Bricks

Dear Gala,

Your grandfather builds things. Shopping centers, towers to live and work in, an industrial park, a track for people who love cars, and he is still at it, at an age when most people have stopped. For him a building is a child. He knows every one of them the way I know you, where it was hard, where it turned out better than the drawing, what it still needs. I started learning this trade at six or seven, walking construction sites next to him, and I kept learning it beside him for years. It was one of the best times of my life. Everything I have done since started there.

This letter is about what that trade teaches, because you are going to own property one day, or be offered some, and the things people believe about bricks are only half true. The other half took me years to learn, first on construction sites and later from the papers I want to tell you about.

Where the value is

Land is worth the people who can reach it. That is the whole secret, and it explains why one block in a city costs a hundred times another block twenty kilometers away that looks the same. The dirt is identical. What differs is how many people can get to that spot in half an hour, and how much they earn when they get there. A shop on a corner where ten thousand people walk by is a different asset from the same shop on a corner where a hundred do, even if the bricks came from the same factory.

The location cannot be fixed later. You can change the building, the tenant, the paint, the name. You cannot move it. When I bought apartments in Miami in 2011, right after the crash, I was buying the corner, the distance to the water and to the jobs, and the buildings that stood on it were almost incidental. That is the first thing your grandfather taught me to see, and it is still the first thing I look at.

Years up, years down

In 1989 Karl Case and Robert Shiller tested whether house prices behave like stock prices. They took repeat sales of the same houses in four American cities and found that they do not. A rise in one year is followed by a further rise the next, of about a quarter to a half the size. A fall is followed by a further fall. In stocks that pattern would be traded away in a week. In houses it persists, and the authors said why. Nobody can sell a house short. Buying and selling one costs several percent each way. So the trend is visible to everyone and usable by almost no one.

What this means for you is that property moves in tides that last years. Two good years are no sign of a top and two bad years are no sign of a bottom. The gauges that tell you where in the tide you are have nothing to do with the price on its own. Divide the price of a house by the yearly rent it would earn, and divide it by the yearly income of the people who buy houses like it. Each city has a normal range for those two ratios. Far above the range, prices have run ahead of what rents and salaries can carry. Below it, they have fallen behind. In 2011 in Miami both ratios were at the bottom of their range, after four years of falling, and that was the reason to buy.

The slow mark

Institutional real estate looked safe for decades, and in 1991 David Geltner explained why. Nobody sells a building every day, so its value comes from an appraiser. And an appraiser does what anyone would do: he looks at what the building was worth last year and moves the number a little up or a little down. The reported value is therefore a moving average of the truth. The true volatility of property is about double what the appraisals show, and its ups and downs arrive a year or two late. The listed property companies, whose shares trade every day, move first. The appraisals follow.

The strip malls I bought in Atlanta in 2014 taught me the practical side. The appraisal I was handed described a building that had barely moved in price for years. The shares of the companies that owned similar buildings had fallen by more than half and come back in the same period. Same asset. One price told the truth every day and the other told it slowly, and banks lend against the slow one. That is how property ruins people. You borrow against an appraisal that says your building is worth a hundred. The market falls, but your appraisal does not move for a year. Then it drops to seventy, all at once. The bank tells you the loan is now too big for the building and asks you to put in cash to make up the difference, cash you may not have, because your money is in the building. And by then nobody is lending to anyone, and nobody is buying either. That is how people who own good buildings lose them.

What the owner keeps

The best history of property returns was built in 2019 by Òscar Jordà and four colleagues, for sixteen countries since 1870. Housing earned about seven percent a year above inflation, the same as stocks, with far less measured volatility. On those numbers property was the best asset in the world. Then other researchers went to the account books of Oxford and Cambridge colleges, which had owned buildings and farmland for most of the twentieth century and had written down every rent, repair and sale. After all costs, the owner of houses had earned about two percent a year above inflation, and the owner of farmland about four and a half. Both numbers are right. The seven percent belongs to a costless index nobody can buy. The two to four percent is what an owner keeps after the roof, the taxes, the management and the empty months.

There is a number that tells you in advance which of the two you are buying. The cap rate is the net income of a building divided by its price, and a paper by Alberto Plazzi and two colleagues showed that it is an expected return quote and nothing more. The industry treats a low cap rate as a sign of quality. Mostly it is a sign of low return. The broker will show you the rent divided by the price. Do your own version: subtract the taxes, the insurance, the management and the repairs from the rent first, and then divide. That smaller number is what the building will pay you.

I built workforce housing for years, apartments for people who work in the city and cannot afford to live near their jobs, and that business taught me where the owner’s two or three percent actually gets made. The plans are always prettier than the site. The site is where a contractor is late, a permit takes eight months and a tenant leaves in winter. The return is made in management, in the months the building is full, and it is lost in the small things that never appear on the plans: a leaking roof, a slow permit, an empty apartment in winter. What lasts in this trade is built slowly and financed carefully, with debt you could carry through two bad years, and every contract is read to the last page. The expensive surprises in this business are almost never on the first page.

What I do

I own property three ways: buildings I hold directly, listed property companies, and funds run by the large managers, spread across types and places. All of it is held free and clear, with no debt, so the slow mark can never call my loan. The listed companies and the funds are the same buildings marked at a different speed, and I judge the whole book against the listed market, because that is what my buildings would fetch if someone priced them every day.

With love,
Papá