Recently the Wall Street Journal published an article titled As Nashville Rapidly Expands, Residents Worry the Metropolis Is Growing Too Fast, and it beautifully illustrates the basic principles of building a real estate investment index. It seems that the accelerating flow of jobs and peoples from larger cities, especially up north to Nashville, has current residents alarmed.
"“There is very little opposition in our town to growth,” said David Briley, newly elected mayor of the Metropolitan Government of Nashville and Davidson County, in an interview. “I would say there is a high level of anxiety about the pace of growth.”"
The metro area grew an astounding 45% from 2000 to 2017, leaving it at roughly 2 million. It has the lowest unemployment rate of any large metro area, 2.7%. (Source.)
This was going on sort of beneath the radar screen, at least in the eyes of the national press who were centered, of course, in the big cities. That is, until the large Wall Street Firm AllianceBernstein moved its HQ from New York to Nashville in May (which I suspect is what put the Nashville boom on the short list for an article in the WSJ).
The country has been gradually, or not so gradually, migrating from Northeast to South. What's driving that? The two things which our principles would point to.
"For decades, part of the South’s appeal has been low housing costs, said Laurel Graefe, deputy regional executive of the Nashville branch of the Federal Reserve Bank of Atlanta. While corporate incentives and relatively low taxation are still drawing businesses and workers, housing demand in some places has far outstripped supply, driving up prices, she said."
Now it appears that commute times are rising and there is a fear that real estate prices will rise too quickly based on the Southward migration of flocks of snow birds from New York and Boston.
They already have risen a lot:
"From 2008 to 2018, housing values, based on a weighted measure of all transactions in the housing market, rose 75% in Nashville, compared with 33% in Charlotte and 26% in Atlanta, according to the Brookings Institution."
This is where the logic of standard cap-weighted REIT investing breaks down. All other things equal (ceteris paribus, in pretentious Latin econo-speak) the higher the price of real estate in a particular market, the more money the REIT dumps into that market. It's not a decision; it's automatic in 'passive' investing. That's what's passive about it -- it follows the market, and if the market creates a real estate bubble in Manhattan or in San Francisco, the passive REIT money lemmingly follows along.
The thing is, despite efficient market theory, bubbles are real -- including real estate bubbles. And they can be regional. They happen when prices rise vastly above the ability to pay them either as purchase prices or as rental/lease prices. Land values have an inherent link to the productivity that occurs on top of it. Residential property costs are paid out of the earnings of the people who live there. Commercial property costs are paid out of the profits of the businesses that operate there.
For a deeper dive on approaches to real estate investing without the pro-bubble biases of cap weighting, click here.