Beware of Demographic Promises

A few years ago, Ian Ippolito (whom I had the pleasure of interviewing on the Capital Spotlight podcast) wrote an article called, “Beware of Sponsor Promises of a Demographic Tailwind”. For those that aren’t familiar, Ian is a successful technology entrepreneur who turned to passive real estate investing in order to grow his wealth and provide his family an income. Ian later founded The Real Estate Crowdfunding Review, a terrific resource for those looking to learn more about passive investing.

In this article, Ian addresses a classic issue with many investment theses, which is that many are happy to pay too much for an investment because the future growth prospects look so good that it may be able to make up for the steep price paid today. This issue can further be described by a pitch totally focused on the qualitative analysis/market fundamentals and not enough on the quantitative analysis which is what really determines financial returns. An example pitch used by Ian to make this point is, “Austin, Texas has been ranked in the top five places for millennials to live, work and play. So, while it was a bit expensive to purchase this property, all these young people moving to Austin in the next couple of years will make this a fantastic investment”. 

This doesn’t mean investing in Austin or any other high growth strategy is bad; it’s not, it usually works. But the problem is people start paying any price to get exposure to said growth. No matter where you’re investing, you have to be very cognizant of the price you’re paying, and not solely rely on demographic tailwinds. I’ve observed this from personal experience. When a growth market becomes frothy and investors from all around the country and world are piling in, people tend to overpay, and prospective returns get compressed. 

Aside from investor competition driving up prices in these scenarios, the other reason which can make chasing growth a faulty investment thesis has to do with the supply side of the equation. Just as investors know about a great market or asset class, developers know as well and they build and build and build, until there is excess supply, mitigating the potential upside of strong demand. There are certain markets or asset classes which are severely difficult to develop, making this factor less relevant. For example, the San Francisco Bay Area is geographically and politically constrained, due to an ocean, mountains, and laws which make development costly and difficult. Another example is mobile home parks, which benefit from “not in my backyard” supply constraints as well as the fact that it is typically not the highest and best use for a piece of land. But even if true supply moats like these exist, there is nothing stopping investors from bidding up prices to remove any possible excess return associated with the favorable supply and demand imbalance.

So where does that leave you? Where should you invest? We don’t believe in just chasing the next trend or the highest growth markets because it’s often you and everybody else overpaying. Instead, we prefer to find markets or strategies where believe we have unique insight or advantage, which may even be contrarian to popular market opinion (and that’s where you see the greatest prospective return, when it does go right – see my quick video about the four quadrants of investing to learn more about consensus versus non-consensus investing).

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About Lone Star Capital 

Lone Star Capital is a real estate investment firm focused on underperforming multifamily properties in Texas and surrounding states. Lone Star creates core-plus and value-add opportunities that deliver superior risk-adjusted returns by implementing moderate to extensive renovations, improving management, and designing creative capital solutions. Lone Star owns over 1,500 units worth nearly $100M. Click through to view our company presentation here.

About the Author

Robert Beardsley oversees acquisitions and capital markets for the firm and has acquired over $100M of multifamily real estate. He has evaluated thousands of opportunities using proprietary underwriting models and published the number one book on multifamily underwriting, The Definitive Guide to Underwriting Multifamily Acquisitions. He has written over 50 articles about underwriting, deal structures, and capital markets and hosts the Capital Spotlight podcast, which is focused on interviewing institutional investors. Robert also helps run Greenoaks Capital, his family's real estate investment and advisory firm. Robert grew up in Silicon Valley and currently lives in New York City, where he enjoys reading nonfiction, traveling, working out, meditating, playing golf and piano.