The Quants Come to Real Estate

Uh-oh. If you thought trying to outbid the cashed up looking guy with dark glasses on the phone at a Sydney auction was bad, spare a thought for the American homebuyer.

There are now hedge funds and institutional investors using algorithmic formulas to buy the best properties for sale all over the United States. Not only that, they’ll bid for it unseen if necessary.

As soon as a property is listed, the Quant analysis is already assessing and quantifying its attributes. The hedge funds are in a race to outbid and outsmart each other.

The Wall Street Journal reports that the statistical analysis the algorithms perform can ‘evaluate home values, proximity to schools and crime rates to outrace rivals for any remaining bargains offered by real-estate agents’.

Not only that but:

Math-driven models powered by historical patterns can size up homes sight unseen and calculate future income in minutes, allowing private-equity giant Blackstone Group LP, the Alaska Permanent Fund Corp. and other bulk purchasers to skirt neighborhoods with softer rental demand or properties that need costly repairs.’

I can’t see the average family having much chance against this by trawling through the US equivalent of Can you?

Institutional funds like these are now dubbed ‘bulk’ buyers because they are building rental portfolios to satisfy investor demand for Australian real estate. How long before this shows up in Australia?

It’s certainly been profitable for giant investment firm Blackstone Group [NYSE:BX], mentioned above. This week the company hit another all-time high. It’s up 200% over the last couple of years.

Blackstone is now the largest private landlord in the US, according to the New York Times. That includes 50,000 rental homes, alongside billions of dollars in other properties like skyscrapers and international assets. It just bought US$14 billion of real estate from General Electric’s portfolio.

According to my colleagues at the Stansberry Digest, Blackstone is still reasonably priced. It trades at a forward price-to-earnings ratio of 11 and yields 5%, based on trailing dividends.

Of course, if you understand the real estate cycle, you’ll know the very thing making Blackstone investors rich will bite back one day. I suspect it will make a great short sale at some point. But that’s a long way off yet. For now, it looks to be onward and upward!

There’s a terrible historical irony to all this. America was once a country that had a natural frontier so vast early settlers thought it would take hundreds of years to settle.

There was so much land they gave it away (especially if you had the right connections to the government) or sold if off real cheap.

US Founding Father Ben Franklin said in 1754, ‘So vast is the territory of North America that it will require many ages to settle it fully; and till it’s settled, labor will never be cheap here, where no man continues long a laborer for others, but gets a plantation of his own.’

In 1837 women workers in Massachusetts shops received wages as high as $5 or $6 a week while the equivalent ladies in Europe could barely earn more than 20 cents a day.

But the frontier closed in the end, and is now securitised and, increasingly, corporatized. The long term slide of American wages began — and was inevitable — when the last of the open territories was gone. Few economists appreciate the historical significance of this. That’s one reason why listening to their advice is financial suicide.

But the rise of the corporate landlord is a telling example of why real estate can continue to push higher. One of the objections we get over at Cycles, Trends and Forecasts is that wages can’t pay the asking price of property. I’m afraid the economics behind property values isn’t as simple as that. You have to consider more factors than the ratio of wages to house prices. See why here.

We can already see trends forming to deal with the problem. The Australian Financial Review reported last week that, ‘National Australia Bank says the proportion of first home buyers signing up for loans with the bank who have the backing of a family member has lifted to 6.7 per cent from 4.8 per cent in 2010.’

Small figures for now, granted. But I’d expect that to keep running. The loans the first homebuyers are taking out are being secured against the assets of someone else in the family, usually the parents. That can get them on the fabled ‘property ladder’ with a small deposits and avoid mortgage lenders insurance.

Already you can see the chain linking the housing market to the wider economy growing ever stronger. When the downturn in the real estate market does come it will ricochet throughout the country like a bullet.

The property ladder takes us to giddy heights, but at the end is a scaffold. The only question is the timing. And you can see the timing right here.


Callum Newman+,
for Markets and Money

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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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