Why Wall Street hates real estate

As I explore in my recent book, Timeless Wealth, real estate has been a cornerstone of wealth creation for literallymillennia.

Arguably, since the very first tribal chief claimed the prime location on a great river for the view and security, and because it sat atop a nice little hill, it’s been that way. Perhaps his wife liked that spot, too, and knew all the other people in the tribe would be envious.

Many of the wealthiest families in all of history built their wealth on two major foundations: owning a business or owning real estate (or both, if they were particularly awesome).

So why does Wall Street not recommend real estate more often for their wealthy clientele?

As with most things - you gotta follow the money.

Following the money is a golden rule in life, as in investing. On Wall Street, the money trail leads directly to a mostly liquid, public stock and bond portfolio.

I want to add here that there is nothing wrong with this. Stocks, in particular, make money. It indirectly benefits from “owning a business.” The returns won’t be as magnified as if you build your own company, but stocks work. No disrespect to stocks.

But “follow the money” will still illuminate this point for us.

First, a liquid stock and bond portfolio is very easy to charge an AUM-based fee on, which is the major premise of Wall Street revenue. Wall Street manages trillions of dollars of investor capital and is highly incentivized to invest it in strategies on which it can charge fees. It doesn’t want to do this if it can't charge fees.

Again, it's totally fair. It’s a business; they run a business, and one cannot begrudge them for running their business profitably. But you, as the investor, may not realize that you are being steered into investments that benefit the investment advisor and their Firm. Perhaps you did know this, but nonetheless, I’m just calling it out.

Second, real estate is management-intensive, difficult to run, and difficult to scale. Wall Street is set up to make it easy and make a lot of money doing it. Real estate can make a lot of money, but it is not easy.

Third, Wall Street is thoroughly and deeply married to the concept of Modern Portfolio Theory. For the uninitiated, MPT is a systematic approach to maximizing return and minimizing risk. On paper, that sounds great. I seriously question the validity of MPT, though, because “risk” is measured in the volatility of the underlying position.

However, if we utilize MPT, private real estate should dominate most other assets on the curve. By the way - dominate is a fun term - it’s actually utilized in Modern Portfolio Theory to signify an investment that is better than others because it exhibits higher returns and lower risk.

So - why should private real estate dominate? It has very low volatility, as it isn’t priced daily - so since “volatility” is the input for risk, real estate seems less risky on paper. In addition, it has high historical returns, benefits from leverage, generates cash flow, tax advantages, and many other really important return factors. And yet - private real estate doesn’t really make it into most MPT portfolios.

For instance, below is a snapshot of the Goldman Sachs model portfolio (for private client investors—a great read, by the way). Notice that real estate occupies a mere 4% allocation.

Capital flows in the Private Wealth business are enormous. You can’t just allocate to small deals. It’s literally impossible. If you are managing even just $100 billion, then the above portfolio requires a $4 billion allocation to real estate. It’s hard to allocate that. Goldman Sachs alone manages client assets worth $1.6 trillion. Now that’s not all managed, by the way - it probably includes sizable single stock positions, etc. But as you can see - the scale is difficult.

And that’s just Goldman. Count JP Morgan, Morgan Stanley, Merrill Lynch - you get the picture.

Now compare and contrast that with the TIGER 21 member asset allocation. Now, there are some caveats: TIGER 21 membership is sharing their total portfolio, not just managed. So, by design, it will probably lean more into illiquid assets.

But let me ask you something: The TIGER 21 membership base is comprised of elite investors, entrepreneurs, and company builders. Their approach is working. However, because the members of TIGER 21 also make direct deals outside of Wall Street, they have the freedom and flexibility to invest in more unique, direct opportunities.

1. It doesn’t fit the fee model neatly

2. It isn’t a scalable investment strategy when you have to allocate billions (you have to deploy an excessive amount of capital)

3. It isn’t a scalable investment strategy because it isn’t a truly passive strategy

4. It doesn’t fit nicely into Modern Portfolio Theory, and its advantages get discounted in the risk/return matrix (illiquidity is a feature, not a bug - but the modeling assumes illiquidity is a problem)

5. The wealth management business has an inherent CYA-ness - the number 1 rule is not to get fired. Nobody will fire anybody if Blackstone underperforms. You may actually fire your advisor if they invest you in a no-name fund that blows up.

And even when Wall Street tries to do real estate, it must go into mega-funds because of the aforementioned sizing issues. This means you’re not capturing best-in-breed smaller managers because they cannot deploy the amount of money Wall Street needs.

So if you’re serious about building wealth, it’s important to be disciplined and systematic with your approach, and to look beyond the Street!