What Goes Up Goes Up and Down

Hamptons Overdrive – Vanity Fair – Michael Shnayerson – August 08

While much of America worries about foreclosure, John Paulson, who made $3.7 billion shorting subprime mortgages, has plunked down $41.3 million for a Southampton estate. Another just went (to Tiger Woods?) for $60 million. And Blackstone’s Stephen Schwarzman is building a vast compound in Water Mill. But, amid whispers about which Wall Street casualties will lose their summer spreads, the market for properties below $10 million is grim.

Alright, it’s Vanity Fair not the Journal of Real Estate Economics but the pictures are better and so’s the gossip and the article is interesting.

There are always winners and the winners are attracted to certain real estate markets. But there are two types of cycles.

In an up-cycle, the winners are replaced by bigger winners. Since the pricing at this level is a reflection of competitive expendable income, as expendable income goes up, prices go up and you end up with the quip that gentrification means billionaires displacing mere millionaires. And for some at the top of the market, there are only up and not-so-up but never down-cycles.

There is also a high level of customer substitution at the most expensive levels since these are global markets and someone in the world is making money – thus you end up with a Russian fertilizer baron in Palm Beach.

But mere mortals must live with down-cycles where the old winners are replaced by new winners – in the Hamptons: securitizers, regulators, securities lawyers, and real estate barons replaced by work-out/bankruptcy specialists, forensic accountants, class-action litigators, and new real estate barons (lawyers and real estate investors always win.)

But there is a time lag between the old winners moving on (“I don’t expect a big bonus this year”) and the new winners moving in (“I expect a big bonus next year”). There is also a psychological tug of war with the new winners expecting the old to concede that the prices were overheated and need to be marked down – how much depending upon the steepness and duration of the down cycle.

But remember two things: 1) each time the tide rises, it carries more people up with it but the amount of land doesn’t increase proportionately and 2) the cycle will turn for mere motals and eventually go back up like a Ferris wheel.