Professor Siegmann's research examined the role of the real estate agent in the house prices transaction, and compared the for-sale-by-fee agent, the new generation of agent that has risen since the advent of the internet, with the performance of the traditional commissioned agent. In the Netherlands, where the study was conducted, commission rates for an agent selling a home is between 1.5% to 2%. This compares with an average of around 5.5% in the United States.
In fact, commission rates in the United States are among some of the highest in the world at an average of around 5.5%. Unlike the United States, most countries have seen significant drops in real estate commissions in the last 15 years or so. The lowest in the world are in Northern Europe at around 1.7%, and the highest is in Mexico at 7.5%. For those countries that have seen drops in commission rates, the average decline has been 34%. That there has been no significant change in the US gives pause for thought: Why is there such pricing uniformity among ostensibly competing agents?
‘Before the internet everyone needed an agent to buy a house and an agent to sell the house’. Agents maintained exclusive access to the multiple listing service and so were the gatekeepers for sellers to a market of buyers, and to buyers who wanted to see what was available to buy.
However, since the advent of the internet, buyers and sellers now have full access to detailed information about all the houses that are available on the market, and yet sellers are still paying, on average 5.5% to agents who are erstwhile intermediaries. This begs the question that, if information is freely available to everyone, ‘what is the use of an agent?’ The former role of the agent was to match buyers and sellers by providing access to a proprietary data network to each side of the transaction, but now the network itself provides direct access for buyers with seller and vice versa.
FOR SALE BY FEE (FSBF)
The for-sale-by-fee agents in this study involved the Seller in showing their house rather than the agent on the principle that the owner is, presumably, the best person to show the house because they know the house better than anyone else. This model of for-sale-by-fee agent emerged once the availability of information became more widespread on the internet. The for-sale-by-fee agent can offer considerably lower fees than the commissioned agent because, by taking the showings from the agent services, a time consuming component of the agent task is eliminated. In addition, relative to the homeowner, the agent is not as good at showing the home because, simply stated, they do not know as much as the agent.
COMMISSION AGENT – A CASE WHERE YOU DON’T GET WHAT YOU PAY FOR
The researchers’ thesis was that the for sale by fee broker to underperform the high paid commission broker. But what they discovered was that the for-sale-by-fee broker not only sold for a higher price but did it slightly quicker than the commissioned agent.
‘This is really remarkable because it means that they are cheaper and better’. For-sale-by-fee agents do better than commissioned agents irrespective of whether it is a cheap house or an expensive house, it does not depend on whether a home is in a rural area or in the city, does not matter if it is for houses that typically take a long time to sell or a short time to sell. Having a for-sale-by-fee agent, where you do the showings to buyers yourself, will give you a better result – you will sell for more, in less time, and it will cost you considerably less to do it.
Simple Conclusion: For-sale-by-fee brokers, when you do the showings yourself, do better than traditional commissioned brokers. Period.
WHY DO FSBF AGENTS OUTPERFORM COMMISSIONED?
There are two possible reasons. One is that the homeowner knows much more about their house than an agent who may be juggling multiple homes at once. The agent cannot know the details of a house as well as the seller does, and this kind of personal information about a home is of value to a buyer. This information could include things like when it was renovated, which contractor did the job, how is the neighborhood and other similarly intimate insights into the home.
The other reason is that inherent in the commissioned agent’s fee structure is the disincentive to prolong a sale to squeeze out a higher price. If an offer comes in that is lower than asking price it is in the commissioned agent’s best interest to recommend the sale because the incremental commission earned from rejecting such an offer and seeking another, higher priced, buyer is not worth the effort. This is a similar theme as we have seen evidenced in other research. If the open houses and showings are managed by the agent but left to the seller to conduct, that additional layer of time consuming labor is removed enhancing the for-sale-by-fee agent’s willingness to prolong a sale in pursuit of a better result for the seller.
Siegmann and his co-authors pondered whether these results were measuring something that they could not see; something else other than the variables they were considering. What they conclude is that there are ‘smart sellers of houses’ who are very comfortable with showing people around and making sure that their house gets sold. It also shows that the added value of professional agent is not that high; there are enough people who can do it themselves.
FSBF IN THE US MARKET
There are many studies, some covered already in this podcast series, and some coming up, that find similar results here in the US. The overall picture is a puzzle; why is it, other than by tacit collusion, that agents in the US all charge the same commissions and yet claim to compete. This is especially true in the millennial internet age where it is very easy to put pictures up online to show your house and provide direct access to buyers who can search freely and without the need of an agent. Perhaps it is because the agent realizes that as soon as they start competing on price, their business is over.
As a buyer ‘you do want to talk to the seller. Why would you not want to talk to the seller? This seems to be a story told by the agents who say “well, but that’s not good, we are professional sellers”… If I sell something that is really valuable, I would like to tell the buyer what I know about it.’
What is being seen in the European market is that agents are beginning to offer more creative ways to advertise their services and to structure their fees. There are those who charge a flat fee, and who offer a modular service, like photography upgrades, or staging advice. In other words, the market is evolving such that sellers are paying for the actual services they are getting and not just for someone to be in the middle.
It is only a matter of time before these models start to dominate the landscape here in the U.S.
What Value Does the Real Estate Agent Bring?
The question that Jonathan Meer and his co-author Douglas Bernheim set out to answer was, what value does the broker add to a residential real estate transaction? One of the challenges in researching this is that the listing services that an agent provides are generally bundled so it is difficult to separate them out to be able to analyze them independently of each other. These services include listing the property on the MLS, taking photographs, staging advice, listing prices, paperwork, showings, handling other brokers and such like. It is a large bundle of services, but what is strange, when you think about it, is the percentage payment model for the services provided. Why is the value of all these bundled services, that might only total a few hundred or at most a couple thousand dollars, result in a commission cost that could be ten times or more as much as the actual cost of the of the services themselves? Not only is this somewhat strange from a financial perspective, but it sets up a classic case of what is known as the principal-agent problem.*
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*The principal agent problem occurs when one person, the principal, hires another, the agent, to act on their behalf in some manner, but where there is imperfect monitoring of the agent’s performance. This creates a dilemma whereby the agents are motivated to act in their own best interests, which are contrary to those of their principals.
Real Estate Agency Unpacked
The classic example of this is the auto-mechanic who knows a lot more than you do, and where you have to trust them to do the work properly and advise you accordingly, but where the incentives for both agent and principal might not be aligned.
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The same applies to the real estate agent who does not capture a meaningfully significant extra amount of commission for significant amount of additional effort they must put in to extracting the best price for a client. For example, working to get an additional $10,000 from a home sale, might be of significant value to the homeowner, but to the sales agent, the amount of additional commission is too small to warrant the extra effort it would require in getting it. The incentives are not aligned between the principal, who would like the extra $10,000, and the agent, from whom getting the extra money for the principal, is not worth the extra effort it would take.
The objective of the study was to unpack the broker expertise services – showing the home, advising on pricing, negotiations – from the value of listing the home on the MLS, and the paperwork services which can be readily calibrated in terms of their actual costs. The Stanford University faculty staff market provided a ‘usefully unusual’ market in which the unpacking of services could be studied, and served as the foundation upon which the analysis was conducted. The university has an office called ‘The Faculty Staff Housing Office’ which acts as a multiple listing service (MLS) because the university retains ownership of the land and limits who is eligible to purchase homes. So many of the real estate agent’s functions are subsumed by this office. The office lists the homes for sale and provides all necessary paperwork to consummate a transaction in the 800 or so homes on the Stanford campus – the equivalent of about 40 blocks in a typical metropolitan area.
Using an Agent Reduced Sales Price by 6-7%
In the late 1990’s, and though not required, there was a sudden uptick in the number of home sellers in this neighborhood using a broker to sell their home, going from none in some years to up to 60% of sales by the mid-2000’s. This came about because of some aggressive marketing on the part of local agents to use their services.
The study allowed for differences in house characteristics, size, number of bedrooms, features etc. They were also able to identify those homes that were sold multiple times over the course of the 30 years of the study and to compare those that sold with an agent against those that sold without an agent.
Finding: The same home sold with the aid of a real estate agent sold for 6% - 7% less than when sold without the aid of an agent.
This provides ‘evidence of very, very strong agency costs, that is the real estate agents’ incentives are aligned differently. They would like to sell the home relatively quickly and if they sell the home two weeks earlier for ten thousand dollars less that means that they are essentially giving up $200 in order to put in maybe 10-20 fewer hours of work into the sale of the house which when you work out the hourly rate of that is not a crazy decision to be making.’
Listed at Lower Prices, Homes Sold Faster
The researchers also discovered that homes listed by agents were much more likely to sell significantly quicker when listed by an agent, which reinforced the idea that agents were motivated to sell for a lower price in a shorter time. These findings were very similar to another famous study by Chad Syverson and Steve Levitt (of Freakanomics fame), where they looked at the Chicago market and compared sales by an agent of client homes, and compared them to sales by that same agent selling his or her own home. They found that when selling their own home, agents take longer to sell, and sell for more. [AG: I will be covering this study in a future episode]. Syverson and Levitt took this to be evidence of the agent-principal problem and it supports the findings of the Stanford study.
The Stanford study also noticed that homes listed with an agent typically listed at a lower initial asking price than those homes listed without, further pointing to the agent-principal conflict where the agent just wants to sell the home for a good price quickly, but not necessarily for the maximum price and to take the time doing so.
While this study is restricted to a unique real estate market, it is nevertheless of a decent size, being a reasonable equivalent in scale to a city neighborhood, and has been replicated in some regards to far larger, more generic real estate markets by other studies – such as the Syverson and Levitt study in Chicago.
Certainly, the internet has begun to make some of the listing services increasingly obsolete. It is important that the individual decides independently whether the services of an agent are in their best financial interests, and it is important that in making this decision that the homeowner is aware of the principal-agent conflict and that the agent is likely operating from a different set of incentives.
The pressure to unbundle services is likely to become more prevalent: buying an MLS listing, or photography for a home as separate and distinct services versus paying 5-6% of the sales price of a home for those same services for example.
The market forces that are driving this unbundling of services could drive the real estate agent to obsolescence the same way as it did, most notably, with the travel agent.
As the generation that is becoming more comfortable with using technology to do pretty much everything in their lives comes on stream to start buying and selling homes, they are also likely to be increasingly uncomfortable with the current bundled services model that comes with a high commission base pricing structure.
STATE OF THE REAL ESTATE CYCLE: PROF. GLENN MUELLER, DENVER.
OFFICE: Demand for office is increasing. The recession is over and all the uses that demand office space are growing. However, technology is changing the way we consume office space. People work from home or use shared office space, and consequently the amount of space required for a new hire has decreased from around 200 square feet, to 120 square feet. Consequently more demand is required to fill space, but with the economy expanding that space is being filled. That said, the office market is highly location dependent because different cities have different industry base profiles that drive the local economies and that is what, in large part, drives office demand.
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INDUSTRIAL: Industrial is in big demand nationwide driven largely by internet sales and the migration from retail to warehouse distribution centers – even though internet sales are just 9% of all retail sales indicating considerable room yet for growth. Occupancy is not at its peak yet but is expected to reach that level by the end of the year this year. Amazon was the biggest consumer of warehouse space last year taking up fully 25% of the entire warehouse supply nationwide. And Amazon are moving from a few huge locations to a more localized format to enable same day delivery schedules, and are being chased by Walmart who are also beginning to expand into a delivery model and consequently beginning to demand warehouse space nationwide. Industrial is ‘hands down the best property type going’. Glenn predicts that: ‘peak occupancy will continue in industrial until 2019’.
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APARTMENTS: Apartments present a ‘good demand story’ with millennials coming on stream not buying as young as prior generations and so fueling demand for apartments. That said, apartments are also among the easiest to finance and so consequently the pipeline of new product is easy to fill and is being overfilled currently leading to hypersupply. And the hypersupply is primarily at the high end of the cost/rent spectrum, the ‘A’ class developments, so it is that end of the market that is going to see reductions in rent levels first but that will cascade down to B and then to C also as renters trade up to higher quality units as rents reduce overall. There is nothing anywhere nationwide – in the cities studied – that indicates occupancies will be rising; every single market is either at peak, or already oversupplied meaning reducing occupancies and rents. In fact, new supply is 10-20% greater than demand can keep up.
RETAIL: ‘Retail is dying on the vine’. Good quality retail and shopping centers are doing well, but not much else, and even that is evolving more to being destination entertainment centers. Grocery anchored centers are still a necessity so will continue to do well. Overall though, retail is extremely slow on the recovery, around half that of any other property type, but the good news is that as supply is very low because it is difficult to finance so there are some bright spots on the map for retail as demand has picked up but supply has remained more stable.
HOTEL: The hotel sector is uniquely the most volatile property type because people rent by the day and so when the economy is doing well people consume hotel rooms but when it is not, they simply stop. But the hotel industry is enjoying some generational changes in demographics where millennials are traveling more than their predecessors and as a consequence are unbelievably profitable right now with an ‘all time best ever peak occupancy of 72.5%’ So with this peak occupancy we are seeing additional supply coming on line with more hotel rooms being built.
The amount of information you can get scanning the internet for a new home is incredible and is rapidly eroding what was once the exclusive domain of the real estate agent. So, what are the skills that the agent needs to focus on to remain relevant?
Today is the second in a series of conversations that I am having to drill down on the dramatically changing landscape for the residential real estate industry, particularly as it pertains to the agent function. My guest today, Paul Anglin, is professor in the college of business and economics at the University of Guelph in Canada whose research into the relationship between listing price and time on market first drew my attention. There are some key findings that he discusses that are consistent with other findings I have discussed in prior podcasts at www.nreforum.org – such as the percentage difference between target selling price and list price. But as my conversation with Professor Anglin progressed we migrated towards the question of agent contribution to the sales process.
Incidentally, in future episodes I speak to several other experts who have conducted similar research, each challenging the idea that the status quo can be maintained – in fact challenging the idea that the real estate sales agent role is relevant in its current form. Just think, if you will, of what happened to the travel agency industry. Subscribe to the series at the national real estate forum dot org website, or www.NREForum.org , to be sure you do not miss any of the provocative conversations coming up.
We tend to think of the relationship between time on market and price primarily in the context of setting the asking price – if we set it too high, it’s going to take longer to sell, or maybe not sell at all, OR if we set that price too low and a buyer pops up immediately maybe we set the price too low. In fact it never fails to astonish me that brokers brag about having sold within a week… doesn’t that just mean they underpriced the house? I don’t get it. There’s this built in conflict, that I discuss in future episodes, that while it may be in the Seller’s best interest to wait longer for a higher price, broker’s prefer to sell quickly because the increase in commission that they get just isn’t worth the wait…
But the question of when to say Yes to an offer – is now too soon, or should I wait longer - is not unique, of course, to real estate transactions. The background to this quandary from an analytical perspective helps to set the foundation upon which we can better understand the problem…
So let’s review… we hear that the optimal list price is between 3-4% above market and this is consistent with other studies, most notably that conducted by Darren Hayunga, my guest last week. Tying into this is the apparently intuitive finding that the higher the list price, within limits, the longer it takes to sell - less intuitive, and certainly more pertinent for agents, is that the higher the list price, the higher the sale price is also likely to be – even if it takes longer to sell. So, while Professor Anglin and I did not discuss this, the question of incremental income for the agent in squeezing out the last dollar for the client – isn’t that a fiduciary responsibility? – comes into focus. Are agent and client interests aligned if the extra effort to maximize sales price results in a really small commission increase for the agent?
In an upcoming episode I discuss a study that examines this idea directly and that reinforces the idea that agents are motivated to sell quickly and for less than they would otherwise yield for their clients, if only they were to persevere and market the property longer. What do you think about this? I would love to hear your thoughts so please leave a comment on linkedin book, or contact me directly at www.nreforum.org
My takeaway from Paul Anglin’s research is that it sheds light on the idea that the agent skillset has changed in the sense that they must now be more media and internet savvy. They have to understand how to stand out online, rather than being just the gatekeeper of information about a property as they used to be. Nowadays online accessibility to information is plentiful and almost provides a full enough understanding of a property for a buyer without actually having to visit the property itself. Not only that but the key components of what go to making up the agent role – provision of photographs, legal paperwork, market information, staging, appointment setting, even pricing and negotiation – each of these are being offered independently of the agent. And as each component of the agent function becomes more easily accessible to the home seller or buyer, the pricing for those functions goes down.
The challenge to the agent system as it currently exists is that the sum of the costs of buying each component of the sales process is very significantly less than the commission the agent charges and so it becomes inevitable to start to ask: how relevant is the agent role – especially at 5 or 6% of the total sale cost – in an age of technology and increasing access to information? Isn’t it just as easy to do it yourself now, for less money and, as the research seems to be suggesting, with a better financial result.
As the millennial generation comes of age and starts to demand housing in greater numbers, they are going to start buying and selling real estate without agents if agents cannot redefine themselves to accommodate the tsunami of changes that are sweeping over every other industry.
Food for thought, and fodder for future episodes at the www.nationalrealestateforum.org , www.nreforum.org Listen in, subscribe, and let me know what you think by using the contact form at the website.
How do we set listing price when we sell our homes and what value do agents bring to the process?
Today’s discussion covers familiar ground for most of us because it relates to those times when we are selling our home and how we come to that most important of decisions: the list price. My guest is Darren Hayunga who is professor of real estate at the University of Georgia. In his first paper on the subject, professor Hayunga begins to look at the relationship between list price, how it is set, and how that relates to the amount of time a home remains on the market before selling. Sellers typically try to set asking price around 3-4% above market price in order to allow for some flexibility during negotiations.
REDUCING LIST PRICE MAY NOT BE THE BEST STRATEGY TO GETTING A QUICK SALE
Discussing ‘urgency’ as the idea that a seller wants to sell quickly, professor Hayunga discovers that if you are in a hurry and set sale price lower than you otherwise might do in an attempt to sell quickly, it will take you just as long to sell and you could end up selling for less.
As our conversation unfolded, professor Hayunga started discussing some results he and other researchers are finding that have very serious implications for the real estate brokerage industry – is the real estate agent becoming obsolete; are we seeing a decline in agent effectiveness as their relevance diminishes? Stay tuned for the latter part of my conversation today to hear more on these topics. And be sure not to miss future episodes as I delve into this important vein of research by going to the www.nationalrealestateforum.org website, www.nreforum.org and subscribing through any of the links I have provided there.
YOU MAY END UP SELLING FOR LESS AND TAKING JUST AS LONG TO DO IT
The takeaways today are that, top line, most people set their asking price 3-4% above market to allow for some negotiation flexibility. If you are not in a hurry to sell your house, set the price higher than this and wait for the right buyer to come to the market. However, if you set the price too high, you may have to reduce the asking price and provided you don’t do this more than once, you should still be able to gain a decent price for your home. On the flip side, if you do want to sell quickly, and you don’t set enough extra price in to allow for some negotiation, not only might it take you just as long to sell anyway, but you may end up selling for less than you need to.
My conversation with Professor Hayunga continued, however, when I asked him to clarify a point regarding agent input in setting sales price and it was there that we started to address the question of agent effectiveness.
We have data showing that agents do not contribute meaningfully to the list price decision when comparing homeowners who use agents against those who do not; we hear that agents sell their own homes for more, and buy for less than when they represent clients; and we also learn of studies that show that using an agent can actually result in a lower sales price – by 6-7% less??
What is going on here? In discussing this particular study – which, incidentally, I am working on including in a future podcast – the conclusion is that the only advantage that an agent has is access to proprietary data through the MLS.
These are serious findings. What happens when the advantage of having access to proprietary data becomes eroded by increasingly free and open access to the same data on sites such as Trulia or Zillow? Are agents really doing everything they can to squeeze out the best sales price for their clients by working harder and waiting longer for the right buyer, or are they giving up quicker, not caring for the incremental commission, but preferring instead to avoid having to conduct m ore open houses and marketing? And why is it that when agents buy for themselves, they buy for less than they do when representing clients, and why do they sell for more when selling their own homes? Do they not have a fiduciary responsibility to put their clients first?
DOES TECHNOLOGY POSE A THREAT TO THE REAL ESTATE AGENT INDUSTRY?
The big question is: is the agent function becoming obsolete? do these data indicate an industry that is facing the disruptive influences of technology. Why shouldn’t we sell our homes online without an agent? What value do agents bring and is that value enough to compensate for lower prices and steep commissions? Did you know that in London, agents typically charge 1% of sales price to sell your home, not 5 or 6% as is the norm here?
If you have any thoughts on this subject, please twit about it, or chime in on linkedinbook or facechat where I will be posting articles and links to this podcast. And don’t forget to subscribe to the podcast series by going to the national real estate forum dot org website, nreforum dot org, where you can also email me directly any thoughts you may have. I will be investigating the subject of agent effectiveness in future episodes and would value your input and thoughts.
For now, thank you for tuning in and thank you Professor Darren Hayunga for providing some stimulating and interesting insights into how we set list price when we sell our homes.
One of the driving goals of this podcast series is to give you high quality meaningful information and insights about the real estate industry that is based on carefully conducted research from which you can come to your own conclusions, and make well informed decisions. My guest today is Jordan Levine who is the senior economist at the California Association of Realtors – and organization with over 180,000 members – and you just can’t do better than Jordan for high density, clear insights based on the consolidation information from a vast array of public and proprietary sources of information. In today’s podcast, Jordan talks about both the headwinds and the tailwinds for the housing market nationwide, with a focus California, and explains that right now is one of the hardest times in history to predict where the industry might be headed. I would welcome any thoughts you might have about what he has to say and where you think the market is heading. Let me know by sharing your insights alongside the article I will attempt to post on my linkedinbook account, if I can ever figure out exactly how to do that, or if you are a twitterer please twit me, or, if you prefer, facechat me with your thoughts.
I am very grateful to Jordan for spending the time with me today to share the results of his research with you. My conversation with him is split into two episodes so be sure to subscribe to the National Real Estate Forum podcast by going to NREForum dot org and clicking on any of the subscription links you will find there. You can also hear more from Jordan by listening to his own podcast series through CAR that is called Housing Matters that can be found on iTunes.
Health Care with Professor Christopher Palmer (Ph.D MIT) UC Berkeley
HEALTHCARE AND IMMIGRATION POLICY: IMPACTS ON REAL ESTATE. PART I: HEALTHCARE
Thank you for joining me again… It has not been entirely consistent yet, but my goal is to syndicate one podcast each week on a Tuesday morning. This week though, in response to listener requests, I am splitting part of the conversation I had with my guest Professor Christopher Palmer at UC Berkeley, into two, slightly shorter, podcasts. In the first, we discuss the effect of changes in healthcare policy on the real estate industry. The second looks at how the Trump doctrine of America First might also impact our industry. Both are available at www.nreforum.org/podcasts .
One of the policy issues that dominate Washington’s agenda is healthcare. It is an issue that has been a high priority for prior administrations, and continues to remain a high priority for the current administration. But the pendulum like swings in policy from the pre-Obama era, through the Affordable Care Act, to the Trump administration’s ‘repeal and replace’ discourse, causes considerable uncertainty not just now, but as real estate investors attempt to predict the future.
So it is my great pleasure to welcome back Professor Palmer. I am very grateful to him for agreeing to be my guest again. In today’s conversation, he and I talked about why a possible reining in of real estate investment in the healthcare industry might result from uncertainty as the Affordable Care Act is restructured. Professor Palmer also shared his thoughts on why Senior housing which, on its face should be more immune to short term policy fluctuations, may also not be quite as invulnerable as some might like to think.
It seems intuitive to me that with as pro-business a government as we have now, there could only be optimism for the real estate industry. So I asked Professor Palmer a question… The Trump administration has a three prong stimulus plan - reduce taxes, spend heavily on infrastructure, and relax regulations – won’t this be a great boost to the real estate economy?
UNCERTAINTY IN POLICY IS DESTABILIZING FOR REAL ESTATE
Uncertainty in healthcare policy and the direction it is headed is not good for planning developments, like hospitals, for example, because not knowing how patients are going to be reimbursed for their medical expenses creates doubts as to how development investments will be returned. The healthcare industry does have some immunity to shifting policy changes because it takes a long term perspective, and because demographic trends that point to a large aging baby-boom population will have some flattening effect on the impact of policy changes.
As the population ages we are going to see greater spending in healthcare related real estate. However, demographics are not a panacea for overriding unpredictability in healthcare. Insurance is how most people plan to pay for their healthcare, so with the ACA we had this roadmap laid out that defined how people were going to be able to finance their healthcare expenditures, but with that being rolled back, once again there is considerable uncertainty across the industry. Which is the anomaly: the Affordable Care Act, or what is the current plan being debated in Washington the anomaly?
Opportunities may arise from identifying those properties that are now seemingly distressed healthcare assets, and acquiring them with the view that in five years time, something that looks more like the ACA will again be the government’s mandate.
SENIOR HOUSING - STRONG DEMOGRAPHICS, BUT HOW WILL SENIORS PAY FOR IT?
Senior housing has been, and continues to be a very successful space in the real estate industry. The aging of the baby boomer generation reaching retirement age and increasingly likely to need senior housing facilities seems, on its face, to be a positive tailwind. However, one thing to watch for is the impact the retirement savings crisis in the United States, and of underfunded pension obligations on long term viability of the senior housing market. Institutions and municipalities have underfunded pension plans that are a looming problem, and combined with an atrociously low savings rate in the United States, the prognosis for how this cohort of aging people is going to retire is not good, let alone how they are going to afford medical expenses, and the costly option of entering senior housing facilities to live out their days. This certainly mitigates the likelihood that senior housing is going to be a sure thing as far as providing certainty on the investment horizon.
There are two takeaways from today’s discussion with Professor Palmer. The first is that the current uncertainty about the healthcare industry creates difficulties in making medium and long term predictions upon which to base underwriting assumptions. However, if you have a firm opinion about whether the Affordable Care Act was a healthcare industry anomaly, or that the Trump administration’s repeal and replace policy is the anomaly, you may be able to find opportunities trading with those on the other side of that debate. The second pertains to the senior housing sector which, though enjoying some tailwinds due to aging population demographics, may yet experience turbulence as its target market finds it increasingly difficult to pay for the services on offer.
If you have enjoyed listening to the podcast, please tell your friends and colleagues about the Forum, and visit us at www.nreforum.org where you can hear earlier episodes and subscribe to the series on iTunes, Android, and other syndication platforms.
Thank you again for joining me in part one of this two part episode. Please join me again for part two, when I discuss with Professor Palmer the impacts of the America First doctrine on the real estate industry.
HOW TRUMP'S AMERICA FIRST DOCTRINE COULD CREATE DISTRESSED REAL ESTATE INVESTMENT OPPORTUNITIES
Welcome to the second of two episodes with Professor Christopher Palmer of UC Berkeley. In the last episode we discussed the impact on real estate of the changes in healthcare policy between the last administration and this one. Today, our conversation focuses on immigration policy as a part of the Trump America First doctrine as it pertains to real estate.
The America first doctrine has, by definition at its core, our relations in the international community. The key policy issues that drive this doctrine include immigration, foreign policy, and international trade, and there are five key areas where their impact may be felt in real estate. One, new development projects, two, the office sector, three, multi-family, four, retail, and five, manufacturing. In my continuing conversation with Professor Palmer, we were discussing the administration’s current focus on immigration restrictions. On its face, it might seem somewhat removed but, actually, how could putting America First affect real estate?
Maybe some of these sectors present investment opportunities as putting America First policies are implemented and, as their impact starts being felt here at home, some real estate comes under distress.
I hope you found this podcast, and the healthcare podcast of interest. Thanks so much for listening. If you like the podcast series, please consider subscribing on iTunes or Android or any of the other syndication platforms so that you don’t miss the next episode as it comes out. Go to www.NREForum.org and there are subscription links on most pages. Thanks once again to Professor Palmer for sharing his thoughts on these important real estate issues, and thank you too for joining me again today.
Past performance is not a guarantee of future results. This boilerplate disclaimer is standard wording for just about any financial investment we might make, but when it comes to buying a home, as sensible as this pithy phrase may be, it is often disregarded. Home buyers tend to be driven by the idea that because prices went up last year, they must go up next year. Their belief in future price rises is often driven by watching past performance of the market, and buying is motivated by a belief in anticipated future price appreciation. Same goes for speculators who, seeing a steady upward trajectory in house prices, assume that this is also a guarantee of future increases in value.
To be sure, there are some fundamental factors that drive price increases, but without being specific about what caused last year’s price rises, how can the buyer be so sure that that prices will go up next year also? Or the year after, or the year after that? or, indeed, that prices won’t go down?
My guest today is professor Charles Nathanson who received his Ph.D. in economics from Harvard and who is currently assistant professor of finance at the Kellogg school of management at Northwestern University. A link to his full bio is at www.nreforum.org and the papers we discussed today are An Extrapolative Model of House Price Dynamics and Speculative Dynamics of Prices and Volume. Professor Nathanson’s research in these studies provides some fascinating – and actionable – insights into what to look for to better assess if there is still upward momentum in pricing or if you are buying at the top of a bubble.
Here are my takeaways from Professor Nathanson’s research. In order to understand what is going on with recent house price increases, we need to know what prior buyers believed when they bought their houses. If they bought under the assumption that prices were going to rise, then their decision may have been irrational and so, possibly, pushed up prices disproportionately to market fundamentals. One way to measure this is to assess what proportion of those increases were driven by house flippers. Brokers should be able to give a sense of this in their own geographical areas. If they are reporting a preponderance of such activity, this might be indicative of being in the later stages in the cycle.
Also compelling is the idea that transactional volume alone is a precursor to where pricing is likely to go. Finding data for transactional volume should not be too difficult, and if one sees a tailing off of volume, it may be the first sign that pricing is also about to stop rising and may be on the way down. Professor Nathanson was reluctant to come to this conclusion without further research, but, again, as a metric to watch for it seems to me that it has some utility.
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My guest today is Professor Glenn Mueller. With 35 years of real estate industry experience, including 26 years of research, Glenn Mueller is a professor for the Burns School of Real Estate and Construction Management at Denver University, one of the oldest and largest programs in the country. Mueller’s research experience includes real estate market-cycle analysis, real estate securities analysis, real estate capital markets, portfolio and diversification analysis, seniors housing analysis and both public and private market-investment strategies. He is also the real estate investment strategist at Dividend Capital Group, www.dividendcapital.com, where he provides real estate market-cycle research and investment strategy for Dividend Capital’s Real Estate Securities, Private Real Estate Investment, Private REIT and Real Estate Debt groups. He is also the co-editor of the Journal of Real Estate Portfolio Management.
At the Dividend Capital Group, professor Mueller, produces a 54 city report examining the cyclical performance of the five major real estate food groups; office, retail, industrial, residential, and hospitality. In my conversation with Professor Mueller he discusses why he is bullish about real estate industry growth in the US over the next few years and why his experience analyzing industry cycles over the last nearly 30 years, leads him to believe that the industry will enjoy considerable stimulus with the incoming administration that could lead to an extension of the current cycle. In fact, he talks about predictions for the next recession being pushed out from 2019/2020, to 2021/2022.
In 1990’s when at Prudential as a research analyst, at a time when the markets were headed down during the savings and loan crisis, they wanted Mueller to monitor what was going on and predict where the market might be going in the future. In this work, he uncovered two types of cycles. One is the local demand-and-supply cycle. This led him to cover 54 different MSAs concurrently, together with their localized industries, so for Detroit the automotive industry, and for New York the financial industry for example. Employment drives the need for space, and as supply varies, where as developing new office buildings is going to be different from city to city, so it is the interaction between these two things drives occupancy levels and rents. The Cycle Report that Prof. Mueller started in 1992 deals with this phenomena. The second cycle is the capital cycle flowing to real estate which used to be national in nature but is now global – and this is what drives prices. The two should work together but do not always.
The way in which government can impact the real estate cycle is by influencing economic growth through stimulus actions, whether that be through lowering taxes, creating new jobs, making life easier for businesses to conduct business etc. Professor Mueller notes that, “this is the first time in a very, very long time, and only the fifth time in history, that we have had a completely coordinated business friendly government where all three branches of our government are interested and focused on the same thing which is business growth”. Consequently, the potential for economic stimulus is high. Exactly this may take place is difficult to predict yet, though infrastructure projects are likely to move forward, reduction in regulations, and making our tax system more competitive with those of overseas will all contribute to boosting the real estate industry. A lot of economists expected a recession in 2019, 2020, but now projections are pushing that out to 2021, 2022. Indeed, US economic cycles typically never last longer than 10 years but we could be in one that is going to last as long as 14 or 15 years.
The impact on individual cities may be influenced depending on which industries are strengthened within those cities. Manufacturing, for example, if it can be repatriated to the US, could have a big impact on those cities with a strong manufacturing base – though this would be a very long term change, and we cannot expect to see much in the short term.
Professor Mueller’s MSA study utilizes data primarily from Costar where they look at new demand that has been created in the marketplace on a quarterly basis. They look at how much new office, retail, industrial, residential, and hospitality space has been rented, as well as at new supply in the prior quarter. From this they are able to determine occupancy rates in each city, and compare that to prior quarters. This leads, in turn, to rent growth analytics determining whether or not rents have risen or fallen in the quarter.
Using this data, Prof. Mueller determines long term averages and then uses that to generate predictive analyses of where the individual city and industry is in its natural growth cycle, and where it is headed. Is the individual city’s market in recovery, expansion, hyper-supply, or recession, on an asset class basis – office, retail, industrial, residential, hospitality. Download the Q4 2016 Cycle Monitor Report here. Prof. Mueller also does a predictive report on a subscription basis that looks out one year. Please email us at firstname.lastname@example.org if you would like to know more about these predictive models. That said, one can reasonably assume that as the general US economy moves forward, so will the real estate markets in the individual MSAs.
As far as the current cycle, we saw the bottom of the market in 2009, recovered all lost jobs by the first quarter 2014, and since then to now we have been in the growth phase. We continue to grow and add new jobs so we continue to be in the expansion phase of the cycle. Even if the growth rate slows down – not go negative, but decelerate – we could still be looking at expansion. We have seen slower economic recovery and growth in this cycle than we have in previous cycles, and consequently we are seeing a longer cycle than previous ones. Layer on to this the additional stimuli that this government is going to bring, then what normally would be a 10 year cycle, could end up being, as noted, a 14 or 15 year cycle this time around. This would keep the real estate cycle going in the same direction, unless we start to overbuild – which we have, in a minor way, been doing for apartment buildings.
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