Alternative investments: an edge...or a cliff?
iBuying, NFTs and more
As people seek alpha—an edge that will land their investments ahead of benchmarks—“alternative investments” are getting a lot of attention.
And, as I do every week, before committing my thoughts to a blog post I met with my team to discuss my ideas. But as we talked, I found that I was jumping from one “hot” investment vehicle to another without getting into a level of depth that I thought would be enlightening or even interesting to you, readers and friends.
And therein lies the problem: in my opinion, the markets are loaded with distraction. Everyone’s jumping around, looking for the next very big and very quick payoff. It’s difficult to go in depth about anything when we have our hands in everything.
To me, the investing environment today is a lot like trying to figure out if I’m better off buying all of my scratch-off lottery tickets at one outlet or if it’s better to run around town and buy a few here and a few there. At the end of the day, it’s still just the lottery—not a long-term wealth-creation strategy.
Nevertheless, as I shake my head over volatility, valuations, and nebulousness, rest assured that I’m also fascinated by it all, so here we go.
Overall investing environment: my view
With another $1.9 trillion pumping into our economy while Covid-19 vaccines roll out and cases go down, I believe we’re on the brink of tremendous economic growth.
I think we’ll see unprecedented GDP growth over the next several years and if we do it right and stick to humanistic principles, we can experience a time of greater income and wealth creation for more Americans than we’ve seen since the post WWII era.
None of this is said without clear-eyed awareness of the tremendous pain and loss and fear that got us here and nothing will make up for the challenges we faced over the last year. We can’t move forward without looking back and acknowledging this.
If there’s comfort, though, I find it in the innovation, progress, courage and creativity that millions of people around the world demonstrated during the pandemic. If we combine that with compassion and an acknowledgement that there is plenty in this world for all, then we just may make some real progress socially as well as economically.
Seeking alpha in residential real estate
Investors of all stripes are searching for alpha—an edge over benchmarks—in just about every stone that can be overturned.
SOURCE: Zillow
First, there’s the emerging field of “ibuying” which, in this case, refers to “instant buyers,” aka companies like Zillow Offers, RedfinNow and Opendoor. They’re tech-driven brokerages that make cash offers on as-is homes, potentially renovate them and put them back on the market. Several of these companies are already publicly traded, with more likely to emerge in the next handful of years.
While technology is behind both operations and offers—Zillow Offers, for example, uses its “Zestimates” as the basis for its cash offers—the information used is still latent, as we discussed in many other blog posts.
On the upside, ibuying saves sellers from real or perceived work and expense related to listing, since no sprucing is needed. If a seller feels “iselling” is easier and isn’t unhappy with the offer, then it could be a win-win. And new approaches and technologies take time to be adopted and optimized and now that we’ve been introduced to it, I think there will always be a market for ibuying and it will likely take on more market share.
On the downside, housing is dynamic and values are dynamic and existing algorithms and data models can’t take that into account. This means that if a Zestimate is based on lagging information, then a Zillow Offers offer may be below the most current market valuation. (Conversely, if and when the residential real estate market cools, Zestimates could potentially reflect overvaluations.)
The best info available still comes from comparables, aka “comps,” or homes of similar size, amenities and siting. (On a related note, Plunk, the tech company that I’m part of and that I’ve also mentioned in past posts, aims to close the gap in property-information latency. It will be a game-changer when it comes to fruition.)
Additionally, it’s hard to say if ibuying companies are overpaying at the outset as a result of the market frenzy and whether that’s part of the reason why even in a smoking-hot real estate market, these companies (or divisions) haven’t yet been profitable.
Having owned a brokerage, I also think there will always be a demand for traditional “show and sell” agent/buyer/seller relationships, too. There will always be buyers who demand high levels of service which, of course, means human interaction.
I’ve often written about how stories and emotions are very much a part of the residential real estate dynamic and AI at this moment in time can’t yet totally replace a trusted agent. I think that people in most markets still believe that agents in their neighborhoods will have a better sense of home and community value in ways that AI can’t replicate yet and, thus, there’s a belief among sellers that with an agent, they won’t be leaving money on the table. Time will tell.
Property technology, aka “proptech”
Related to ibuying but also broader are property technology, or proptech, companies, many of which are publicly traded. As defined by Motley Fool’s Millionacres team:
“Put simply, proptech is the use of technology to drive efficiencies in real estate, ultimately leading to improved asset returns, reduced friction, and greater transparency. Household names in the proptech industry include Zillow (NASDAQ: Z) (NASDAQ: ZG), a home sale listing site; Airbnb, a vacation rental listing site; and Opendoor, an iBuying platform.”
While they’re not always directly in the business as brokerages, they often create software and systems that support this massive industry. When I started this blog nearly a year ago, residential real estate in the U.S. had a valuation of around $33.6 trillion and according to a recent Zillow analysis, it increased by another $2.5 trillion in 2020. In my personal analysis, we’re most likely closing in on $40 trillion now.
A flag in the industry?
I don’t want to be an alarmist and call it a “red flag,” but I think we should take note of trends and a recent change by Fannie Mae. Calculated Risk highlighted a Mortgage Bankers’ Association (MBA) report saying that in February 2021, 10.5% of mortgage applications were for non-primary residences (along with this chart showing the steep increases in purchases of second homes and investment properties):
Then, in mid-March, Mortgage News Daily reported that Fannie Mae.
“...has sent lenders an advanced notice that additional risk criteria is coming for loans it acquires from lenders. Lender Letter 2021-08 lays out changes mandated by amendments to the Senior Preferred Stock Purchase Agreement (PSPA) between the Federal Housing Finance Agency (FHFA) and the Department of the Treasury in mid-January. The letter focuses on the new 7 percent limitation on acquisitions of loans secured by second homes or investment properties. All limits are measured as 52-week moving averages. As the investor and second home share of acquisitions is already above 7 percent and has been since 2013, this new rule will certainly have an impact.”
What exactly that means for home sales, valuations and inventory is yet to be seen, but I think it’s predictive of a probable sense that valuations are too high, once again pointing to moving averages, as I’ve discussed in previous blogs.
Purchasing property-tax liens
Another alternative way to invest in residential real estate that’s getting increased attention is by purchasing certificates for property-tax liens. As explained by Investopedia:
“Investors who purchase property tax liens are typically required to immediately pay back the full amount of the lien to the issuing municipality. In all but two states, the tax lien issuer collects the principal, interest, and any penalties; pays the lien certificate holder, and then collects the lien certificate if it’s not on file. The property owner must repay the investor the entire amount of the lien plus interest, which varies from one state to another—but is typically between 10% and 12%. If the investor paid a premium for the lien, this may be added to the amount that is repaid in some instances.”
While this avenue can potentially make investors money, it certainly carries its own set of risks and, in my opinion, feels predatory in nature, which means I’ll never be a fan of this method and, thus, won’t go into it in depth here.
NFTs: Non-fungible tokens
Unless you were hiding under a rock these last couple of weeks, you’ve heard about Beeple’s $69 million NFT. You’ve heard about a digital design collective, Hashmasks, that had a few dozen Twitter followers one day and barely a blink later, sold a bunch of digital images for $16 million in Ethereum cryptocurrency.
And now you’re busy scouring the internet for the next big NFT opportunity or spending too much time and energy worrying that you’ll miss it again.
I’m not risk averse, I’m not change averse and I love innovation. But decades of investing has taught me that the markets that are the most resilient and adaptive win, versus those that are rich in concept but lacking in backing. So I generally view the NFT frenzy along the lines of cryptocurrency frenzy—it’s a lot of money for...what?
I believe that data has value and those who amalgamate and use it well can create value from it. I believe that blockchain has value. But is spending millions on a digital address—often, as with art, one that you may not even own the copyright to—more valuable than a tangible object? I think that NFTs and crypto are particularly risky because there’s no tangible underpinning and they’re significantly intertwined. If and when one drops, do others go down with it?
As always, I’m not here to give investment advice, I just give my opinions on the things that are swirling around us and clearly, there are a lot of people who disagree with me. But I simply don’t see it. I don’t see the better mousetrap, so if you want me to pay millions, please give me a painting to hang on my wall.
In a nutshell
I think that high-risk opportunities like NFTs and cryptocurrency come to the forefront when investors assume that the markets will always go up. As history has shown, though, that’s not the case.
And it’s true that everything has sped up, including expectations of returns: today’s time frame is so compressed that a method used by Warren Buffett to create billions in wealth for himself and others now seems stodgy to many investors.
“More and now” seems to be the mantra. I say, beware of irrational exuberance and alternate alpha returns during extreme times.
In my opinion, investing in tangible assets, including housing, is still the smartest way to go. Even with ibuying, at the end of the day companies like Zillow and Opendoor still have tangible assets on hand. If the market drops for a while, they have something to hold onto, improve and sell when things turn around.
Overvaluation is found in just about every investable area and people are dropping money in things that don’t make sense. Many of the people who are making these huge investments also have huge amounts of money to play with and potentially lose. Most investors don’t fall into that category.
Suggested reading: Working Backwards
Working Backwards: Insights, Stories, and Secrets from Inside Amazon by Colin Bryar and Bill Carr is this week’s book. Whether you love or hate Amazon and its founder, Jeff Bezos, there’s no getting around the impact that both have had on just about every aspect of life in America and beyond.
Bezos had vision and forethought and experimented with a myriad of concepts to build efficiencies—and throughout, he knew that the customer was the most important aspect of the business. There are great lessons about success and challenges here.
Although I don’t put myself on the same block as Bezos, with my real estate brokerage I worked hard to create a culture and team that understood that our best success would come when we put the clients first. It took a while to get buy-in but once we did, the agents who took our vision to heart did well and revenues soared. It felt pretty magical for many years and in this book, I loved learning about that experience through the perspective of Amazon. I hope you enjoy it, too.
