Nils is a rich guy, with a net worth of something like $20 million. Our CPA friend and Nils's nephew Lars is considerably less wealthy, but he has much more than the average person. Lars has many very wealthy clients. He's happy himself being less wealthy but quite comfortable, but he does find it interesting to think about how rich people get and stay rich. It's sort of part of his job to help people do this.
So he's started looking at his list of clients for clues. This is not done out of envy but of (mostly professional) curiosity. He realizes he has at least one preconception upon taking on this unscientific study. OK, let's make it sound a little more scholarly and say Lars has a hypothesis.
His strong guess is that there is a positive correlation between large wealth and the proportion of real estate in one's holdings. No, he isn't thinking of his several big-earning lawyer and physician clients who have a mansion, a large mortgage, and little else to show for their efforts. Lars is looking at those with sizeable net worth, the difference between their assets and liabilities.
To Lars it doesn't necessarily appear that real estate grows in value a lot faster than other investments. It's several other things about it: illiquidity, leverage, and something he calls groundedness.
For one, you can't spend real estate. If Panza has $1 million in cash and stocks and Cervantes the same value of equity in real estate, Panza can quickly create funds to buy an expensive new horse. Cervantes, hobbled by illiquidity, has to watch his investment stay in place.
Second is the benefit of leverage. Even if Panza keeps his fund invested, it will earn $75,000 if it grows by 7.5% in a given year. Let's say Cervantes' $1 million equity consists of a $2 million property with a 5% mortgage for $1 million. If his holding grows by 7.5% in value, that's $150,000 of gain minus $50,000 in interest on the mortgage, for a net advance of $100,000. Lars realizes that this part of the theory has been severely tested in recent difficult years in real estate.
The third part of the hypothesis that Lars calls "groundedness" (no pun intended) is more subjective. Real estate investment brings real-world things like troubled tenants and overcharging service providers, testers of will and teachers of lessons. If an investor can deal with these things, he or she will have feet on the ground, and balance. The world of securities is much more intangible and free of earthly hassles. One can be a bit more head-in-the-clouds and still operate there. Lars is betting on the more grounded type.
So Lars's study starts with a hypothesis. He'll be happy to have it proven or not. He's just looking forward to the analysis.