The Dangers of Euphoria in Real Estate Investments

November 25, 2014

by Keith Jurow

There is widespread consensus that the real estate crisis is over.  The possibility of a repeat of the collapse of 2008-2009 is inconceivable to investment advisors and their wealthy clients.

Wealthy investors have been flocking back to real estate with abandon.  TIGER 21 – an organization for ultra-high-net worth investors (UHNW) – publishes the results of its asset-allocation survey of its members every quarter.  The latest survey for the third quarter illustrates this point very well.  Take a good look.

Real estate

Of the members surveyed for the 12 months ending in the third quarter, the average portfolio allocation to real estate was 25%.  That is six percentage points higher than the average reported in the first quarter of last year.  It is also as high as the allocation was in 2007, at the height of the real estate bubble.

This percentage allocation to real estate is the highest of any asset class including public equities.  Wealthy investors are now as comfortable with the prospects for real estate investments as they were in 2007.

The unseen dangers of complacency

Because of this complacency, wealth management firms and RIAs widely believe that you do not need to talk about risks at all.

Wealthy investors no longer think it is necessary to be vigilant about possible risks to their portfolio.  Market risks that would be heeded during less optimistic times are brushed aside or overlooked.  Tail risks — like those that surfaced in 2008 — are simply dismissed.  Credit risks of default are minimized and often ignored.

The most dangerous problem is that assumptions are taken as facts.  What do I mean?  The assumption that we are in economic recovery is not questioned by the pundits and Wall Street analysts.

We all know there is a recovery, right?  It’s a certainty … so no need to discuss the matter.  A classic example of this was the Barron’s article in April 2013 on “What’s the Best Path to Real Estate Profits.”  The author began by proclaiming that “The housing crisis that wiped out trillions of dollars of personal wealth and shook investor confidence is finally over.”

Not a word was said about residual risks that remain after the largest real estate collapse in American history.  The author’s unstated assumption was that we all know the crisis has ended and that recovery is well underway.  If that’s a fact, why would there be any need to discuss possible risks still lurking out there in housing markets?

Herd mentality is insidious.  Those analysts and pundits who share this thinking find it exceedingly difficult to see that what they accept as fact is merely an assumption.

Advisors must consider the possibility that what is assumed may not be true.  This means challenging common perceptions.  While not an easy task, it is absolutely essential for any investment advisor whose clients have large asset portfolios at risk.