Monday, May 02, 2005

Whoever Said There's Money in Real Estate?

Following up on a point I raised in my prior post (entitled What's the Likelihood of "Making It" as a "Pure Investor"?, April 29, 2005), I now focus on the real estate category. We have seen that only three (6%) of the world's top 50 richest people obtained their wealth primarily through real estate, and all three are Hong Kong citizens. Doesn't this seem a bit odd, since nowadays everybody (and his uncle!) who owns property, particularly in the U.S., is making gobs and gobs of "easy" money in real estate? Where are all the wealthy American real estate magnates?

For insight into real estate as a source of wealth in the U.S., I take a look at the Forbes 2004 list of The 400 Richest Americans. Below are the names of those Americans on the list whose net worth came from real estate:

Rank: Name, Net Worth, Residence

38. Donald Bren, $4.3 bil., Newport Beach, CA
74. Donald Trump, $2.6 bil., New York, NY
79. Leonard Norman Stern, $2.5 bil., New York, NY
87. Samuel Zell, $2.4 bil., Chicago, IL
97. Leona Mindy Rosenthal Helmsley, $2.2 bil., New York, NY
106. Richard Edward Rainwater, $2.0 bil., Fort Worth, TX
152. Melvin Simon, $1.6 bil., Indianapolis, IN
165. John Albert Sobrato, $1.5 bil., Atherton, CA
234. Thomas John Flatley, $1.2 bil., Milton, MA
260. Carl Edwin Berg, $1.1 bil., Atherton, CA
260. Edward P. Roski, Jr., $1.1 bil., Los Angeles, CA
260. Alexander Gus Spanos, $1.1 bil., Stockton, CA
278. John Arrillaga, $1.1 bil., Palo Alto, CA
278. Neil Gary Bluhm, $1.0 bil., Chicago, IL
278. Richard Taylor Perry, $1.0 bil., Palo Alto, CA
340. A. Alfred Taubman, $0.9 bil., Bloomfield Hills, MI
363. Marvin L. "Buzz" Oates, $0.825 bil., Sacramento, CA
389. Walter Herbert Shorenstein, $0.75 bil., San Francisco, CA

Perusal of the list reveals that:

1. We must drop all the way down to #38 (Donald Bren) on the Forbes 400 American list before we encounter the first person whose riches derive from real estate. (Incidentally, Donald Bren ranks #122 in the world. Among those with wealth from real estate on the worldwide list, he ranks behind five others--three Hong Kong citizens, one British person and one Japanese.)

2. Just 18 out of the 400 names (i.e., a scant 4.5%) on the Forbes 400 American list attribute their wealth to real estate.

3. The geographical distribution of these 18 people with real estate wealth is: nine in California (five of these in the Bay area), three in New York, two in Chicago, IL, and one in each of four other states.

How do we interpret this situation with only a small percentage of the wealthiest Americans having obtained riches through real estate, even though real estate has long been in a bull market? Assuming that the Forbes list is accurate (and I would guess that it is, because the magazine has been tracking America's wealthiest for many years, presumably refining their ranking and fact-gathering methodology along the way), I suspect that some combination of the following behind-the-scenes factors could be at work:

a. "Old" Asset: Real estate has been around forever (well, at least since European settlers introduced the concept of land ownership on American soil--or stole land from the American Indians, to phrase what happened another way).

b. Low Volatility: Being a "mature" asset, real estate tends to rise in value over time but has much lower volatility than individual stock prices, making it that much more difficult to amass a real estate super-fortune during a lifetime.

c. Generational Wealth Dispersion: With inheritance laws and generational wealth dispersion effects, highly concentrated wealth tends to remain in families only a few generations. Children of the rich tend not to be as financially successful as their more entrepreneurial parent(s), just as the children of the tallest people tend not to become as tall as their parents (a type of mean reversion phenomenon is at work here). One example of this effect is how the late Sam Walton's estate (Wal-Mart) has been divided five ways between his wife and children, who will likely divvy it up further among their children, without any one child or grandchild ever succeeding in realizing long-run returns comparable to founder Sam's.

d. Derivative Wealth: Real estate tends to benefit from wealth creation in other areas but has little to no intrinsic value per se (i.e., how much is dirt worth?). For example, so many of the real estate billionaires live in the Bay area and New York because their wealth is derived from property appreciation driven by wealth creation in the technology (Silicon Valley) and financial (Wall Street) sectors.

The result is fragmented ownership of a low volatility, old asset. Compared to concentrated ownership of relatively new companies in the hands of their founder-entrepreneurs--think Microsoft (Bill Gates, Paul Allen), Dell (Michael Dell) and Oracle (Larry Ellison), or more recently, eBay (Pierre Omidyar) and Amazon (Jeff Bezos), or even more recently, Google (Sergey Brin, Larry Page)--it is much harder for an investor to make a colossal amount of "quick money" in real estate.

So, yes, there is money in real estate. However, it seems unlikely that real estate magnates will ever (at least under the present form of American capitalism with its breadth of entrepreneurial opportunities in the manufacturing and service sectors) occupy more than 5% (or maybe 10%) of the top slots among the wealthiest people in America or the world. Instead, real estate will probably continue to "derive" wealth from other high growth areas such as technology, producing plenty of rich landlords but very few, if any, of the incredibly super-rich.

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