/ "Our sample includes all S&P and MSCI thematic indices with at least 3 years of data as of end April 2021.
"Our conclusions should not be generalized to thematic investing in general, since our analysis is exclusively based on data from two index providers."
3/ "The history has backfilled data, as the first S&P thematic indices were launched in 2016; MSCI indices were launched as recently as 2020. Backfilled returns are probably biased upwards (e.g. survivorship bias), but this is less of a concern for estimating factor exposures."
"How do you endure the ‘line item risk’ of alternatives? How do you participate in the upside of an increasingly overvalued stock market? What value do bonds bring at the zero bound? The answer boils down to some new capital-efficient ETFs & mutual funds." podcasts.apple.com/us/podcast/res…
1/ Explaining the Recent Failure of Value Investing (Lev, Srivastava)
"We identify two reasons for the failure of value investing: (1) accounting deficiencies and (2) fundamental economic developments which slowed down mean reversion of value & glamour."
2/ "The value strategy had already lost much of its potency in the late 1980s and yielded negative returns in the 1990s, barring a brief resurgence in 2000-2006.
"The expensing of intangibles started to have a major effect on book values and earnings in the late 1980s."
3/ "The effect of our intangibles book-value adjustments are more pronounced for glamour than for value stocks. Among glamour stocks, our adjustments had a larger effect on small than large companies, since small, high-growth glamour firms tend to invest heavily in intangibles."
TLDR: Maybe. Valuations are consistent with this, especially considering real yields, but borrowers are also in better shape than in 2006.
Maybe build a one-sheet Excel model for expected housing returns and decide for yourself.
Thread
2/ Most of the realtors I've talked to tell me that the housing market is even hotter than in 2005, at least when metrics like months of inventory, days on market, and rapid price increases are concerned.
3/ Where I live, houses are on the market for <20 days on average, and buyers pay an average of 10% above asking and waive their inspection contingencies. Some are coming in with all cash.
Inventory (valuation) matters a lot in the short (long) term.