Lion of the Blogosphere

Can one make profit by predicting gentrification?

Steve Sailer writes:

This seems like a business — using data to predict gentrification — that has been underinvested in. My wife and I went with a Graham-Buffett “Value Investing” approach to forecasting gentrification in Chicago in 1988, buying a well-made 1923 condo near the beaches, on the grounds that the main very long run feature distinguishing one neighborhood from another in Chicago is proximity to Lake Michigan (and all the amenities that come with it).

But, that wasn’t a fashionable view in Chicago up through 1997, so if we had wanted to sell during our first eight years, we would have barely gotten what we paid for the place. The people who did better in 1988-1997 were the Momentum Investors, the proto-hipsters who flocked together to the the dumpy inland neighborhood of Bucktown (Liz Phair’s “Guyville”). Because my wife and I are pretty contrarian by personality, we missed out on that. As Keynes remarked, markets can sometimes stay irrational longer than you can stay solvent.

But then our neighborhood suddenly became fashionable in 1998 (hey, it’s the lakefront ), just like back in 1988 we had assumed it eventually would, and we wound up doing fine.

Anyway, it seems like some sabermetrician-types should stop playing around with baseball statistics and start churning massive amounts of data to figure out underlying patterns, if any, in gentrification.

While this theoretically sounds like a profitable use of HBD knowledge, I am pessimistic about this. For starters, the real estate market is a lot more “efficient” than people realize. As you should know, “efficient” is a term of art in finance and economics that refers to the fact that free markets already take into account all publicly known information in order to arrive at the market price for investments. Because all of the data that you have access to is also accessible to everyone else. Although you may think you have some special cynical or HBD-related insight, I suspect that experienced real estate investors and developers are already secret believers in HBD, or at least they know enough to know what kind of people moving into a neighborhood cause prices to go up, and what kind of people cause prices to go down.

Even if you predict that Bedford-Stuyvesant is a future up-and-coming neighborhood, do you really want to be robbed and beat up by the local residents (as happened to these hipsters) while waiting for the neighborhood to improve?

The way to actually make money in real estate in a heavily regulated environment like New York City is to have inside knowledge about the real-state approval and development process which only comes from experience working in the industry.

Written by Lion of the Blogosphere

July 21, 2014 at 12:04 PM

Posted in Investments

36 Responses

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  1. But if one had known that Williamsburg was going to be invaded by hipsters, one could have gotten really wealthy buying crappy apartment blocks, right?

    afaik, williamsburg is more expensive than living in the fancy pants upper east side type places now…

    jjbees

    July 21, 2014 at 12:35 PM

  2. Here in my hometown of Indianapolis gentrification seems to follow the same cycle. First artists move into a depressed area because of low rents. A few art galleries then pop up. The art galleries attract visitors. Some restaurants and bars start up to cater to the visitors. Then people start moving into the area. This causes the rents to rise and the artists can’t afford to be there and move. The numbers of bars continue to increase. You start to get too many people getting drunk and starting fights. The neighborhood starts to go down. The bars drop in quality and so do the customers; shootings and robberies increase. Local white liberals and little old black church ladies start to have “stop the violence” rallies but none of the people actually committing the violence show up. If you see this happen in your city, I would invest in an area right after the point the art galleries start opening and get out when the shootings and robberies start to increase.

    Mark

    July 21, 2014 at 12:35 PM

    • Yep. When the bars start to advertise “hip-hop” night, the neighborhood already peaked.

      E. Rekshun

      July 21, 2014 at 1:43 PM

    • I think it is when the bars are pushing cheap domestic beer instead of microbrews, it is time to go. As with many investments, the trick is more knowing when to sell than when to buy. Buying late can be bad but selling late can be much worse.

      superdestroyer

      July 21, 2014 at 5:52 PM

  3. This is where LofB is off-base.

    I’m a commercial real estate lender based in NYC but lend throughout North America. Have been doing it for almost 15 years.

    Since real estate investing involves lots of leverage, if you’re right, you’ll make a fortune, if you’re wrong, you’ll lose your equity with the bank taking the rest of the downside risk. Consider it optionality as Taleb spouts about.

    Just make sure it’s a non-recourse mortgage loan. They’re somewhat easy to get right now based on the lending environment.

    You don’t need to be in the neighbourhood while it’s undergoing gentrification. You can purchase a small investment property, renovate it, but live in your lily-white suburb while the tenants there go through the ups and downs associated with gentrification.

    The thing with real estate is that there’s inefficiencies everywhere on account of the illiquidity of the market (closing’s take a minimum of 30 days at the best of times), complexity of purchasing real estate (lawyers, title agents, appraisers, etc.), the fact that one needs financing, a lot of old families (especially jewish) still own the real estate but don’t have the chops anymore, maintaining a depreciating asset, dealing with tenants, etc.

    You can make the argument that you should then purchase MBS, CMBS, REITs, etc., but then you start becoming a trader and not a real estate investor and begin missing out on the inefficiencies.

    My point is is that if you know a local market really well, i.e., you know the buildings and stores, notice changes in vacancy or people living there, you can spot positive or negative trends. And then take advantage by buying a building (can be in mint shape if you wish) and holding on until that trend comes true. Or selling if it doesn’t. Hopefully it’s cashflowing to pay for all expenses incl. interest, so worst case you take a whack on your equity if your speculation doesn’t pan out.

    Here’s one trend to spot that at least (in the past) has determined a gentrifying trend: where are the gays moving to?

    Back in 2002 I was working on a deal on 9th Ave. and 45th St. At that time brokers were trying to call the neighbourhood Clinton, even though everybody knew it as Hell’s Kitchen.

    Most of the walk-ups there were in bad shape, there were a few bars and restaurants, but the neighbourhood was definitely run down. The crappy Port Authority Bus Terminal acted(s) like an anchor dragging on this neighbourhood.

    I had to present the loan to my mortgage committee, whose board consisted of real estate investors from throughout the city, mostly Jewish. I was having a tough time convincing everyone else that the deal had merit, until one committee member, an old Jewish owner, said “the gays are moving there, because they’re being outpriced in the West Village”. This is exactly what I was thinking but wasn’t allowed to say, however once he said that, they approved the deal (he also owned numerous walk-ups there and started talking about rental increases).

    Gays generally have more disposable income and demands that draw tenants that make a neighbourhood more appealing. For example, bars, clubs, studios, good restaurants, clothing boutiques, etc. They are less afraid of living in a bad neighbourhood because they’ll never have to raise children there.

    Long story short, LotB lives there now, a tenant and demographic that most real estate investors salivate over. He’s starting to make that neighbourhood unaffordable for the gays there.

    I don’t know if LotB would’ve lived there in 2002.

    So, fellow readers who want to dabble in real estate, I pose a question now to you: where are the gays moving to in your city?

    DdR

    July 21, 2014 at 1:03 PM

    • I think that the gentrification of Hell’s Kitchen began when Worldwide Plaza was completed in 1989.

      Lion of the Blogosphere

      July 21, 2014 at 2:10 PM

      • It’s more like the Time Warner Center being the catalyst for gentrification of Hell’s Kitchen, which really began in the early Y2Ks.

        JS

        July 22, 2014 at 7:36 AM

    • Right, and in an era of big data, it shouldn’t be overwhelmingly hard to monitor the top 50 real estate markets in the country for location trends among gay men.

      Steve Sailer

      July 21, 2014 at 6:03 PM

      • Steve, didn’t you do a write-up critiquing Richard Florida for making the same exact argument as Ddr, a few months back??

        Roli

        July 22, 2014 at 3:42 AM

  4. “The way to actually make money in real estate in a heavily regulated environment like New York City is to have inside knowledge about the real-state approval and development process which only comes from experience working in the industry.”

    I know a family that owns about 150 hotels comparable to Holiday Inn. In fact, some of their hotels actually are Holiday Inns.They’re located throughout the Southeast, Southwest and Upper Midwest. They started out in the late 50’s as a plastering/drywall contractor. They’re big break came when they bought up a lot of land located near the ramps of a new interstate being built to replace an old highway. The interesting thing is that they purchased the land before anyone else knew where the interstate was going to be built. Hmmm….

    destructure

    July 21, 2014 at 2:46 PM

    • I’m sure it was a lucky guess….

      This reminds me of The Honeymooners sketch “The Brother-in-Law”, where Ralph and Ed invest in a hotel based on the promise of a new highway being built.

      ScarletNumber

      July 21, 2014 at 4:51 PM

    • Behind every fortune is a crime.

      Glengarry

      July 21, 2014 at 6:39 PM

  5. Gentrification will be a fad which will be quite forgotten by say 2030.

    I actually agree with LotB. Politicians can make or break gentrification, and basically the areas which get gentrified earlier tend to be bought up beforehand by the insiders.

    If there is only a chance to buy one single property and wait till the ship arrives, it is very easy to go wrong.

    Colmainen

    July 21, 2014 at 2:56 PM

  6. The flippers generally get properties before they ever go on the market. Having the access to those properties is key, or at least that’s what it looks like when I see properties going for 100% over the last sale after a cheap remodel.. I don’t know how you do that, maybe you have to demonstrate to an agent that you’ll provide repeat business, or else be an agent yourself. The flippers say that the way is to canvass the neighborhood with mailings.

    bjdubbs

    July 21, 2014 at 4:52 PM

  7. Bedford-Stuyvesant has been on the upswing for many years. Gentrification was actually a minor theme in Spike Lee’s movie Do the Right Thing, which came out 25 years ago. What the ‘hood has, in surprising abundance, is a high-quality housing stock, or at least a housing stock with potential. Its townhouses were built to last.

    Peter

    ironrailsironweights

    July 21, 2014 at 5:08 PM

  8. I don’t doubt that urban real estate investing is pretty efficient, just as the market for baseball players was pretty efficient 30 years. But a whole lot of intellectual effort has gone into using data to gain alpha in the latter, but the former which is maybe 3 or 4 orders of magnitude bigger seems to be mostly seat of the pants decisionmaking still.

    For example, this distinction I drew above between value investing and momentum investing in urban properties seems pretty useful, but I’ve almost never seen it enunciated.

    Steve Sailer

    July 21, 2014 at 6:01 PM

    • Steve,

      I think part of it is the ego factor. If you’re a money baller, they’ll talk about you on ESPN. If you’re a professional investor in publicly traded securities, you can get on CNBC. Bill Ackman gets to have a public pissing match with John Hempton re HLF, for example. But if you’re a commercial real estate investor? Not so much (Trump doesn’t really count here, as he’s on TV more as a reality TV star.). You can be successful and make loads of money, but real estate is missing a couple of the exciting aspects of stocks and sports:

      1) The ticker. Stocks get bought and sold every trading day, and you can see their prices scroll along the crawl on CNBC or Bloomberg. Baseball players play all the time in season, and you can see their stats on the crawl on ESPN. A large real estate property may sell once a decade.

      2) The two-sided trade. You can buy a stock or short it, and there can be famous investors on both sides of the trade. You can bet on one baseball team or another to win a game. If Robert Durst buys or builds a big building, you can’t take the other side of that trade. You can’t take his side of it either.

      Dave Pinsen

      July 22, 2014 at 1:31 AM

    • Steve,

      You are forgetting a powerful phenomenon that Lion talks about – self actualization. It is much more fun and personally rewarding (though not financially) digging into baseball statistics, B-R, fangraphs, lahman’s database and finding kernels of truth in baseball (or whatever sport you wish to apply analytics to) over real estate.

      Attending MIT-Sloan Sports Conference is much more interesting and fun than some conference on deriving alpha from RE/REIT’s.

      uatu

      July 22, 2014 at 4:58 AM

      • The problem with sports analytics is that sports are inherently unpredictable because of the tournament style of play. No two teams play each other often enough to generate reliable data. Thus, the results have a lar stochastic component that makes it exciting.

        map

        July 22, 2014 at 1:01 PM

  9. I think betting on an immigration amnesty is a good HBD play. When it happens, the prices in Hispanic neighborhoods will go up. You could get tons of excellent foreclosure properties there in the last few years. I don’t think you can lose money if the amnesty doesn’t happen.

    Yakov

    July 21, 2014 at 9:40 PM

  10. Most areas in NYC are post gentrified because all non-gentrified areas are too far from Manhattan, and they either have a prole demographic, which makes any gentrification, a non-issue, or NAMs, which means let’s forget about it.

    JS

    July 22, 2014 at 7:26 AM

    • There are always trends going on in the market. You can buy Class B/C office buildings in Manhattan for $500/sq. ft. and flip them north of $2,000/sq. ft. after you rezone them and build them out as luxury condos. I’m working on a financing like this right now. The sponsor is basically putting in none of this money, rather he’s using OPM and structuring a tight promote.

      Why do you care about the demographics if you’re purchasing a property as an investment? Some of the best investments in Manhattan are five-floor walk-ups in Harlem, Washington Heights, Inwood, The Bronx, Kew Gardens, Forest City, etc. Do you think the owners look like their tenants? I hate to break it to you, but they don’t, but that doesn’t stop them from buying the places given that the cap rates are attractive and that a lender will offer 75% LTV financing.

      DdR

      July 22, 2014 at 2:20 PM

      • No one said you couldn’t buy a piece of real estate as an investment, including property in Staten Island. I was saying the gentrification lines in NYC have been drawn and set already. There is no more gentrifying of outlying areas.

        They’re not even tearing down housing projects so NAMs in NYC are here to stay. The unlucky ones who don’t live in subsidizing housing will leave.

        Yes, the owners do have to look like their tenants in order for it to be lucrative. Good luck evicting deadbeat NAMs, and most of them you wouldn’t want anyway, as a credit check turns out to be the case.

        JS

        July 22, 2014 at 4:00 PM

      • Are you saying that all neighbourhoods in NYC are static in terms of gentrification? Because over the year I lived in North Harlem (145th St. and Edgecombe Ave.), the percentage of NAMs, while still a majority, was definitely decreasing.

        “They’re not even tearing down housing projects so NAMs in NYC are here to stay. The unlucky ones who don’t live in subsidizing housing will leave.”

        You’re right, but they’re slowly converting a good chunk of the Mitchell Lama projects into coops.

        http://cooperator.com/articles/1171/1/The-Mitchell-Lama-Buyout-Process/Page1.html

        “Yes, the owners do have to look like their tenants in order for it to be lucrative. Good luck evicting deadbeat NAMs, and most of them you wouldn’t want anyway, as a credit check turns out to be the case.”

        If they receive Section 8 vouchers, then they have to behave otherwise they lose their subsidy and have to return to a project. Trust me, they behave.

        If a deadbeat NAM stops paying rent on his/her rent-stabilized apartment, then that’s a homerun for the Landlord, who can eventually evict a tenant in heavy arrears, renovate it, and accordingly increase the legal rent for that unit by 1/40th of what the LL invested in the renovation:

        http://www.nyshcr.org/Rent/factsheets/orafac26.htm

        DdR

        July 23, 2014 at 9:52 AM

      • Mitchell Lama are not housing projects. They’re middle income housing. I’m talking about NYCHA complexes where people pay next to nothing in rent and many of the tenants are on the Section 8 housing program. The tenants are usually the riff raff types and are either low income or on welfare, where as MLs are for people with middle class jobs. NYC has swathes of hideous project buildings that houses NAMs and will remain there as long the de Blasio types are in power. And guess what? With our deeply entrenched PC culture, any Republican Mayor will also bow to their demands when it comes any welfare programs, so don’t expect a large exodus of undesirables leaving NYC, or a wrecking ball to knock down their homes.

        Are you saying that all neighbourhoods in NYC are static in terms of gentrification? Because over the year I lived in North Harlem (145th St. and Edgecombe Ave.), the percentage of NAMs, while still a majority, was definitely decreasing.

        Harlem has already been gentrifying for quite sometime. Again, I said there will be no more gentrification of additional neighborhoods going forward because they are too far from Manhattan and the de Blasio types have already brainwashed the general psyche that gentrification is bad.

        JS

        July 23, 2014 at 11:31 AM

      • My grandparents lived in a Mitchell Lama building in Brooklyn and it was pretty safe (although not beautiful); almost all of the residents were older Jewish people.

      • If they receive Section 8 vouchers, then they have to behave otherwise they lose their subsidy and have to return to a project. Trust me, they behave.

        Blacks in NYC, no matter what class they belong to (very few upper middle to wealthy blacks to talk about them), will harbor resentment and an inferiority complex in the backdrop of Whites and other non-White groups who do way better than them. Therefore, they will become an irritant for any non-black person dealing with them.

        JS

        July 23, 2014 at 11:36 AM

      • More true of blacks who were born here and descended from American slaves, less true of immigrant blacks.

  11. I wonder if portland would be a good play for RE investing – strong nimby-ism depressess supply, and even the worst parts of portland are no where near as ‘hood’ as east, midwest, southern, or socal cities.

    The issue of course is you have to find pockets of depressed RE near massive economic engines – portland lacks that as it is filled with people content to be economically mediocre while pursuing self actualization.

    uatu

    July 22, 2014 at 1:34 PM

    • Tell me why you can’t still invest in Portland?

      People, there are market inefficiencies everywhere in real estate. There are literally millions of investment properties in the United States and the data to analyse them is immense!

      If you think Portland’s a good bet (and I would argue it is based on demographics and high barriers to new construction), then start looking for some investment property. You can even buy a two-unit place if you’re gun shy.

      DdR

      July 22, 2014 at 4:09 PM

      • The reason I am shy to invest in portland is because the sheer lack of industry/sectors/companies that bring young(ish) people in with high incomes. Even a city like Baltimore has more young high earners than portland would.

        So portland seems to then become a pure supply play where you are at the whims of zoning/permit issuance rather than having the ‘income effect’ hedge as well in the form of high value industries/sectors congregating.

        There really is only Nike and Intel out there (adidas north america as well, but they could move to boston long term) and Nike doubled down in expanding in the suburbs.

        I didn’t have enough capital to invest in seattle which has seen immense value spikes in condos post-crash – some places in belltown have almost doubled in 3-4 years.

        If you could marry portland’s demographics and high barriers of new cons with even baltimore’s job base (which is weak compared to rest of boswash corridor), that would be a better market to invest in IMO.

        Then again I’m a RE amateur – not a pro so that is probably also clouding my judgement and appetite for risk.

        uatu

        July 22, 2014 at 9:41 PM

      • “The reason I am shy to invest in portland is because the sheer lack of industry/sectors/companies that bring young(ish) people in with high incomes. Even a city like Baltimore has more young high earners than portland would. ”

        There’s other draws besides just jobs in Portland. Great scenery, Willamette Valley, fishing, etc. A lot of rich Californians are moving there because of the arbitrage play on buying a house there versus San Fran. And this pisses Portlandians off to no end.

        “So portland seems to then become a pure supply play where you are at the whims of zoning/permit issuance rather than having the ‘income effect’ hedge as well in the form of high value industries/sectors congregating.

        There really is only Nike and Intel out there (adidas north america as well, but they could move to boston long term) and Nike doubled down in expanding in the suburbs.”

        If you buy now, and the high barriers to zoning and permit-approval process don’t change (probably won’t), then the asset appreciation will in all likelihood outstrip general inflation.

        Nike is expanding in the Sunset corridor. Don’t forget Salesforce.com (they’re also expanding). And Intel has no plans on leaving Beaverton anytime soon.

        Vancouver WA has been on a tear the last 10 years on account of the income and sales tax arbitrage that people are playing there. Have you considered that city to live?

        Are you just talking about buying a condo for your own use? If prices haven’t escalated too much in Portland, then I’d buy. If they’ve gone up by more than 50%, then I’d wait on the sidelines until the next downturn. But you could be waiting for another few years.

        DdR

        July 23, 2014 at 10:08 AM

  12. O/T – The American Flags at the base towers of the Brooklyn Bridge have been replaced with “surrender” flags. Telltale sign to come as America is falling on its knees?

    http://www.nydailynews.com/new-york/nyc-crime/american-flags-stolen-atop-brooklyn-bridge-cops-article-1.1875673

    American security is a joke!

    JS

    July 22, 2014 at 4:04 PM

    • This must have been done by high-IQ hipsters.

      “Security” primarily prevents crimes by the average and the stupid.

      Lion of the Blogosphere

      July 22, 2014 at 4:16 PM

      • So are Hipsters aware of the fact that life isn’t all that rosy now in America?

        JS

        July 22, 2014 at 5:30 PM

  13. Low income tenants who live in subsidized luxury housing in NYC must use separate entrances to their residences known as “poor doors”.

    http://money.msn.com/investing/post–front-doors-are-for-the-rich-in-these-buildings

    That’s right: So-called “poor doors” (or separate entrances for poor people, usually located in the back of the building, out of view from the upper-class tenants) are increasingly common among New York’s swanky residential buildings that house the superrich alongside a handful of low-income people in order to get tax credits from the city.

    Let’s make separate everything for Whites and blacks while we’re at it. Integration was and is always a failure in American society.

    JS

    July 23, 2014 at 7:31 AM


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