Real Estate And The Life-Cycle Economy

[Dan DiFilippo]

Those here who are familiar with more conventional investing may know about life-cycle funds.  For those who are not, a life-cycle fund is a fund that is chartered in such a way that it invests according to the interests of a specific age cohort.  Obviously, investment goals will vary from person to person.  But generally speaking, however, it's agreed that in their younger years, one will prefer to make investments that are higher risk, lower liquidity, lower income-generating, and with a disproportionately high potential for outsized gains.  As someone approaches retirement, their appetite tends to change to the opposite of all of these.  They will make investments that are higher liquidity, higher income-generating, and with a disproportionately low potential for outsized losses.  A life-cycle fund will be designed to target a certain age cohort (perhaps born within a fixed decade) and make investments according to the stage of life that cohort is presently in.  This is to say that it will start aggressively but it will gradually pare down its initial investments and replace them with more stable ones.  As the cohort ages into retirement, the fund will be allocated almost completely to only the safest assets on the market.

Although it eludes everyday notice, the United States (and arguably, the whole world) functions in a similar fashion.  The Boomers showed up to the labor market around 1970.  This influx persisted for about fifteen years.  Just like a life-cycle fund, the entire American economy found itself naturally rearranging itself around this group of young workers.  The explosion of productivity enabled massive credit expansion as families, houses, and communities were built.  Boomers didn't have as many children as their parents did.  And while infant-mortality and childhood attrition rates are much lower than they were some seventy years ago, we still have failed to meet replacement (certainly not domestically).  We have had one generation steering the ship for much longer than their rightful turn.  Though they are losing some control, they are trying to get this life-cycle economy into its retirement phase.

Though most are flourishingly unaware of it, Boomers are insatiably ravenous consumers (and notoriously awful savers).  Debt-based monetary expansion will have that effect.  Many of them experienced some sort of loss in 2008, but they were more than happy to pretend things went back to normal.  The fiscal and monetary authorities assured them that things were fixed, GDP was moving again, unemployment got back under control, and consumer price metrics were manipulated to reflect calm waters.  And most of all, credit retreated from the risk involved in business and went into mortgage.  Given this boost, many Americans found their home values back to the 2006 highs within just a few years.  Following this, oil prices going through the floor in 2014 put a couple of extra years on the clock.  At that point, why not just write off 2008 as a fluke?  It was much easier than trying to understand the mispricing of financial insurance contracts within a gordian system of interbank credit.  That's what we have Federal Reserve officials for.  And they told us we wouldn't see another crisis in our lifetimes.

But that toothpaste tube can only be squeezed so hard.  And as money continues contracting in conjunction with slowing global debt issuance, we are wading into our next big challenge.  We have 60 million Boomers turning 70 in the next fifteen years.  The statistics on this cohort are misleading.  The average person in this fifteen year age range has a net worth of some $1,000,000.  That's not bad.  And while some would argue the details, most would agree that retirement is very possible with that amount of money.  Especially as social security and medicare get parachuted in as income supplements.  This doesn't reflect most of those people, however.  In fact, this average number of $1,000,000 falls at the 80th wealth percentile.  Down at the 50th percentile of this age range, we see a net worth of about $250,000.  That isn't a number that quite works for retirement.  Especially not when safe, income-generating assets are at their highest ever prices (and therefore lowest yields).  $250,000 invested in US Treasury Bonds at current rates would pay $3,000 or so in a year; an almost negligible amount of income in terms of retirement planning.  And keep in mind, 50% of group in question have less than this.

To make matters worse, these figures include primary residence.  In fact, at the 50th percentile, home equity is more than half of net worth.  Consider the effects of this.  What it means is that the retirements of millions of people are subject to the immediate fate the housing market.  For now, prices are still on a trend.  Between purchases being made and credit being extended, it's much too early to call the death of real estate broadly throughout the country (with the possible exceptions of the major cities).  Mortgage rates are printing in the 2-3% range, which supports this.  Upstream, this is even bolstered by central bank asset purchases of mortgage-backed securities.  Perversely, we know the foreclosure wall has to be coming, given how many mortgages are presently in forebearance.  But they essentially haven't been allowed to impact prices yet.  In the meantime, Americans are drawing out all of the wealth they can while the drawing is good.  They've milled through over $100B in cash out refinances since March.

These Boomers are going to face a lifestyle change.  If nothing else, this year has forced them to take a sober look at their household balance sheets and realistically plan their retirements.  If more than half of their net worth is in their home, then it is essentially impaired.  If they want to start investing some more money (and get it out of a real estate market that they are afraid is in a bubble), then the best thing that they can do is get to a low cost of living state with inexpensive housing.  Buy with leverage while interest rates are low, and then they have access to what had been equity in their old home to turn around and invest if they can.

The next ten years should be interesting.