Long holds may work for stocks but in real estate they don’t correlate with higher returns. Surprising? We thought so.

Returns in real estate can happen quickly, or take decades, or never materialize, but it’s easy to think that a good exit opportunity will appear even if a hold period is longer than expected. The basis for that optimism about the future may be flawed, however. To explain why, we need to have a drink, or seven.

Imagine you are dropped in the middle of a grassy field. And you’re very drunk. You start walking - stumbling? - with no destination, and where you end up walking is random. Now imagine the same scenario, except the field is on a slight slant, higher at one end and lower at the other. You start walking again, but this time, odds are you’re going to go downhill over time.

This illustrates the difference between two concepts: a Random Walk vs. a Random Walk with Drift (RWD). The RWD model underlies many investment strategies, especially long-term holds. We assume - because it’s been true over time - that most stock prices have unpredictable short-term fluctuations (the “walk”) with an overall upward trend over time (the “drift”).

The longer you hold an asset in a RWD world, the more it reflects broader market trends, which themselves are driven by generally positive economic growth, so the greater your expected return on that asset. This may have been what Warren Buffet had in mind when he said about well-run businesses, “Our favorite holding period is forever.”

Well, maybe it’s good The Oracle was not a big real estate investor. Researcher Jacob Sagi’s new work tells us individual real estate investments defy this logic and real estate returns are independent of the holding period.²  

A simple illustration:

• Adam buys an office building, holds it for 2 years, and earns a 15% profit.

• Dan holds an identical property for 10 years and earns a 20% profit.

If the RWD theory held, Dan should have earned significantly more to compensate for the longer exposure and benefit from the “drift.” But per Sagi, deciding to hold an asset longer does not increase the chances returns will be higher. Does that land funny to you? It did for us, and the study’s author acknowledges his findings might be “puzzling” and counter-intuitive, but that’s a we problem, not a problem with the science, as he demonstrates with “an exhaustive series of empirical tests that the RWD assumption is far from an appropriate description for CRE asset prices.”

His research found that returns from real estate investments do not drift higher over time, but why not? Why isn’t RWD appropriate? When boiled down this is because of a significant market inefficiency: the inherent illiquidity of real estate especially compared to equities. Illiquidity in real estate has many roots, including high transaction costs, long sale processes, few buyers given high investment size, and changes in debt capital markets. The inability to get in and out at the optimal moments means buyers and sellers don’t exercise full or immediate agency over their portfolio decisions. If we had a highly efficient market, real estate investments would move in an RWD format, like stocks and other securities do. 

Another way to look at this: Those investors who do get in and out at the right time and under the right circumstances do quite well, earning themselves significant transactional alpha. That kind of alpha stems from investing at the right time in the cycle or from an idiosyncratic inefficiency, like buying from a motivated seller, finding an off-market deal, or having negotiation leverage. High investment returns in real estate also can reflect selling optimally (nicely done!), which again is taking advantage of market timing or idiosyncratic advantages. Importantly, transactional alpha - which is at the core of real estate returns, Sagi argues - doesn’t care about time. It’s also worth noting that if Sagi is right and market inefficiency is the big driver of returns, the boundaries of potential returns are quite wide, opening up the possibilities of short-term triple-digit IRRs (and 10-year zeros). 

The lesson: In real estate, hold period alone has no relationship to returns. In and of itself a longer hold will not increase your profit. Instead, opportunism determines performance. If investors can point to circumstances that are real answers to ‘why buy now?’ and ‘why sell now?’ they are likely identifying transactional alpha, which is what you need if you’re thinking of pulling the trigger. In all events, if you’re on the fence about a buy or sell, take a beat before betting on RWD and a longer hold, because that might get in the way of the right investment decision.

The Rake

Three good articles.

• DC Area Rents Haven’t Gotten the DOGE Memo - ABC local

  Arlington and the wider DC metro area are experiencing a significant surge in rental costs this spring. Instability in the job market is leading to rent-for-longer decisions among potential homebuyers. This redfin piece has a great chart.

• National average multifamily rent increased in February - Multifamily Dive

  Yardi Matrix reports that the national average multifamily rent increased slightly in February to $1,751, with year-over-year growth remaining steady at 1.2%. NYC, KC, and Columbus are top 3 for YoY rent growth.

• Denver Hotel Makes Time List of World’s Greatest Places - Westword

  The Populus, a carbon-positive hotel designed by Studio Gang to look like an aspen tree from the outside and forest inside, has earned a spot on Time Magazine’s prestigious "World's Greatest Places" list, adding another unique and valuable hotel to Denver’s already-strong hospitality portfolio.

The Harvesters

Someone making real estate interesting. They don't pay us for this, unfortunately.

Who: Madera Residential

What: An established Texas multifamily manager that runs on their own technology, power and wifi, plus they just recruited the best mind in housing to help set strategy.

The Sparkle: Attacks value-add opportunities with the broadest and deepest set of skills we’ve seen in a manager/sponsor. Driving their management teams is their own lead-generation software, IoT software and hardware, managed wifi, and even their own energy company. That plus they hired Jay Parsons, arguably the most sought after housing researcher and forecaster in the businesses. Madera is now expanding into the Southeast and beyond.

Quote: "Our… investment strategy is designed to build maximum value for each person involved in our properties, from our apartment residents to our property investors."

From the Back Forty

A little of what’s out there.

Riffing on today’s theme, here are millions of digital monkeys working hard (but randomly) right now to write music and see how long it takes to compose familiar songs. They started in 2020 and have made some progress!

Link: https://pudding.cool/2020/04/infinite/

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1  https://nypost.com/2024/12/09/business/macys-unloads-brooklyn-store-for-rock-bottom-price-of-23m-sources/https://doi.org/10.1093/rfs/hhaa122

2  Jacob S Sagi, Asset-Level Risk and Return in Real Estate Investments, The Review of Financial Studies, Volume 34, Issue 8, August 2021, Pages 3647–3694, https://doi.org/10.1093/rfs/hhaa12