Ken Deshies, SnowHome properties

<i>Ken Deshaies of SnowHome properties, sees biases in real estate investment, but thinks that professionals in the field can help people cut through some prejudgment. He took time to answer a few questions about real estate investment.</i>

<b>Q: Do you see a lot of biases guide real estate investment? If so, what kind?</b>

Certainly, there are biases inherent in any investment decision. One would hope that professional advice would help any investor overcome at least some of their biases, but at least two dynamics may inhibit the taking of good advice:

(1) disinterest on the part of the investor for any advice contrary to their preferences; and

(2) incompetence or lack of knowledge on the part of the advisor.

Nevertheless, biases governing a decision to purchase real estate would certainly include accumulation of wealth, desire to include shelter with investing, expansion and/or stabilization of vacation possibilities, gaining ownership of a limited commodity (land), and a desire to leverage an investment for greater returns.

<b>Q: Do you think Summit County is in somewhat of a bubble — more immune to real estate downtrends — than the majority of the nation? Why or why not? </b>

There is a certain immunity from the downtrends currently being experienced in the majority of the nation. If you look at where the markets have softened, they are almost all in major metropolitan areas — where primary home ownership depends largely on the availability of good jobs. However, historically, Summit County has been uptrending since the early 1980s. Our market is differentiated from major metropolitan areas by several dynamics, all of which argue for a continued uptrend:

• Summit County is predominantly a second home market — roughly two thirds of all properties in the county are owned by non-residents. The market is changing somewhat as more retirees find their way to live here full time, but even in that case, we are talking about people who have saved or earned their way to retirement heaven. We are actually finding more and more people whose primary home is here and their second or third homes are elsewhere.

• Summit County is approaching build-out. That is, in roughly four years, all the land available for development will have been built on (or the development will have been accounted for and planned). There will be no more land available.

• Multi-family building permits have plummeted, while single family permits have spiked. Inventory is roughly 30 percent of normal.

• Locals’ housing is becoming less and less affordable, prompting every community and the county to push for more affordable construction or conversion. We clearly have more buyers than property available in that sector, as well.

• With regard to second homes, we are servicing predominantly two vital sectors of the American population — GenYers and baby boomers. GenYers represent a hard working younger generation with well-paying jobs who do not want to wait for retirement to enjoy life. And, of course, baby boomers have reached the age where they feel they have earned it. Those with the resources are flocking to resorts like ours.

• It is predicted that our population will double in the next 15 years. At that time, it is estimated that we will be short over 2,000 housing units.

• The laws of supply and demand clearly argue for a continued healthy real estate market in Summit County.

<b>Q: Do you think that real estate or stocks are a safer bet right now? Why or why not?</b>

The stock market has experienced wide swings in value over the past 20 years.

During that time, overall home values have continued to rise steadily and contribute significantly to household wealth and spending patterns. That argues for investing in real estate.

Last, but not least, many people have either been victims of, or generated much anger over, such investment fiascoes as Enron and Qwest, along with reported huge incomes of CEOs who lead their companies to the brink of ruin, or at least do nothing obvious to earn their salaries and benefits. In real estate, you just have more control.

Steve Smith, RightPathInvestments & Financial Planning

<i>Steve Smith, of RightPathInvestments & Financial Planning, thinks people’s fascination with real estate is, well ... fascinating. He said that real estate could be the poster child for behavioral finance issues.</i>

<b>Q: What you mean by “behavioral finance issues,” as it relates to real estate and stocks?</b>

SS: Behavioral finance — a Nobel Prize winning science — describes the biases that guide our investment decision making, often leading to mistakes.

Recency bias is a good example: by extrapolating recent price activity into the future, we might expect that the extraordinary gains in Summit County real estate will continue. The same phenomenon applies to stocks. But, prices don’t rise infinitely. There’s no theoretical basis for real estate to go up over time higher than the rate of inflation. And reversion to the mean is an extremely strong force, as we are seeing in markets like Florida and the Southwest. I believe we can expect higher future returns in markets that have dropped over the last five years, rather than those that have doubled. Right now, such markets are hard to find.

<b>Q: What components comprise return to a real estate investor?</b>

SS: There are four components — but it’s difficult to ascertain which ones (and in which proportions) are responsible for the success or failure of an investment:

1) The real estate “market”: Like all asset classes, real estate prices are determined by economic forces — GDP, inflation, credit availability, etc. However, Yale Professor Robert Schiller’s research shows that, over time, the return on the real estate asset class has been little more than inflation.

2) Property characteristics: Many investors are confident in achieving return through their selection of property type (i.e., apartment, condo, retail, office) and locations. From my perspective, the market is responsible for providing most of the return, just as with stocks. The risk of concentration in too few property characteristics should be diversified away.

3) Leverage: Remember that leverage — borrowing most of the purchase price -- works in both directions, magnifying your losses when the market goes down.

4) Sweat equity: This component makes it difficult to determine what part of the return is due to the investment and what part is due to hard work — like finding and keeping tenants or handling a midnight call about a burst pipe.

<b>Q: And, what components comprise return to a stock investor?</b>

SS: The fundamental component is that your ownership of stock provides capital to a company. Your return is equal to the cost of capital to the business. As companies and their earnings grow, so does your potential return. Of course, the market value of your claim on a company’s earnings changes as the price/earnings multiple changes. This is the speculative component, which is neutralized over a long time horizon.

<b>Q: In this market, what do you think is a better investment — the stock market or local real estate? Why?</b>

SS: Honestly, I can’t predict which will turn out to be the better investment. As a financial planner, I view buying a home — even a second home — as more of a use asset than an investment, although it could do well as both.

Let’s distinguish here between investing and speculating. Investors should think of their investments in terms of the overall portfolio. Well-diversified portfolios have exposure to both stocks and real estate.

Further, the stock market is a world market — and real estate is, too. Owning predominately local real estate creates enormous concentration risk. By owning U.S. and international REIT index funds within a diversified portfolio, an investor can be exposed to all the world’s real estate markets pretty easily.