Is Private Equity ruining Real Estate?

As always, it's been an incredible honor and privilege to contribute to the San Francisco Chronicle, a paper that we've been readers of since I was a student and my parents thought the newspaper would be an excellent way of teaching me about the world. I've been grateful to the San Francisco Chronicle for always publishing my unfiltered, unbiased, and unmodified opinions, but we are limited to +/- 200 words in these columns and many want deeper explanations. Well, here we go.

Q. Private equity firms are buying homes and keeping them vacant. How is this affecting the market?

A. I love this question as it seems so simple, but is a question that has taken decades in the making. For such a simple question, the answer is often very complex. There are so many layers to this that make this a fantastic question. First and foremost, we belong to a country and society which are strong proponents of having a free market, a land of vast opportunity, and where a nobody can become a somebody. We send off our children to the best schools for them to learn how to make a living, to create products within a system to provide for themselves, their family and their communities. Some of these children learn to work with market incentives, to build for demand and to build where they can turn a profit. Other children learn how to capitalize on markets, often with concepts such as arbitrage or market manipulation. 

Now we take a snapshot of the housing market since from the 60's to today. The first two decades are often referred to as the "Golden Age of Capitalism" due to the post-war economic boom. A rapidly expanding middle class, and in retrospect the end to incentives for affordable housing. Developers have been incentivized to build toward the American appetite, thus is to say - bigger is better. As we transitioned into the 80's we were in full swing. Robin Leach with his "Lifestyles of the Rich and Famous", into the 90s with MTV Cribs, as the years progressed we, as a nation, were obsessed with luxury goods. Once confined within gated country clubs, we now had a thirst for stately homes, and luxury apartment complexes, something that absolutely did not exist in the 60's. Thus, developers were incentivized to build luxury properties and as a result, America as a whole has been in a severe shortage of affordable housing for over 60 years today. 

The other concept at play here is supply and demand. The more of something the less it costs, the less of something, the more. Being that we are at an all-time low for affordable housing, that means the cost of all housing has risen. Now, bring in Private Equity. If they are able to come into a neighborhood, community, town, or city, and acquire a controlling share of properties. Pair that with an external driver to the area, such as schools or jobs, then Private Equity is able to almost dictate the price of these homes as they have created artificial scarcity. 

Now, is that what these companies are doing? The answer again is, it's not that simple. There are various reasons a Private Equity company could be scooping up properties and it is not often as nefarious as the press would want us to think. Some have cash on their books and simply wish to stash it in something other than bonds or equity investments. Property for the most part is safe, stable, and fairly liquid. They may simply be holding these for a short time and then re-selling. 

But I digress, to bring things back to the question - Both Developers and Private Equity are doing exactly as they have been taught and trained. Developers build products where they are able to sell and make a good profit on. For decades they have been rewarded with building and selling luxury products. Private Equity is also doing exactly what they were built for, to leverage movements in the market to create the best financial result for their investors, this product just so happens to be American real estate. 

Now to the underlying tone of the question - where's the problem and how do we solve it? I will be the first to tell you that this is not happening in the Bay Area, our prices are much too expensive and most Private Equity firms do not have the capital nor appetite risk to play in this market. They are typically looking in 2nd tier markets - Greater Sacramento, Inland Empire, Phoenix-Arizona, Denver-Colorado, Henderson/Las Vegas-Nevada, you get the idea. Just like you and I, they are able to secure homes for 20% down, meaning if they had a $10,000,000 fund they are able to purchase $50,000,000 in real estate. $50,000,000 in assets sure looks better than a(often risky) $10,000,000 investment into a business.

If we are to fix this, then we should address the root of this and this is to provide developers, and potentially Private Equity, an incentive to develop and build more affordable housing. We can redefine what the American Dream looks like. Pair that dream with a vision and a timeline, and build a plan that may solve affordability as we know it. Developers and Private Equity are merely symptoms of a deeper problem. One that I am hopeful we can solve for.