Looking at 10 major world economies, McKinsey & Company said in November that in those countries “net worth has tripled since 2000, but the increase mainly reflects valuation gains in real assets, especially real estate, rather than investment in productive assets that drive our economies.”
The idea that real estate is not “productive” seems curious.
Is it not productive to house people indoors? To have an asset that can produce rent, mortgage interest, and property taxes? To own an asset with a visible and measurable worth that can be financed and refinanced? Doesn’t real estate employ a lot of people in finance, law, brokerage, construction, insurance, maintenance, and repair?
Real estate realities
According to the Federal Reserve, real estate equity held by households amounted to $8.5 trillion in April 2011. Corrected for inflation, this sum was equal to $10.1 trillion ten years later. In fact, household equity this April actually stood at $23.6 trillion. Homeowners gained $12.5 trillion in real buying power over a ten-year period.
Andrew DePietro, posting on Forbes, explained in August that “the real estate industry ranked No. 1 as the industry with the largest GDP in Q1 2021, at more than $4 trillion ($4,008,708,000,000). That is up 3.4% from Q1 2020, when the real estate industry’s gross output was $3.88 trillion, reflecting in part the massive rebound in housing market activity across the country that has occurred over the last 12 months.” (parenthesis his)
Warren Buffett, in his 2011 annual letter to Berkshire Hathaway shareholders, said he preferred “productive assets, whether businesses, farms, or real estate.”
“Ideally,” he said, “these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM, and our own See’s Candy meet that double-barreled test.”
Berkshire Hathaway is not generally seen as a “real estate” company, but it actually has substantial property and property-related assets. For instance, its Burlington Northern Santa Fe railroad owned land for transportation purposes worth $6.2 billion in 2020. Berkshire’s Clayton Homes is a major producer of modular and manufactured homes and also originates financing for such properties. Berkshire Hathaway HomeServices is a real estate brokerage franchise network that in 2020 represented more than $138 billion in sale volume.
A savings glut misspent?
McKinsey explains that “in an economy increasingly propelled by intangible assets like software and other intellectual property, a glut of savings has struggled to find investments offering sufficient economic returns and lasting value to investors. These savings have found their way instead into real estate, which in 2020 accounted for two-thirds of net worth.”
Alternatively, perhaps real estate investors and owners in general are simply happy with the risk/reward balance they now get from their property.
It’s sometimes said that real estate equity should be “put to work” as if such equity is idle. It isn’t. Less debt is good for many households because smaller mortgages can mean lower monthly cash costs and a better debt-to-income ratio.
A large percent of owner-occupied homes, perhaps 35% or so, are mortgage-free. Owners without debt don’t have to worry about interest costs, late payments, missed payments, or even foreclosure from non-payment in the event of an income decline or an outright job loss.
In fact, buying homes for cash is entirely common, especially for real estate investors. The National Association of Realtors (NAR) says that in October all-cash sales accounted for 24% of all existing home purchases. The majority of those all-cash deals – 17% – were with investors.
“Our research suggests that there’s a growing number of people investing in residential real estate,” said Rick Sharga, executive vice president at RealtyTrac. “For both fix-and-flip and hold-and-rent investors, real estate is clearly viewed as a productive asset, and often as the primary element of their investment portfolios.”
The cash glut
Earlier this month Bloomberg reported that “there’s so much spare cash sloshing around U.S. funding markets that investors are choosing to park almost half a trillion dollars at the central bank — earning absolutely nothing.”
It’s not just the US where the supply of capital greatly exceeds demand. In September, the Financial Times, citing the Bloomberg Barclays Global Agg Neg Yielding Debt Index, said that “bonds worth $14.8 trillion – more than a fifth (21.6%) of the debt issued by governments and companies around the world – are currently trading with negative yields.” (parenthesis theirs)
Given the vast cash surplus now in place, one has to wonder why additional capital from homeowners is needed to bulk up the global balance sheet. How much of a return is available in a marketplace already saturated with cash? For many owners, the answer is that their real estate is both productive and in no need of additional debt, thank you very much.