Sunday, May 17, 2009

Supply and Demand for Homes
is Different from Securities

There is a new crop on the lawns at this time of year. This is the crop of homes for sale, homes for rent and the Open House signs of various real estate brokers. Due to the desirability of getting children registered into the preferred schools, the spring is when a lot of homes come on the market in suburbia and elsewhere. In 2009 there appears to be a bumper crop of these signs. The pricing for both the buyers and renters are heavily influenced by the “comparables.” In order not to lose the sale to a competing offer, the comparables list “recent” sales of similar properties within the agents’ target area. Those real estate agents that have access may display other properties that are listed in the local multiple listings, but caution that the prices shown are treated with some suspicion as they are the “offer” price, not the price on the close. Rarely are current prices discussed in terms of the cost to recreate the same property from scratch. Almost never is there any detailed discussion as to future value, other than some generalized view of the rate of price increase in the region. (Never price decline.) What seems to be the price decision is based largely on past, or to some degree current prices, but not future prices.

In the world of stocks and bonds, pricing considerations are quite different. The nearest stock investor approach to the residential real estate buyer is the statistically-oriented “value” investor. This kind of buyer looks at historic book value, perhaps adjusted for accounting and valuation factors. Often the value buyer knows the history of a security’s price/book value. When current price-to-book value levels are near their bottoms, the security is attractive for purchase. There is a special class of value buyer of securities similar to the residential property buyer who is a specialist in tearing down a home and rebuilding on the same space a larger, more expensive property. In the securities’ world these are the so called “net-net” buyers who look to dispose of all elements of the security issuer that has not been turned into cash. (Notice, that I said security, not stock, because distressed fixed income buyers often play a similar role.) Like the “tear down and rebuilder” home buyer, a net-net buyer may perceive that the assets behind a security could be more profitably used by others if the property was no longer being used in its present activity. Many so called “value” buyers are largely looking backwards for their purchase guidance, believing that the current prices represent an arbitrage opportunity versus the historic prices, while the real estate redeveloper and the net-net buyers have a very specific future orientation.

There is another larger, and often much larger, group of stock buyers. These are the “growth” stock buyers. Originally as practiced by Mr. T. Rowe Price and a few others, this meant investing in stocks of companies that had earnings per share that were growing faster than the growth of earnings in the market in general. This definition of “growth” has been diluted over the years to mean growth of capital. While I disapprove of this dilution, I can understand it. As the number of growth stock investors grew exponentially and the economy began to grow more slowly, the number of true, continuous growth stocks on a secular basis shrank just as the competition for them increased; therefore assembling a true growth stock became very difficult. Interestingly, a past record of growth was not an absolute requirement, but a future of rising earnings was expected. Mr. Price, who I had the privilege of meeting, anticipated this problem by naming his growth fund the T. Rowe Price Growth Stock Outlook Fund. The term “outlook” itself shows a future orientation that most value investors and home buyers don’t have.

There is, however, a great similarity on the part of the sellers of both homes and securities. At the time of sale, particularly in the case of actual or pressing needs to sell, it is one’s neighbors and co-ventures in the stock that dictates the price for an impatient seller. Too often most institutional investors do not pay sufficient attention to the motivations of their current co-ventures in the stock, so they tend to move at the same time to their disadvantage. Thus the lesson for the seller of homes is to wait until the various real estate placards come down or lead the market down with a quick sale at a bargain price. For the securities investor, as Sir John Templeton, another old and valued client, would say, only sell when there is a better bargain available and try to avoid selling when others are selling.

Particularly at this time in our economy, I will be happier if I see fewer real estate signs.

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