Wall Street v. Real Estate: Which Is More Trustworthy?

by | BiggerPockets.com

Wall Street (in particular, the S&P 500) has clearly been on something of a tear lately. But as they say in the fine print in all those ads, past performance is no guarantee of future performance. While the same could be said about real estate, at least with real estate, what you see is what you get.

Currently, real estate has a pretty cruddy reputation as an investment class throughout the U.S. for the obvious reason that values have plummeted nearly everywhere. But, poke a little deeper and you’ll realize that the real estate asset bubble (and the ensuing crash) was engineered by the same group that caused the stock market crash – the Wall Street insiders who, in a greedy rush to sell more and more asset based securities, bought and repackaged loans of ever-more dubious quality. No wonder real estate asset prices got out of hand – as is now generally recognized, people were buying houses that never should have in the first place, and got loans that were guaranteed to explode down the road, in some cases only a few months after they were written. Did you ever hear the one about the Mariachi singer claiming a six figure income? No, not a joke: WaMu approved his loan – and took a photo of him in his Mariachi outfit to “document” his income.

Then, undoubtedly, the Mariachi’s loan was pooled together with others and resold, all with the help of the bond rating agencies that allowed Wall Street to pull the wool over the eyes of pension funds and other unfortunates who actually bought these pools of junk loans. The suckers never saw it coming: as the New York Times put it, “buyers relied on the opinions of credit ratings agencies . . . These turned out to be overly rosy, and investors suffered hundreds of billions in losses when the loans underlying these securities went bad.”

Lately, there have been a few efforts to take the ratings agencies to task, most recently by California Attorney General Jerry Brown, who is in the midst of a seven month investigation into whether ratings agencies “acted improperly during the credit boom by assigning super-safe, triple-A ratings to mortgage-backed securities that later turned out to be extremely risky and in some cases worthless.”

Did you get that – AAA ratings for something that turned out to be “worthless.” Someone please explain that one to me.

Where does that leave the average person who has learned to become distrustful of the once-seemingly infallible Wall Street system of investing? Real estate, of course. The good news is that the crash of real estate values have created a lot of great deals – and the backlash from the junk loans has tightened credit considerably, making a repeat of the last bubble unlikely for the foreseeable future. If you buy an investment-grade property right, you need not lie awake at night wondering if that “triple A” rated “investment” your broker sold you was actually a worthless piece of paper – because you have a performing physical asset that will be around for a long time, one you can touch, feel, and rent for a profit. And even when it’s gone, you still have the land. That’s more than you can say for much of what’s been sold to investors on Wall Street the past few years.

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  1. Flo – While I know that your post specifically looks at Wall Street vs. Real Estate, I think that placing all the blame for causing the bubble on Wall Street is a bit of a simple way to go. Wall Street was not alone, and both politicians and consumers alike are also equally to blame. Many politicians pushed homeownership for everyone — especially those who couldn’t afford it, both turning a blind eye to the lending policies of Wall Street, and encouraging consumers to take advantage of these policies. Consumers, thirsty for great deals and the profits that could be acheived thanks to these policies, took advantage, ignoring any sense of fiscal responsibility. Sure there were people who were duped, but the vast number of people simply didn’t do their homework.

    While Wall Street certainly profited while the going was good, so too did the consumer and the politicians. All are to blame and all should get slapped with the GREEDY label that you slapped on the Banks.

  2. I’m glad you said that Josh as I was about to write that too. Let’s face it there are a lot of things that happen on Wall Street that aren’t right. One only needs to take a look at the latest fraud charges that were laid against Goldman to know that is a very real issue.

    But at the end of the day we are each responsible for the actions we take. And while I agree that real estate offers an investor a whole lot more control and for many people is an asset that is easier to trust – I think the responsibility is still on the individual to research and assess each and every investment opportunity carefully. Not every house is a good investment just like not every business or every stock is. You have to research and research and research to figure out what is right for you and what the risks are. Then you balance the risk with the return to see if it’s right for you. And that is the only way to invest in anything.

      • Yep – but even they should do their research!! The mortgage products some people signed up for are crazy … average joe should have asked more questions and cared more about their money.

        There’s a business tv station I watch and they surveyed their viewers (so, arguably more business and investment savvy people) and even only 43% of their viewers knew what kind of return they were getting on their investments.

        The average joe needs to be take more responsibility for their money. We work WAAAAYYYYYY to hard to earn it not to care where it goes.

        Obviously this is a hot topic for me ….

    • Josh and Julie,

      Thanks for your comment; I certainly agree that there is plenty of blame to spread around, even among real estate and loan professionals. But, as Wall Street is very much in the news these days, I thought it would be a good time to reflect on its connection to the problems in the real estate market.

  3. I completely agree with Josh and Julies comments.

    Unfortunately our school system does not teach financial accountability and stewardship. So as a society people make decisions based on there perception and not facts. And when things go bad, they point fingers and blame everyone but themselves.

    There are shady politicians, shady borrowers, banks, investors, etc.. But there are also very good ones that operate with integrity and within the law.

  4. Florence, good post. To the average citizen, there is a huge disconnect between Wall Street and what led to the real estate market crashing. Obviously without WS’s part, the market wouldn’t have risen (to ultimately crash). But as you duly noted, there are many to blame. I, for one, think that consumers should take more accountability instead of trying to pass all the blame to mortgage brokers (which I hear constantly… ‘I didnt know what I was signing’ or ‘I was never told those would be the terms’… Ignorance is not an excuse, specially in matters in which we should all exercise diligence).

  5. I like your article!
    My father, and his father, all said that bricks and mortar were the way to make money….I don’t disagree with them, but the world changes, and sadly so does the morals of certain elements associated with home and/or investment ownership. Obviously the banks became greedy, our regulatory bodies were lax or corrupt, and not to leave out the buyer who, in many cases, lied about his income,etc. to get the loan approved.
    Yes, the ownership of property at this moment is definitely a sound move, with prices so low, many bargains are to had!
    However, and this is where I must disagree, I believe there is so much more money to be made on Wall Street, at the moment, then anywhere else. I love the markets!!!
    This is not saying that I would put all my eggs-in-one-basket, diversification is the name of the game.
    Best of luck with all investment avenues!
    .-= Ian Harvey´s last blog ..Market Outlook for Week Beginning April 19, 2010 =-.

  6. So I know it’s easy to demonize banks and “greedy financiers” and so on… but… there are so many problems with this post and with some of the comments that it’s difficult to know where to begin.

    1. If Goldman Sachs (or any “greedy banker”) actually broke the rules, they will be penalized appropriately. But that’s a big IF.

    In the “fraud” case Florence is referring to, it seems that the waters are murky to say the least as to whether GS did anything actually wrong: http://www.nytimes.com/2010/04/20/business/20sec.html?hp Note that the SEC isn’t claiming that GS misled anyone as to the securities they were selling, but that GS misled people as to how those securities were created. That’s a novel claim if I’ve ever heard one. Imagine the impact of a “guilty” ruling on this one and extend that to housing. Disclosure forms will now be bound books that details exactly who worked on the foundation, which plumber laid the pipes, where materials were bought, etc. or else you will face fraud charges because you didn’t disclose some conflict of interest — maybe the plumber was related to the general contractor, but you didn’t disclose it.

    It’s total bullshit to the thinking person, but as long as politicians can make hay out of it… I guess we’ll suffer through the demonization of wealth.

    2. “AAA ratings turned out to be worthless.”

    Apparently, the OP doesn’t quite grasp the idea of ratings, or of bonds, or of financial risk. Turns out, ratings represent merely the opinions of financial experts who weigh various factors and make a judgment call on how safe an investment is. Turns out that ratings are not a guarantee of any sort, nor is a bond some sort of insurance policy.

    When even the writer for an investment-oriented site like BiggerPockets doesn’t have a good grasp on the relationship between risk and return, how is the average Joe citizen expected to know anything at all?

    If Jerry Brown, notoriously slippery politician, is investigating “improper behavior” by ratings agencies, I suppose I’m far more likely to think it’s a witchhunt to drum up political exposure. The last crusader on Wall Street, let’s remember, was one Elliot Spitzer. If Brown turns up actual evidence of insider trading or fraud or collusion, great — let’s punish those guys. But if investigation alone is enough to warrant drawing conclusions, why even bother with investigations and trials and such?

    3. Those pushing houses as “an investment” and claiming that prices are so low there are bargains to be had are going to need to justify those statements a little bit more, especially on a finance site.

    To claim that there are bargains to be had, one must assume some proper level of pricing for housing below which homes are trading right now as an asset class. I don’t think there is such a level of pricing right now with some 5-7 millions homes in the shadow inventory. But at least someone’s gonna have to pull some historical data on ratio of income to housing costs and show how we’re below the 20-30 year averages to claim “now is a great time to buy due to all the bargains”.

    And finally, to claim that real estate is a great investment and offers the investor greater control… control over what? Stocks and bonds may be regulated, but they’re not regulate at the micro level like real estate is. The impact of some 3-person zoning board’s decision on the value of your real estate investment can’t be overlooked. In fact, the impact of even private HOA rules on value can’t be overlooked.

    “Performing physical asset”? That depends now doesn’t it? Performing how? Would a termite infestation change the “performing” part just a bit? Probably.

    Nor, I think, can investment returns be calculated without looking at the cost of money — very few people buy a house in cash. Even those who do have to take opportunity cost into account. So unless the appreciation + benefits (like rent foregone since you own a house in which you live) outpace mortgage interest payments + other costs (like taxes), classifying real estate as an investment is precisely the kind of hazy thinking that got us all into this mess in the first place.

    I find myself increasingly at odds with the conventional wisdom on this issue.


    • Great commentary, Rob.

      1) We’ve got at least 2 1/2 more years of the demonization of wealth. Until that changes, we’re going to be seeing more of the same on every level. Just look at the Dodd Bill and what it proposes for entrepreneurship and accredited investors amongst other things.
      2) Nothing to add
      3) The typical homeowner who is buying their property as an investment needs to spend some time on our forums. This topic has been covered extensively there. As for those true investors out there, they recognize that bargains can be had at any time, provided you know what to look for, and you have the right strategy. Unfortunately, most “investors” have little idea what that is.

      Conventional wisdom is increasingly telling us that everything that we do is evil – I say F-that wosdom and everyone pushing it. If the wealthy & middle classes are de-incentivized to continue creating wealth (starting to feel that way), all those who rely on current and future benefits provided by the government will have nothing left. We’re on a slippery slope here.

    • Justin Boland on

      @Rob Hahn

      I agree with you on the Goldman charges being small potatoes, and I agree with your objections to “housing as investment,” but when you write off the responsibility of the ratings agencies, you’ve lost me. If only Moodys and S&P were “merely the opinions of financial experts who weigh various factors and make a judgment call” — that would indicate the experts involved actually had models and information to work with.

      The thing is, by the own admission again and again, they didn’t. They did not understand these financial instruments, did not have origination data describing what they were composed of, and did not have testable models to evaluate risk. What they did have, however, was a limitless capacity to take people’s money in exchange for pretending they had a “judgement call” to make.

      I would agree that “institutional investors” share the blame here, for taking the ratings agencies word as bond. They got lazy and they are responsible for that. I think you can use the “Caveat Emptor” when dealing with money managers and investment bankers, but when your entire business model is selling your unbiased expert opinions and evaluations, you have to be more honest. A hedge fund manager can say “I went with my gut” — that’s totally unacceptable for a ratings agency. They’re obligated to be doing actual work and research and thinking beyond browsing through the same prospectus every other investor got and putting a “AAA” seal of approval on it.

      If not, why not? I’m open to being wrong here.

      • Hi Justin,

        With respect to the ratings agencies… well, I’m of two minds on that.

        On the one hand, if literally these guys did nothing but pull ratings out their ass — or worse, if they were paid off to come up with ratings, as was often the case during the Dotcom bubble — then yeah, I think that’s criminal fraud and they should go away for a while. If those ratings agencies did nothing beyond reading a prospectus, then yeah, they’re likely liable for fraud at least with their customers who presumably expected (and were told) that the analysts would do more than attend an earnings teleconference call.

        On the other hand, if what they were doing was consistent with industry practice for how various sophisticated participants valued mortgage-backed securities (wrongly, as it turns out, due to significant flaws in the mathematical models which is the case as I understand it), then I don’t know how much I can blame them for honest mistakes. The world is filled with brilliant people making dumbass mistakes (Long Term Capital Management, anybody?) but as long as those are honest mistakes, we let the market punish them not the government.

        What Jerry Brown is doing is grandstanding and nothing more.

        But my real point is that AAA rating is not a guarantee of performance. Nothing is. There is risk in all investments, no matter how small — and that risk is what leads to any sort of return at all. There can be no such thing as a risk-free return; even US Treasuries are subject to some risk of default (vanishingly small, albeit getting larger by the day as we spend like drunken sailors on all sorts of goodies).

        I’m tired of the “I lost money; you said this was a solid investment, so you owe me” mentality is all. Yeah, you lost money, because investments are risky whether in AAA bonds or in real estate or in businesses or in government bonds. I didn’t hear people complain when they made money from those same risky investments.

        But yes, if the ratings agencies really didn’t do squat, didn’t make an effort, sure, I say let the hedge funds who relied on them sue them out of existence. Why California tax dollars are being spent on that, however, is way beyond me.


  7. Hi Florence –

    I guess I’m taking issue with the kind of shallow analysis that the NY Times — consistent with its general ignorance of things financial and economic — does to draw these unwarranted conclusions. For example:

    A two-bedroom Spanish-style condominium in Beverly Hills, Calif., for example, recently went on the market for $1.075 million, notes Don Heller of Prudential California Realty. Including taxes, condo fees and the tax deduction for mortgage interest, a typical buyer making a 20 percent down payment would face an effective monthly payment of about $6,000. Compare that with the monthly rent on a similar two-bedroom condo nearby — $7,600.

    Yeah… okay… so let’s nevermind the opportunity cost from the $200K in cash I’ve sunk into this 2BR condo? What would that have returned in the capital markets over the period of ownership? Does the $6K monthly payment include property taxes, insurance charges, maintenance, and potential for catastrophic loss in fire, earthquake, and the like?

    It’s precisely this sort of simplistic “analysis” that contributed and continues to contribute to the mentality behind the housing bubble.

    Even at a cursory examination, shouldn’t the NYT reporter have done some research to find out how many homes in particular areas might be underwater, and therefore in the 5-7m shadow inventory that hangs over real estate like the sword of Damocles? Shouldn’t he have done some basic math about amortization tables to show that in order for ownership to outpace rentals, you have to look at roughly 7-10 years of continuous ownership?

    One thing I do feel strongly about is that realtors and other financial advisors need to do a better job of educating their clients about the financial consequences of home ownership. I wrote about this a while back on Inman (subscription required) and put the associated spreadsheet on my blog (get it here if you’re interested), and it’s amazing to me that so few professionals bother to go through an analysis. And that worksheet isn’t true analysis with true numbers; it’s just a template!

    But at the end of the day, I agree that no matter who else might be to blame, the individual who signed his name to the mortgage or to the purchase agreement is responsible. I don’t care if greedy Wall Street tycoons bamboozled you; your fault for getting bamboozled. I don’t care if corruptocrats in DC and Sacramento enabled sharpsters to defraud you; your fault for being stupid enough to get defrauded. Despite the continuous assault on the basic values of being a grownup adult in the United States, I am naive enough to believe that at some point, we have to take responsibility for our own decisions and stop looking to Big Daddy Government to protect you from your own mistakes.

    The demonization of wealth and of Wall Street and all these is wholly inappropriate for a culture of grownups who take responsibility for their own mistakes; and that is why I’m so incensed about it.



  8. Quite frankly, there is too much blame to go around. As they say; Hind site is always 20/20. With that said; Greed is and always will be the motivating factor for Wall Street as well as for Real Estate. The Financial meltdown and Great Recession that we all have experienced and are living through right now hasn’t changed the Greed Factor one bit. Another Sub-Prime Fixed rate mortgage market is headed for default and growing as we speak.
    .-= Dwight (Matt) Mathews´s last blog ..The Next Great Recession 2011-2012?? =-.

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