A Free Investment Tip For My Loyal Readers
I have no money to speak of, so for those of you who do, I offer this bit of advice, free and clear – short real estate. Seriously.
A group of MIT economists has determined that the return on commercial real estate transactions last year was a whopping 34%. We all know that housing is in a big-time bubble. Now, I know a lot of these transactions are private, so you can’t really short them – but you can short REITs, and they returned 12.2 percent themselves. The MIT economists also reported that the return on the “four major commercial property types — office, retail, apartment and industrial — were all high, ranging from 29 percent to 40 percent.”
So seriously – do yourself a favor – believe me, if I had the money, I would. Short real estate. You won’t regret it…(Kos and Atrios would never do you a solid like this, trust me)…
Real estate may be overvalued, but shorting is only a good strategy if you’re reasonably certain the values are going down in the near term.
Consider: When the NASDAQ hit 3,000 in 1999 many people thought the stock market was completely overvalued. And they were right. But in the short term, the NASDAQ went up another 60 percent before plummeting. Anyone who placed a $10,000 short on tech stocks in 1999 would have made a $5,000 profit, but only if they first came up with $6,000 to cover the short term increase and, if they didn’t have that kind of money, would have lost their entire investment.
Peter Lynch (disciple of Warren Buffet) once advised people to never short stocks and, if you do, short stocks that have already plunged precipitously, not stocks that continue to dangle off the precipice, Wiley Coyote-like, apparently oblivious to the laws of gravity.
Funny you should mention that, as for the past month or two I have been thinking of shorting the REIT ishare (ticker IYR) since it was 65 — it’s now 72 — but I’ve held off because a) I don’t want to pay the dividend in addition to the short interest and b) I’ve learned never to short on valuation alone, because there will always be someone willing to pay a higher valuation. The time to short is before a precipitating event — the burst of the real estate bubble is the longest-predicted event since the guy who sold Babe Ruth to the Yankees predicted a Red Sox World Series win, but it’s gonna happen…
If anybody cares (a big assumption here) the other short I’m thinking of is India Fund (ticker IFN) — it trades at a huge premium to NAV and has doubled in the past year — I think there’s a lot of air under that stock –
My guess is that the market will have a nice run for a month or two, and then all the money will be made on the short side — but if I were smarter, I would be richer –
You don’t need money to short. You are borrowing the stock from your broker and then selling it to the highest bidder. The real problem comes if the stock has gone up in price and you have to buy it back at more than you sold it and then give it back to your broker.
If shorting real estate is such a “sure thing” then you have nothing to worry about.
Good point, Muffin, and Sean P…and peter, if I were smarter, I’d have enough money to quit my day job and blog (and other writing) full time…
But you have that degree in Economics from Texas Tech. Didn’t they lure you to that school with fantastic stories about making 6 figures a year, being a multi-millionaire, and retiring at 35?
Seriously, there is a nasty downside to shorting stocks. Your potential to make money is limited to the amount you sold it for since the stock can only decline to zero. The real nasty problem is when the stock price shoots out of sight to the upside and your potential to lose money is unlimited. Selling it at $10 a share and watching it go to $500 creates some serious money problems.
With an exception, such as shorting GM, I limit my shorting to the ETF’s (DIA, QQQ, SPY) where the volatility is limited both to the upside and downside. I short very rarely. The negatives just outweigh the positives.
Remember, no guts, no glory.
Yeah, but when you make money on capital which you borrowed, it’s so cool…
I’ve had wins and losses shorting stocks, mostly in the Internet industry. The hardest part is holding on to a losing position becase, as you note, there is infinite exposure (or, more precisely, your exposure is whatever you have in the brokerage account where you have the short). Your mind plays games and you lose your nerve.
I thought of shorting Google recently, but lost my nerve because I don’t think it is wise to bet against any company that is also a verb (although you probably could have done pretty well shorting Xerox).
It is always a good thing to remember what Keynes said: the market can remain irrational longer than you can remain solvent.
Guys,
You cannot short REITs unless you are willing to cover the dividend on the securities you have borrowed. Since most REITs are returning yields in the 4-8% range, it takes an institutional invstor with a strong swap trading desk to pursure this strategy. A prominent economist who must remain namless has been running a hedge fund doing just this for the past 3 years. You may be able to buy put options to avoid the dividend problem, but you are still putting out cash every 6 months waiting for the plunge. However…
Reality check 1: During the past 100 years, no decline in US commercial real estate was over 20%. Even in Japan’sdarkest days the decline was under 35%. This is not a return on shorting that justifies the unlimited downside risk.
Reality check 2: Office space is increasing in occupancy even as leasing rates are rising. Retail space returns have been flat but remarkably steady, and there are no indications of a decline. Multifamily returns are actually improving as people are being priced out of new homeownership by rising interest rates. Even hospitality is improving. There may be sectors that are shrinking, such as the overbuilt self-storage market and possilby gas stations, but overall the market fundamentals are still strong.
The reason for the recent outsized returns is that the capitalization rates (ratios of income to price) have compressed due to the influx of capital and low interest rates. In fact, cap rates are tied to interest very closely. As they fall prices rise and so do returns. This is Real Estate Econ 101. We will not see 20%+ returns in the US for some time again, but I expect that we will see the more normal 12-15% for at least 5 years more, barring economic shocks.
If you are hankering to short something, short the homebuilders. The condo glut is here and they are still building. Or, if you are really confident, then short the lenders. In Japan, (and in the US during the S&L fiasco) it was them who took the biggest fall.
djg, very interesting…thanks for the informative comments.
After considering your points, I like the shorting the homebuilders strategy better…
As noted in the second post, short interest is the downside of shorting REIT stocks — but if you were smart enough to short the sector in the late nineties, you would have had enough profits from a multi-year decline to pay for all of the Rolaids you would have consumed holding a short position.
As for the homebuilders: the time to short them was a few months ago when they were a lot higher — I think all of the potential bad news is priced into the stocks, and they trade for six or seven times trailing earnings. The good ones also have strong balance sheets and they own a lot of land.
But that’s what makes for a market…
sorry, meant to say paying the dividend is the downside — you have to pay short interest on any stock you borrow –
Hi Mark,
You have some very smart contributors in the comments to your site. Perhaps John McCain does have a chance to be nominated and elected. Then again, smart voters don’t really decide elections.
Have you ever considered becoming an integrator? Sean P., peter, Muffin the Cat, and djg, are all very good thinkers and writers. All of them would add intelligent diversity to your site.
I think Peter would agree that in any scenario regarding real estate, you wouldn’t want to bet that home prices in the Bay area will be decreasing anytime soon. Too many stock options are being vested and cashed out now – a former colleague who went into the home rehab business a few years ago (he’s in Palo Alto) is booked solid for the next two years.
I can see why you don’t have any money.
Well, that’s just plain mean…
David, I’ve considered opening the blog to contributors, but I haven’t made any decisions yet…
I read about a hedge fund manager known for his prescience who sold his condo in San Francisco and rented instead. If I were smarter, I would probably do the same. However, I really like my house, it has some great trees, and it’s across the street from where my kid will go to middle school. However, if I were moving here for the first time, I would rent without a doubt.
The Bay Area is unusual in that there is virtually no land to build on – I live on a peninsula surrounded by water, in San Mateo county where about half of the land is owned by the state or the government and hence undeveloped. So my guess is that even if the demand decreases, housing prices won’t collapse, they will just be flat to slightly down. Right now, buyers and sellers are playing chicken: housing prices are flat, but the amount of time a house is on the market is on the increase. Early warning sign of a bust? We’ll see…
Perhaps we’ll see a continuation of the micro – markets there, Peter. My friend works mostly in Palo Alto, Los Gatos and Mountain View, where most of the tech stock option holders want to live. Many of his recent clients bought their homes in advance of the first Google options becoming vested, since they knew that those folks would be bidding up the prices there exponentially.
I almost moved there ten years ago, and was stunned at the prices at the time. Can’t imagine what it would be like at the present – and you’re quite right, there’s no available land to build on anymore.
Palo Alto is outrageously expensive (even by California standards) because it has a terrific school system, as Steve Jobs and other residents made a substantial donation to fund the schools. Mountain View and Los Gatos are also expensive (e.g., three bedroom homes start at one million or so) but not as bad. The only bargains (using the term relatively) are on the coast, as a lot of people want to avoid the fog. When I moved here from New York, I was able to rent a four bedroom house on the beach for less than I was paying for a two bedroom apartment in Manhattan. My wife got tired of the fog, so we bought a house in San Mateo in 1998, when things were expensive but not ridiculously so. I liked living at the beach better – nothing beats listening to the waves as you go to sleep –
I used to make the drive to Half Moon Bay when I worked out of my start – up’s offices in Redwood City, and had a few hours to spare.
Half Moon Bay is the town I lived in — and I could hit a golf ball from my back lawn to the water — sigh –
Peter,
You live in Half Moon Bay. How close are you to that Taco Bell by the ocean? I’ll be out there in June.
The Taco Bell is up in Pacifica, about ten miles North of Half Moon Bay — we now live in Belmont, which is about ten miles due East of HMB (I’m about a mile from the intersection of routes 92 and 280) — let me know when you are in town, you can meet our two cats –
You’re right. For whatever reason, Half Moon Bay stuck in my mind. Getting old I guess. It’s been about two years since I have visited. It is a cool Taco Bell to go to just off the ocean.
[...] to being wrong in many of my prognostications, but this one, I saw coming. On March 14, 2006, I had this to say: I have no money to speak of, so for those of you who do, I offer this bit of advice, free and [...]