My Realty Gains
Stefan Tsvetkov is the Founder of RealtyQuant (www.realtyquant.com), a company that brings data-driven and quantitative techniques to the real estate industry. On a mission to add industry value through education, investment, technology, and analytics.Financial engineer turned multifamily investor, analytics speaker, and live webinar host. He holds a Master’s degree in Financial Engineering from Columbia University, and during his finance career managed ~$90 billion derivatives portfolio jointly with colleagues.Featured on multiple Podcast and Webinar events including Elevate, Best Ever Real Estate Show, Investing in the U.S. etc. Host of Finance Meets Real Estate webinar series.
What You’re Going to Learn:
Prashant Kumar, CCIM – You have a great background, data-driven background. And we would not go too much into the technical details because the purpose is to give value to a lot of high-tech minds who do not have time for themselves, who work for 12-15 hours a day at their job, and after that, they just want to go get back home and then invest passively, potentially, like in the stock market. The stock market is a Passive Investment, but there are Real Estate investments out there which are much more lucrative than the stock market. We want to get your perspective. What do you say to these people?
Stefan – Yeah, and I completely understand this perspective myself. I belong to a finance professional and I have invested possibly in various types of asset classes. I want to say one thing I’ve done, at least at my company, Realty Quantity is like some work on picking markets that is a very interesting question. What I want to say is at times people are having concerns about their session. So I want to give a positive perspective of being able, as possible investors and continue investing comfortably and it may be not overly worried and so forth. Some of the approaches to that revolve around downside risk.
The downside risk is the concept where there is Real Estate, it is a fundamental asset. Real Estate is something comparative to if you have in the stock market utility companies or things like that. It is sort of value stocks or companies that are relatively easy to understand their future earnings and relatively easy to understand their
pricing in comparison to something like Tesla, let’s say just for high tech people like Tesla is something very hard to value. Where should the Tesla stock price be? But if we have something like the stock market in San Francisco, in Atlanta, Georgia, or in different markets across the US. It is in my opinion that’s something I’ve been trying to influence others on. It’s easy to understand where it should be valued, based on fundamentals of income, population, and housing supply and so that then gives you, once you know this what I call market evaluation, that then gives you a perspective as a passive investor to pick markets where you know they’re not overvoted. If you’re not comfortable under any market cycle that is impending, then that is a change of market cycle that could be happening.
You would be comfortable that okay, your Real Estate is not going to lose value. Real Estate has different downside risk profit and stocks, we can get into that more, but it’s a different downside risk profile in the first place, such as it doesn’t stick here on the downside, so to say. Whenever you’re in not overvalued markets, even if you have triggers like some of the current triggers in terms of higher interest rates reduction in future home sales, and so forth, those triggers do not just in pricing so much in the event of like under to third party Real estate. And so this is like some of the perspectives. I can speak to some markets.
Prashant Kumar, CCIM – Yes, we would like to hear your perspective. Definitely. What you are trying to explain is that Real Estate is a fundamental market, right?
Everybody needs a place to live. It’s not like a volatile stock market. Location doesn’t matter in the stock market, but in Real Estate, location matters a lot and what I’m hearing from you is, that you are saying if you are in San Francisco or Atlanta, every market has its different characteristics and you have different data points. Some of the global data points like an increase in interest rate do not affect some markets, while it may affect other markets more depending on the strength of the individual market.
Stefan – I would say dependent on not so much the upside strength of that market as much as where is it currently standing in its profile, valuation profile.
For example, if we have a market that’s overvalued by 20%, obviously that has some downside risk in the event interest rates go up and in the event, home sales are reduced and so forth, on the contrary, you’re in a market like many markets in the Midwest and Northeast, and let’s say it’s a market that’s 5% undervalued, it’s very statistically unlikely and that’s going to be the case. Even if interest rates increase, it’s more like the price is yours, the price is going to stay the same. So that’s kind of the dynamic that I’ve been seeing based on looking at the data, looking at the history.
How does the strength of a market affect the pricing of Multifamily Apartments in Real Estate Investing?
Prashant Kumar, CCIM – It is a very important point that not all the markets can get the same variation in the home sale prices. It is all dependent on the strength of where the market is standing today. If the market is too high, then maybe there is a chance of a large delta. If the market is at a very strong base, then the chance of the delta is very low.
Stefan – That’s something that I do with my company is providing market data for that in the event, not like pitching anything here, but in the event, providing market data to sort of giving an intuition for different valuations in different markets and appreciation potential. Appreciation potential is another interesting thing. And that’s also applicable to a passive investor because if you think about how we pick markets right now, so we would look at population growth, drop growth, income growth, and all those different variables, fundamental variables, and we pick those variables and then we say Charlotte, North Carolina is a great market because it’s better in those variables than those other ones but in itself, it’s not a super data-driven approach like that’s because you’re kind of like taking those few data points and we don’t look at it across the US for every single market or county and compare that well.
The other thing is I did a study where I tried to forecast price appreciation based on first forecasting those fundamentals forecasting, population growth, income growth, housing supply growth, and then of that to forecast the prices. I found that I had like a 7% error that was like five times bigger than how they forecasted just prices themselves, passive investor because suppose that they’re picking like a syndicator to invest in. They can go to different markets, they’re working in different markets and they can go to a market that well.
They can simply look at the price history of those markets and chances are it kind of may sound strange, but chances are they’re going to do a better selection. Unless we are early in the market cycle, like 2011 or 2012, then they would need the fundamentals themselves. But if we’re deeper than the market cycle chancellor, they would have predicted pocket depreciation way better to perhaps five times better error rate.
If you do it technically by just pulling the prices, just like looking at how does that price perform? Well, if yes, then there’s pretty high momentum and just looking at the price charts basically, which is quite interesting, looking at the price charts themselves by doing a study like this gave like five times smaller error and then looking at the fundamentals and then predicting prices of that, that’s quite interesting. So that’s one thing that I feel is a very useful application and it depends on the market. Some markets have more momentum. Markets in Florida and Texas have very high, well I would say Florida, Massachusetts even by the way interestingly, they have very high momentum and momentum can be tested in different ways. Like auto, correlation is one like what’s the correlation this year versus last year’s prices. The autocorrelation there in Portland matrix cost to nearing 80%, which is very high. In markets like that, simply pulling picking like whichever cities have performed very well and looking at historical prices, even though its historical prices are not predictors of the future but if you have autocorrelation they are. And so that’s kind of like the more accurate approach. I was able to forecast 2018 and 2019 price appreciation by state, let’s say just as an example, within a 1.4% error based on 45-year old history. It’s very accurate. But when I went to the route of population and income and housing supply, I had a 7%, which is big. I mean 7% is big.
It’s a very interesting perspective. So if they want to pick like the best-appreciating best-appreciating markets, if they went let’s say in Phoenix, Arizona or those like very booming like western mark like Phoenix and Austin and so forth to be the case that they appreciated, chances are that the past couple of years, chances are that trend is going to continue.
Now of course that’s dependent on like let’s say if we where to have a perhaps a recession or other kind of triggers or change in the market cycle and then that could reverse but under the same market cycle with pretty strong momentum and very much picking appreciation on that by the host even for over evolved markets. So even if they’re over evolved, the same appreciation predictors are the strongest ones. It’s very interesting, it’s just simultaneously those markets then carry downside risk whenever the market cycle ends at some point.
Prashant Kumar, CCIM – Very nice, very nice expansion.
Prashant Kumar, CCIM – Then look for the operators who are doing some business in those markets and potentially invest with them. But the purpose of today’s webinar is to discuss the benefits of passive investing. We were talking earlier and you had some good points regarding depreciation and stuff like that. Do you want to elaborate on some of them?
Stefan – Real Estate Investing Superior is extremely tax efficient. If you have a cash flow in terms of the cap rate, and interest rate spread then you have a given cash flow of the property and you’re able to generally erase a lot of them, let’s say the tax that you would have on that cash flow with the depreciation that’s a significant benefit, but then from there, it comes to those various more advanced techniques like cost aggregation and so forth. Now, Passive Investors need to work for sponsors who are perhaps doing cost segregation studies on their projects.
I’m doing a cost aggregation study on a joint venture project. We just went on and we are doing a cost aggregation study just to essentially have a significant deduction on our taxes like the same year that applies an even bigger impact on Real Estate, professional status, and so forth. But overall I would say it’s essential to speak to your CPA and to more advanced tax professionals like Brett Wards and people like that who do like even deferred sales trust because it is a great benefit for Passive Investors. Real Estate applies to stocks and applies to cryptocurrencies. In the event, you have a big enough position that you want to sell. That’s something I recommended to a friend of mine who works at Google where one can do a DST even on a stock sale that is, let’s say of a significant value. So those are like very big tech plans.
Now, from there I would say those are some that apply to the more positive side. I wanted to briefly mention what I think which markets maybe people should invest in when they pick sponsors for it.
So it’s very interesting right now because people are concerned about their sessions. The one interesting thing is if you take the big picture across countries, there is the thing that is called the scans economies. The scans economies are the small open economies that are commodity exporters that have independent central banks where the central banks cut interest rates during the 2014-2016 commodity cranch. Those are in Sweden, Canada, Australia, Norway, and New Zealand. Those countries, they’re like in very different geographies, but they share those same components and they happen to have very overvalued Real Estate and some of you may have heard those countries, they do share this trait of having very overwhelmingly compared to their fundamentals, it’s a functional central bank policy of cutting rates very well. They’re like very much, I would say comparatively at risk in the event of other macroeconomic drivers changing right now, such as the yield curb inversion that happened and consumer sentiment dropping. This kind of recession triggers.
Now, recession doesn’t always pair with Real Estate drop by the way. People stay calm and most of the time it’s not like more often there’s no Real Estate job during a recession but it’s still an interesting consideration. The scans economies are one thing to watch. So Canada and Australia and so forth.
Now in the US. Which are like some of the markets that are more at risk. So the first one to watch, and I’ve spoken on this before, is Idaho. So Idaho is well in multiple sources between 40 and Atlantic University. The mood is an analytic study, my study that I have a derivative one and perhaps the fourth one, I’m not remembering the name. The most overvalued in the US. This market cycle is Boise in Idaho and that’s like based on fundamentals
of income. Idaho is the one market to be a little bit cautious about, I would say and then some western markets, well some states like Nevada and Arizona and Utah a little bit have moved also higher and there’s like some increased valuations with inflation in Portland and taxes, not to super concerning levels, but relatively speaking, but then investing in the Midwest, midwest broadly is very fairly valuable to states like Indiana and Ohio and Kentucky are still fairly valid. Then the Northeast where it’s not so desirable, it’s various policies for the different sponsors of Real Estate.
But the Northeast is generally undervalued right now in terms of very low downside risk. That’s an interesting perspective. So more cautious in terms of recession in places like Boise, Austin, and Phoenix, some of the very booming markets, they will continue booming a lot perhaps while we’re in the same market cycle due to momentum, as I mentioned earlier, but more cautious on the downside risk and then much less in places like Seville, Kentucky, and Indianapolis and I guess even like Pittsburgh and markets like that in the Midwest and Northeast, I would not be too concerned there. I had a meeting with this private equity fund and they adjusted their strategy to invest ahead of the prospect of the procession to invest in only secondary and tertiary Midwest markets.
I thought it was very interesting because it’s okay, the midwest is fairly working and that’s quite safe. If you’re even in secondary and territory in Midwest, you’re going to be fine this month.
Yeah, with passive investors that’s kind of my advice to depend on your Restore account. You can still invest in Phoenix. It’s appreciating. Like projects have made a fortune in Phoenix right now. It’s appreciated a lot. But just to be aware of like the same as downside risk you have there. So just kind of based on your risk to us now, You need to have the exact database and as I said, Reality quantum.com is one place for that. You can look up like others you can look up some more general studies with Bloomberg Economics, Moody Analytics, and other bigger companies. Just being aware of market valuation and being aware of downsizing risk in some of those Western and a little bit southern markets So that’s the current situation.
For example – If you’re in California and you want to invest in California, or buy a house in California, or invest in indication California, well, it’s fair now if you’re investing in San Francisco, it’s undervalued now that’s due to its weak fundamentals as well, right. Because there’s like all the issues with coveting and it went deeper undervalued with Covet but in a way assuming unless it drops on the fundamentals themselves, which is possible, that happened in San Francisco, dropping on the access to fundamentals is not likely there.
It’s kind of an interesting perspective where people left California to invest in Nevada because it’s cheap but then now Nevada is expensive on relative terms and California is fairly on relative terms. It’s quite interesting. California may be more expensive in absolute terms, but in relative it’s fairly valuable and Nevada is expensive and relative. I think, when picking a market that some of the very trendy, very booming markets I would perhaps stay away in the event of considering you would curve inversion and that just kind of perhaps investment sponsors who are more inclined to can mention markets like Neville, Kentucky, Indianapolis and places like that.
Prashant Kumar, CCIM – Awesome. It’s a nail on the head.
In today’s Podcast, Mr. Prashant Kumar CCIM, on behalf of My Realty Gains, invites Omar Khan to guide us through- “Meditation and Mindset help us Grow through Passive Investing”
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