Why Real Estate Advice Is Dangerous: Hyperlocality
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Everyone seems to have a gut reaction about real estate as an investment, and those opinions clash violently. I used to wonder about this – at family gatherings, my intelligent cousin would try and convince my equally intelligent uncle from across the country why real estate was an excellent bet, and my uncle would maintain that it was a risky money sink.
How can incredibly thoughtful, well educated people differ so strongly on what should be an arguably objective topic? It wasn’t like they were just arguing over their risk tolerance. They were arguing over the actual performance of the housing market! Isn’t there data to support one view over another?
There is, and it explains why this blowout occurs, with implications on who you should and should not take advice from.
Real estate is hyper local. And because we tend to absorb data about real estate through osmosis (driving around, hearing stories from our friends on how their home has sold, etc.), we are a reflection of the performance of the specific places we grew up in.
What’s more, real estate has gone through a tectonic shift in the last 10 years, specifically with the subprime crisis. That major exogenous force – and the ensuing gangbusters recovery in many areas of the country – are perhaps once-in-a-lifetime experiences, which create not just a difference between different geographies but between different generations. If you are under the age of 35, you have a very different subset of data you are drawing from compared to older generations.
Real Estate is Hyper Local
As it turns out, real estate performance is hyperlocal. Buying a share of Microsoft is buying a share of Microsoft. But buying a house yields hugely different performance depending on where in the country you live.
US Housing Price Appreciation – Last 10 Years (2005-2015)
Chart from Brian Larrabee
US Housing Price Appreciation – 5 Years (2010-2015)
Chart from Brian Larrabee
It makes total sense that sitting in California the last few years, you are desperate to get in on the gold rush, with your broker warning you to “get in before you are priced out!” And it makes total sense that your Aunt and Uncle in Connecticut or Arkansas give a giant yawn when you talk about it. Why is their nephew so crazy about houses? The stock market has done way better for them!
The hyper local focus goes even deeper. Check out this chart of North Texas 2015 Appreciation, spanning from Denton County to Ellis County, the area which surrounds the Dallas-Ft Worth Metro. Oak Lawn residents (red – zone 17) aren’t going to have the same opinions as their neighbors in Oak Cliff (green – zone 14).
Graphic from Dallas Morning News
Even Strategy Is Hyperlocal
Two areas can both have shown strong performance for real estate investments, but the approach that worked may be different. In the bay area, it is common to bank on appreciation to make you money, and that means that the carrying costs of the house (property taxes, maintenance, etc.) often exceed how much you can generate in rent. However, in other areas of the country, appreciation is much lower so investments only make sense when there are high rent to property value ratios. This is why your Aunt might think you are foolish to be investing in a San Francisco property that is negative cash flow.
Charts from Bigger Pockets’ 2015 Real Estate Market Index.
Approach the advice of folks who live in a different geography with caution.
Take care to view your appreciation estimates in light of the incredibly unique events of the past decade (the subprime crisis and subsequent recovery). Realize that folks from different generations have different subsets of data to work with and that the run-up in real estate on the coasts in the last 5-10 years is partly driven by a once-in-a-lifetime subprime crisis event.
Go extremely local in your research and focus on the drivers for growth in your chosen neighborhood, district, and state.
Real estate can be an extremely lucrative investment, but its performance is highly tied to hyperlocal conditions.