Whatever else may be learned from today’s housing markets, this much is clear: Real estate and Wall Street are now inextricably intertwined in ways that weren’t so prevalent a decade or more ago. Real estate companies depend on Wall Street, broadly defined, to fund startups, raise capital, create liquidity and hedge risk just as Wall Street, again broadly defined, relies on real property as an opportunity to diversify investments and earn solid returns on capital.
Whatever else may be learned from today’s housing markets, this much is clear: Real estate and Wall Street are now inextricably intertwined in ways that weren’t so prevalent a decade or more ago. Real estate companies depend on Wall Street, broadly defined, to fund startups, raise capital, create liquidity and hedge risk just as Wall Street, again broadly defined, relies on real property as an opportunity to diversify investments and earn solid returns on capital. Moreover, these interdependences have important implications and lessons for the people whose livelihoods depend on these two sectors of the U.S. economy.
A few observations may clarify this argument:
Real estate depends on investment capital. Much has been said and written about the sudden disappearance of mortgage money this summer as Wall Street soured on securitized mortgages. This dynamic demonstrated the extent to which mortgage companies were dependent on the financial markets for funds. And it wasn’t only small no-name lenders that were forced to curtail their operations, layoff armies of workers or even close up shop altogether when the paradigm shifted. The big guys were impacted as well, and the finger-pointing and blame-gaming involved both sides of the problem.
Global issues can trigger local effects. While housing markets always have been and always will be local, financial markets have become highly globalized. This dynamic suggests that the more real estate becomes interdependent with financial markets, the more local housing markets could be affected by global issues. Individual markets may be affected in unique ways, and the national market may also see new trends develop as a result of these influences. One example has been the rising prices of certain building products as fast-developing global markets have experienced unprecedented demand and even shortages of materiel.
Capital markets can constrain growth. It’s no secret that Wall Street hammered the share prices of publicly traded mortgage companies, home builders, real estate brokerages and title insurers in the first nine months of this year. The result has been not only investment losses for shareholders, but also the prospect of fewer or more costly opportunities for those public companies to raise additional capital. The point may seem obvious, but without easy access to affordable capital, companies are less able to open new outposts, buy more equipment, acquire smaller competitors, create new jobs or finance other corporate needs. That’s not to say growth will be impossible, but rather that the cost of capital may be higher.
Venture capital may be harder to obtain. Zillow and Reply notwithstanding, Wall Street’s wrath may make venture capitalists more reluctant to finance real estate startups, especially since quick and profitable exits through initial public offerings or acquisitions by larger companies may be more difficult to achieve as investment capital is constrained. Venture capital that favors real estate may be more expensive for entrepreneurs as investors demand more control and more value for smaller investments. These trends could hinder innovation in real estate or make innovation slower or more costly. On the plus side, this constraint may prevent some pointless or unworkable ideas from making their way into the marketplace.
Investment capital may revert to stocks. Investors, be they institutions or individuals, who bought real estate as a hedge against the risks of the stock market may rethink the wisdom of that strategy as the valuation of some properties declines. Those who can hang on to properties in good markets for the long term may be satisfied with the return on their investments. But speculators and flippers who were caught with too much inventory may be eager to move whatever money they’re able to extract out of real estate back into equities. On the flip side, some housing markets may present good buying opportunities for investors today.
Short-term thinking may prevail. Wall Street has long been known as a bastion of short-term goals and brutally quick punishments for companies that fail to meet analysts’ expectations. Intellectually and psychologically, homeowners and real estate practitioners adopted this type of thinking in recent years. Those who expected a quick return on real estate either as homeowners or salespeople have now discovered again that property is an illiquid asset and that real estate is cyclical. These new attitudes and habits of short-term thinking may be difficult, if not impossible, to reverse and may make real estate’s cycles even more volatile.
One implication of these interdependences is that Wall Street and real estate need to be more aware of and better educated about the differences and similarities between the two industries. It’s an all-too-common fallacious assumption that real estate markets work the same way that financial markets do–and vice versa.
While both Wall Street and real estate benefit from the involvement of many talented and smart people, more of an effort could still be made on both sides to learn and understand more about the dynamics, practices and trends in each others’ markets. The more these two interdependent worlds can come together, and the better they can understand each other, the better the outlook for homeowners, practitioners and investors will be.
Marcie Geffner is a real estate reporter in Los Angeles.
Copyright 2007 Marcie Geffner. All rights reserved. No part of this article may be used or reproduced in any manner whatsoever without written permission of the author.