Speculators Disappear as Luxury Investments Lose Their Luster

Focus: ALTERNATIVE INVESTMENTS

Steven Pomeranz Image Steven Pomeranz Host, The Steve Pomeranz Show

The economy is firing on all cylinders, but why are luxury investments fading? Here's how the decline will affect you even if you’re not invested, writes Steve Pomeranz, CFP, who is the host of an investment program on NPR affiliates.

The U.S. economy appears to be firing on all cylinders with near full employment, hardly any inflation, and a soaring stock market. Still, there are signs of drag in luxury markets like high-end condos, fine art, wine, and collectible cars, among others.

These markets have become more appealing in recent years to rich investors and traders who are wary of low-interest bonds and high-flying stocks, yet don’t want to let their cash just sit on the sidelines.

Of course, they may also have a passion for art or cars beyond whatever monetary value these items may have as investments ready to be sold at the right price, but it’s safe to say that many of them do see luxury products as an alternative asset class to bonds and equities.

One major difference with alternative asset classes is that they tend to be more difficult to assess and price their risk compared to stocks and bonds.

The problem today for some of these investors is that this risk is now at their door, and the value of their luxury property appears to have stalled out and may now be in the process of deflating. The returns for these asset classes are starting to sag and, in many cases, are actually tumbling.

The venerable British real estate company Knight Frank tracks a luxury investment index, and in 2016 it posted its weakest performance since 2009. Andrew Shirley, the editor of this report, said, in effect, that across most sectors of the luxury investment universe buyers are becoming more cautious about paying too much for their acquisitions.

In fairness, it’s not all bad news for all luxury investments. Luxury company stocks are beating average market returns and there are still occasional stories of moon-shot bids at art auctions.

For example, a Basquiat just sold for $110 million at auction but, by and large, the trend is in a downward direction.

One asset class that is getting punished especially badly right now is high-end real estate, from luxury condos to mansions and extravagant city apartments.

There’s an oversupply of luxury realty inventory in cities like New York and Miami and across the country.

What defines the luxury and ultra-luxury price range varies in different locations, but the story is largely the same: The speculative buyers and foreign investors who have been responsible for much of the demand in luxury property have largely disappeared.

The recent strength of the dollar has made investing in U.S. property far more expensive for Brazilian, Chinese, and other foreigners, and they’ve responded by retreating from this sector of the market. The bottom line is that luxury real estate markets around the country now appear to be “correcting”—which is usually defined as a 10% decline—and it remains to be seen how much further prices will have to fall to bring the buyers back.

Some realtors specializing in luxury property in Miami are saying that the market is even worse than the crash of 2007.  

Not only that, but there are many who believe that things will have to get worse before they get better. Miami is suffering from a glut of luxury condos, and building is ongoing, with some estimating that it currently has enough inventory to last for the next 6-8 years.

One of the greatest risks in building these large projects is the disconnect between current demand and the time it takes to finally complete a project. What may look like a good bet today, can sour quickly if demand dries up due to an economic recession or just plain old overbuilding. Demand doesn’t even have to fall off a cliff. Considering the amount of borrowed money needed to get these projects off the ground and completed, even a slight softening can bring things to a crashing halt.

I’m not saying that is where we are today, but developers are getting desperate, offering huge incentives to brokers for sales. Realtors are advising clients to cut their asking prices dramatically if they want to sell in the next 2 years. Otherwise, they should expect to hang on to their property for a lot longer.

In New York City, the pain was being felt most severely in homes listed for over $20 million. According to broker Darren Sukenik, “Nobody is drinking the Kool-Aid anymore. When it was go-go times and people were just throwing money around, people bought into that dream.”

Of course, the people buying into the dream that he refers to had very large stacks of money sitting around that they could play with by speculating on extremely expensive real estate.

A Russian oligarch lost hundreds of millions of dollars on art investments in the past few years, but does that actually make a dent in the art market, and even if it did, who would be hurt other than big-time art collectors? What effect does any of this activity or lack of activity, for that matter, in luxury markets have outside the rarefied circles of the super-rich?

It’s hard to see a direct effect on the middle class, though in a seeming paradox, luxury real estate’s decline, instead of spreading a contagion of lower prices to the non-luxury spectrum, may actually increase the price of properties below the luxury class.

The reason being that would-be luxury buyers are now seeking greater value at lower prices, increasing demand for sub-luxury property.

With all of this activity, whether it’s luxury or sub-luxury, there are jobs at stake as well. These include profits and losses for luxury goods makers and the myriad of other business directly or indirectly to the real estate market.

On the positive side, if you happen to win the lottery or inherit a boatload of money in the next few years, you may be able to pick up a high-rise condo in South Beach, a vintage Ferrari, or a Picasso painting for a steal in the next couple of years.

To find out more, go to www.stevepomeranz.com