I was talking to an old friend on the West Coast the other day. His business is located in Sacramento, but most of his customer base is in the Bay Area, so he was looking for an apartment and a small office space in San Francisco.
His search turned up rents that were, as he put it, "more than the cost of [his] first three cars combined, each month."
Office space was even worse. The deciding factor for him was that his price range put him soundly in the middle of what can charitably be called "urban war zones," where a trip around the corner for a bite to eat could turn into something like a bad day in Baghdad - a real bullet festival.
So there was no way my friend wanted to - regularly, each month - fork over exorbitant sums for digs like this. He said he'll continue to make the drive in and stay in a nicer, less hectic, and far more reasonably priced smaller city.
It is the same story I am hearing about other hot spots like New York, Los Angeles, Washington, D.C., and other big-city markets.
The economy is booming for the moment, and with a red-hot labor market in play, pricing in markets like Washington and New York, already on the steep side, is probably going quickly worsen (or "improve," depending on how you're invested).
There's no way around it: If you want to live downtown in the big city today, you will have to pay through the nose.
Increasingly, we are finding there are a lot of people who do not wish to do so - and that's the key to the shares I'm going to tell you about right now.
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Turns Out Millennials Aren't So "Weird" After All
Years ago, real estate legend Sam Zell noticed that the Millennial generation - very roughly speaking, the folks born between about 1982 and 2000 - was getting married and having kids a lot later than their parents.
This generation had zero interest in buying homes, and even less interest after seeing what happened to housing prices in the credit crisis.
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Instead, this cohort wanted to be "downtown" - in a 24/7 city center environment, with arts, nightlife, dining, excitement, and other diversions within arm's reach.
Zell (definitely not a Millennial) positioned himself accordingly: He scooped up apartments in New York, Chicago, Seattle, and San Francisco. It's paid off beyond measure for him and his investors, including shareholders of his apartment REIT, Equity Residential (NYSE: EQR).
But here's my prediction: I think we will see that trend reverse a bit over the next decade.
Millennials are starting to do what nearly every other generation that's come before them has done eventually: Get married and have kids after all. Even those that don't necessarily want to buy a house are thinking that 24/7 living is too much - and too expensive. I think we increasingly see them move to smaller, "second-tier" cities and settle on a more "18/6" kind of lifestyle.
This is significant not because I give a damn about whatever organic, small-batch zeitgeist these whippersnappers are surfing at the moment or whatever, but because there's serious money to be made here - and lost, as it turns out.
Bob Dylan Was Right: The Times They Are a-Changin'
These trends are going to bring about some changes in apartment REITs, without doubt.
REITs that own a lot of downtown apartments in major cities could see some rent declines and rising occupancy rates. The numbers I'm looking at suggest most of them appear to be fully valued, even somewhat overvalued right now. I think they're probably a somewhat risky choice for new money.
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On the other hand, REITs that own a lot of apartments in secondary markets like Tampa, Fla., Nashville, Tenn., Charlotte, N.C., and other smaller, thriving cities will be much more attractive.
This will impact other segments of the REIT market as well.
The big-city office markets, for instance, have been fairly hot for years, but in the hottest markets, we're seeing some slowing. If the people are going to be looking for smaller cities to live in, then the office space in those smaller places will see higher occupancy rates and increasing rents at the expense of the bigger markets.
I think we will see a lot of companies make similar decisions as their millennial employees.
It may not always seem like it, but the executives running most companies are also, you know, people. They like safer communities, better public education, lower taxes, and sunshine as much as everyone else does.
Now that corporate tax rates have been lowered, lower individual tax rates and quality of life will become more of a factor in where these leaders decide to, say, plunk down that new operating division or production facility for many companies.
Technology is going to help speed up the migration to smaller towns and cities as well. With today's communication and production technology, I don't need to spend an hour each way in Los Angeles traffic to attend the design meeting and meet with vendors at a downtown office tower; I can do all of that from a condo in Oceanside or even Lake Tahoe most of the time. Why write my line of code in Seattle when I can easily do so from the beach in Fort Myers, Fla.?
Now, I am not predicting the emptying out of our big cities. There will always be plenty of people who want to live and work in mid-town Manhattan or go to work on Wacker Drive by day and catch the train to a condo in Wrigleyville in the evening.
Rather, what I am suggesting is that just about all the big money to be made investing in those real estate markets has already been made. There's not enough cheap upside left to make these REITs attractive. It is time to shift our thinking and consider repositioning our portfolios to REITs with significant holdings in secondary markets.
Time to start thinking small(er) to capture big gains.
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About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.