Mike S. Shapiro, Chairman HOM Real Estate Group, Co-Founder + Managing Director Plunk, Forbes Author + Podcast, Speaker, Coach, Investor.
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Despite all we hear about asset classes increasing in value across the board and the unprecedented strength of the U.S. economy, as a real estate entrepreneur and former professional trader, here’s what keeps me up at night: I believe we only know part of the story and that the piece we’re missing — our current inability to account for “invisible” or “hidden” leverage can have significant implications for our country’s economic health.
The hitch? We likely won’t know until it’s too late.
In a nutshell, “leverage” is the term for funds that are borrowed (outright or against an asset) with a goal of using those funds for further financial gain. Applied wisely, leverage has fueled wealth and economic growth for centuries; however, as with any debt, when things go south, borrowers can find themselves underwater, financially speaking. This is simply the reality of our economic system.
The risk is amplified when investors leverage assets that are inherently more difficult to track — such as cryptocurrencies, fine art, collectible cars and wine collections — and that are likely used far more often than our economic data shows. Trickier still, this kind of borrowing masks the multiplier effects of risk and debt, and it tends to be prevalent during times like these when we’re feeling optimistic and asset valuations “seem” to be on a never-ending upward trajectory.
‘Invisible’ Leverage And Residential Real Estate
In January 2021, Zillow reported that the value of residential real estate in the U.S. was about $36.2 trillion (this is a best estimate, always in flux and likely higher by now). According to a May 2021 report from the Federal Reserve Bank of New York, there’s about $10 trillion in outstanding mortgages and home equity. And Statista reported that, in 2020, Americans owned about 65% equity in their homes.
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On the surface, this adds up. But here’s why I think this is an issue: I pay close attention to property listings and sale prices and, in my opinion, there are far more multi-million-dollar listings and sales than there are people with the income levels needed to buy and maintain them. Just putting together the necessary down payment of 20% — $600,000 for a $3 million home, for example — is an enormous expenditure.
Where’s the money coming from? Certainly, there are people who level up and reinvest in homes that cross this price threshold with each purchase of a new primary home. There are also international and corporate investors. But from my perspective, there have to be a lot of people who are over-leveraging crypto and NFTs and margin accounts to buy these multi-million-dollar homes — and because it’s hard to track, we don’t know how much debt actually exists.
The risk is amplified as leverage gets compounded, too. Here’s an example: Let’s say I own a home and have $50,000 in available equity. I take that out because with current low interest rates, I believe that I can make enough money investing elsewhere to make it worth the cost of the home equity loan. So far, all trackable.
Let’s say I use this $50,000 to purchase crypto, which I then leverage again (for anywhere from 2x to 5x or more). Soon, the original home equity has been leveraged several times and has become less trackable. I then leverage this to purchase a multi-million-dollar home.
My theory is that Americans probably own much less residential real estate equity than the data shows — more like 10% to 20%, rather than 65% — which we’d see if “hidden” leverage could be factored in.
This is just one example of how “invisible” leverage makes our financial foundation less stable than it appears.
Wealth, Or Just An Illusion?
Just as we know from history that what goes down will go up, we also know that what goes up eventually comes down. What happens when this occurs to thousands of highly leveraged people at once — or even hundreds of thousands or millions? If we don’t have all the data, our economic models are inaccurate at best and broken at worst.
At the basis of this is that for many investors, “invisible” leverage has become one more way to gamify assets in the hope of quick (and potentially substantial) returns. While it has likely created some real wealth, in my opinion, it has also created the illusion of wealth. This is important because when times are good — and many investors have only known good times — it’s too easy to get caught up in the wave and believe that the ride will last and last.
My advice? Now could be a great time to grow your wealth, but before you jump further into the swell that is our current economy, make sure your financial life raft is secure.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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