Gary Eldred:  To value properties, most buyers focus on past sales prices. If they glimpse the future at all, they simplistically project past market conditions forward. But for your analysis, Rick, you look into your crystal ball.

Rick Dryer: If by my crystal ball you mean layering the probabilities, I believe you are right.  Though I'm no Nostradamus, through systematic study, I can see which areas of the country should experience above-average rates of appreciation.

Gary Eldred: Why don’t you use the past to project the future? What’s wrong with the approach that most homebuyers and investors rely on?

Rick Dryer: Let me address your first question. We’ve discussed Peter Drucker’s book, The Age of Discontinuity.

Gary Eldred: Yes. Drucker showed that all forecasts incorporate assumptions founded upon a base of knowledge, cultural attitudes, belief systems ,existing technology as well as a basketful of other data—some recognized, some not.

Rick Dryer: Right. If, for example, you want to see where property prices are heading, closely examine your base of assumptions. Bring background factors into light. Go outside your normal paradigm and persistently try to discover underlying changes that will disrupt, flatten, or accelerate trend lines.

Gary Eldred: The executives of Kodak and Polaroid should have paid more attention to Drucker’s message. They were woefully unprepared to cope with the advance of digital technology.

Rick Dryer: Right. What was once cutting edge technology thirty and forty years ago has been crushed by the new digital age in photography. You didn’t want to be selling even the best buggy whips in the early 1900s when Henry Ford was rolling out his first cars. In real estate, too, millions of dollars have been lost by investors who failed to anticipate discontinuities—the Texas oil bust of the mid-1980s, the California housing recession of the early 1990s that resulted from cutbacks in defense spending in response to the fall of Communism and the Soviet Union.

Gary Eldred: Dodging bullets is good, of course. But Rick, with your Right Place Right Time™ strategies, you prefer to look on the bright side. While you keep your defenses alert, you mainly want to identify emerging changes and discontinuities that will push up property values.

Rick Dryer: History shows that when you verify an emerging trend and you hop on board, you can make a lot of money. There is no risk free way, but isn’t there a difference between risk and risky?

Gary Eldred: Before we get into the specific trends and discontinuities that you see emerging, contrast your approach to the valuation method used by most property buyers.

Schumacher tells of a fourplex that he bought in 1964 at a price of $35,000... in 1994 that property would have sold for $1.6 million... At the time he bought that fourplex, other investors were probably turning the deal down because the seller wouldn’t let it go for $30,000.

Rick Dryer: As we have discussed, typical buyers try to estimate a property’s market value. If they negotiate a price that is less than that figure, they think they have scored a good deal. They win bragging rights. Their ego gets a boost. In fact, some of the real estate gurus flat out tell investors, “Walk away from any deal that you cannot close for at least a 20 percent discount off market value.” But tell me, Gary, what outcome should investors really prefer—a quick discount today of $10,000 or $20,000, or an extra gain of $100,000 or more from  appreciation?

Gary Eldred: That reminds me of David Schumacher, a wealthy California real estate investor. He makes a similar point in his book, Buy and Hold. Schumacher tells of a fourplex that he bought in 1964 at a price of $35,000. In 1994 (when Schumacher wrote his book), that property would have sold for $1.6 million. He then asked his readers, “Would it have mattered if I had paid $100,000 instead of $35,000?” He answers, “No. That property still would have earned me a fortune.” By hypothesizing a 1964 purchase price of $100,000, Schumacher exaggerates for effect. However, at the time he bought that fourplex, other investors were probably turning the deal down because the seller wouldn’t let it go for $30,000.

Rick Dryer: I love Mr. Schumacher’s Buy and Hold strategy. In wasting a lot of time looking for the mythical, unicorn-like, below market purchase, instant profit stuff, nearly everyday I see potential investors pass up true bargains.  Looking for the bargain unicorn they pass up the race horse.

Gary Eldred: I do that same mistake over and over.  People delay, procrastinate, or walk away from great properties, all because they don’t envision the longer term profits that lie before them. They lose out to investors with a better vision of the future.

Rick Dryer: Of course, we’re not saying that investors should pay any price at any time.

Gary Eldred: No, that’s simply the greater fool theory.

Rick Dryer: Maybe I should return to that Warren Buffet quote that captures our point. Buffet says that he would rather buy a company with a great future at a fair price than a less promising company at a bargain price.

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
                              -Warren Buffett

Gary Eldred: Over time that fair price for a great company or a great location will look like a tremendous bargain. Also, in my experience, Rick, it seems that when properties sell for steeply discounted prices, they frequently represent those that are likely to appreciate at a below average rate. Or they may even present substantial risk if  a stagnant or declining market provokes the discount.

Rick Dryer:  Right. Incidentally, those discounts could be reflected in relatively high cash flow, because temporarily, the acquisition cost to income on a loser property can be strong. We’ll discuss in a later Dialogue how, counter intuitively, too much cash flow at purchase can be a red flag. You know, Gary, your point relates to another problem with the discount-to-market approach. The bargain price buyers think they are getting may prove illusory.

Gary Eldred: That’s because market value itself only captures the past, not the present—much less the future.

Rick Dryer: That’s right.  Those comp sales figures that agents, appraisers, and investors rely on may not reflect the current market. Even when the comp sale dates are just a month or two old, their sales contracts may actually have been signed three or four months earlier. At least 6 to 8 weeks--sometimes more-- elapses from the date the buyer and seller first sign a purchase contract and the date their sales price is eventually closed recorded in the public records.

Gary Eldred: I’ve seen deals in falling markets where prices 10 percent to 20 percent below  comp sale prices did not reflect in any real sense of the word, a bargain. Those supposedly “below market” prices actually reflected an emerging market turndown that the naive buyer failed to recognize.

Rick Dryer:  No doubt about it. If your only touchstones for value are past sales prices, you not only could be passing up a better opportunity elsewhere, you may be buying into a market decline. We’ve seen that already in certain Florida markets this year.

Gary Eldred:  So, Rick, what do you emphasize when you envision the future?

Rick Dryer: We look at many factors, but demographics rank as one of the most essential.

Gary Eldred: Demographics refer to dozens of characteristics such as income, wealth, age, sex, race, religion, height, weight, education, etc. Which do you look at?

Rick Dryer:  Well,  not much on height and weight! In a nut shell, we look at any population characteristic that points to an increase in the demand for housing.

Gary Eldred: Such as the creative class?

Rick Dryer: That’s right, sometimes called knowledge workers.

Gary Eldred:  Explain the meaning of the term creative class.

Rick Dryer: The term creative class was ushered into the demographic lexicon by Professor Richard Florida in his bestselling book, The Rise of the Creative Class.

Gary Eldred: You know Professor Florida, don’t you?

Rick Dryer: Yes. We invited him to speak at our Right Place Right Time™ seminars.

Gary Eldred: So what does he and his creative class concepts have to do with real estate investing?

Chicago and Boston have lost tens of thousands of factory jobs, yet the economies of those cities have shown tremendous growth as well as steep increases in the prices of houses and apartment buildings.

Rick Dryer: Let me begin by posing this question—Why have Terre Haute and many other Midwestern cities lost their once vibrant economies?

Gary Eldred: The standard answer for Terre Haute is that the previously  good-paying jobs in the factories and mines have disappeared.

Rick Dryer:  Mere symptoms, not root causes. Chicago and Boston have lost tens of thousands of factory jobs, yet the economies of those cities have shown tremendous growth as well as steep increases in the prices of houses and apartment buildings.

Gary Eldred: Okay, let me try this as a root cause. The economy of Terre Haute has failed to keep pace with other areas because I moved away.

Rick Dryer: That’s right. I’ll bet that you and most of the other bright, ambitious, and entrepreneurially-inclined youths of your day  decided that you wanted to live someplace other than Terre Haute.

Gary Eldred: We sure did.

Rick Dryer: Where have you lived?

Gary Eldred: Vancouver, Charlottesville, Silicon Valley, Chicago, Dubai, and several cities in Florida.

Rick Dryer: Did you find a good job in the factories or mines in those areas?

Gary Eldred: No. I wasn’t looking. There aren’t many factories or mines in most of those cities. Anyway, I have only lived in areas where I wanted to live. The job, if any, was secondary. Today, much of my work is based at 40 Wall Street, New York City, but I live in Florida.

Rick Dryer: Have property values in the areas where you have lived increased much?

Gary Eldred: They have all skyrocketed.

Rick Dryer: Now you know why I am interested in those places that will attract up-and-coming members of the creative class. In his research on economic development, Florida (the professor not the state) found that the people he called the creative class drive economic growth and economic growth pushes up property prices. Florida also described the creative class in a way that matches your behavior, Gary.  He says that creative classes actually select their locations in which to orient their search for work rather than move  wherever a job happens to be located.

Gary Eldred: As I also recall, Professor Florida writes of the three Ts—Talent, Technology, and Tolerance. Compared to the general population, members of the creative class display higher levels of education; they are at the forefront of new technologies; they are innovative, open to new ideas, and entrepreneurially inclined; and they are tolerant of differing beliefs, attitudes, and lifestyles.

Rick Dryer: Good memory.

Gary Eldred: Thanks. But it’s not too difficult to describe the creative class because most of the people I call friends and associates fit this description.

Rick Dryer: Birds of a feather flock together.

Gary Eldred: That “flock-together” tendency holds import for area analysis, doesn’t it?

Rick Dryer: Right. Name any creative class enclave and you will find others who want to move there because they know they will find kindred spirits.

Gary Eldred: How does the concept of “discontinuities” enter this picture? Why won’t the same creative class enclaves continue to grow as they have in the past?

Rick Dryer:  One reason—they are unaffordable. In most of the longstanding creative class areas, entry-level home prices quickly head north of $500,000. Move-up residences usually start at $1 million or more. The younger (and temporarily less affluent) members of the creative class must locate elsewhere.

Gary Eldred: Such as North Carolina?

Rick Dryer:  North Carolina presents a good example. The trend has already started. North Carolina has nationally acclaimed universities such as Duke, Davidson, and UNC, solid elementary and secondary schools, research triangle, progressive attitudes, and an appealing climate accented by mountains, beaches, and forest. Our socio-economic research studies rank North Carolina near the top in its ability to attract the creative class.

Gary Eldred: $200k to $300k won’t buy a decent condominium in Vancouver, Boston, or San Francisco. How much for an upscale entry level home in Charlotte?

Rick Dryer: It varies, but generally you will find a wide choice within the $200,000 to $300,000 price range.

Gary Eldred: Executive type estate homes?

Rick Dryer: $300,000 to $750,000—maybe $1 million if you really want extravagance.

Gary Eldred: I recently looked at a 1,400-square-foot, fixer-upper in Palo Alto, California for $1.3 million.

Rick Dryer:  That explains why large numbers of those productive, creative folks who might like Palo Alto, San Francisco, or Boston are now choosing North Carolina—especially Charlotte and the Research Triangle areas.

Gary Eldred: Well, what indicators other than the creative class point to future economic growth and increasing property prices?

Rick Dryer: That’s a good question we can address in later conversations.