Dwight Cass
06/01/2004
Most of us are inured by experience to the idea that our investment portfolios will occasionally be a source more of dread than of comfort. We realize that our equity, fixed income and credit investments can and will suffer occasional setbacks, some of which may take years to mend. But when we soberly consider these “expected losses,” as financial statisticians call them, we take comfort from the fact that the markets price our investments to compensate us for enduring these hazards. And, although we are often loathe to consider them, we can and do manage the impact of potentially more devastating unexpected losses (a hedge fund manager’s fraud, a terrorist attack, a national financial crisis) by diversifying our portfolios where possible, and hedging our larger, concentrated exposures to particular assets.
This almost organic balance of
risk and return, mediated by the capital markets, is not perfect, but it is
comprehensible and, for the most part, it works. Unfortunately, it bears almost
no relevance to what may be our most financially—and emotionally—important
asset: land.Land is illiquid (that is, difficult to price and requiring time to buy and sell) and almost impossible to hedge. Land exposures are notoriously complicated to diversify, unless we can assemble a very large portfolio, and they are highly correlated to regional geographic fortunes. (Remember the toxic effect the New England recession of the late 1980s and early 1990s had on real estate values in the region.) Instruments designed to overcome these problems, like real estate investment trusts, often behave more like equity investments than real estate.
Homes and Heritage
Beyond this, for many of us, land represents more than
simply another asset class to be wedged in our portfolio. It may form a
cornerstone to a family legacy—in some cases, one dating back centuries. It
often plays a central role in defining who we are, and is therefore crucial to
maintaining our family’s cohesion and achieving our goals.
But the fact that
real estate is an investment, and one subject to the vicissitudes of the market,
must, unfortunately be borne in mind. Since it often comprises a large part of
the value of our estates, we need to evaluate and manage it responsibly. Its
robust performance during the post-bubble malaise has been a source of comfort.
However, those of us now importuned by developers may wonder if they will fall
silent when interest rates begin to rise and the markets for housing and
commercial real estate begin to cool.
This is not a distant concern. On the
morning this issue went to press, the government released the core consumer
price index for March; it was twice as high as expected, and interest rates
immediately (though no doubt temporarily) jumped in response. Longer-term
rates—those that actually bear on the mortgage market’s behavior more than the
short-term levers manipulated by the Fed—are expected to trend higher soon. They
have been artificially depressed by foreign central banks, especially the Bank
of Japan, which have purchased U.S. Treasuries as part of their strategies to
manage their currencies.
These macroeconomic uncertainties are perhaps of
secondary importance to the fact that, as most real estate analysts tacitly
admit, some parts of the market are currently “overbought.” Capital flows into
many types of commercial real estate have pushed prices far higher than the fundamentals of investment in income-producing properties justify. Some may
recall a similar situation nearly two decades ago: the painful aftermath of the
real estate boom of the 1980s, which produced such a glut of capacity that it
took a decade for prices in many major markets to regain their previous
heights.
Those with significant landholdings may feel that the desire to
skirt the Charybdis of these macroeconomic and market uncertainties forces them
to veer too close to the Scylla of hurried decision-making. We have all seen the
unfortunate consequences. Near my own home on Long Island, there have been
innumerable examples in which farming families that have worked the land since
the 1600s have, in the past 20 years, sold their legacies to developers who have
polluted the landscape with awkward clusters of identical, aluminum-clad
McMansions. But there are alternatives. Land can, through the use of easements
and careful, intelligent improvement (where we partner with a developer whose
sense of the land mirrors our own) prove both a good investment and an ongoing
source of pride.
Dwight Cass
Editor-in-Chief