How Markets Work

We’re going to sunny Florida this morning (not me, the story). A beautiful place and one that has made a lot of people scratch their heads recently.

Particularly regarding the real estate market.

Let’s dive in and learn how markets work.

I’ve talked with quite a few people recently who think Florida’s real estate market is over valued.

I am not an expert in FL real estate valuations, so I can’t definitively say it is or not.

But I do understand taxes, balance sheets, and financial planning concepts for high net worth and ultra high net worth families.

Furthermore, I think fleshing out what is happening in Florida will teach us a lot about how markets work.

If you go to Zillow right now and head to Naples, you’ll see numbers that are hard to comprehend.

And then, if you add up the value of one block of homes, and the numbers can quickly hit the 10s or millions, if not hundreds of millions.

The Florida real estate market has been on fire, and people keep buying these properties.

What is going on? How is this sustainable? I though interest rates were suppose to slow down the real estate markets?

Math decides to enter the room with the Johnson family (a hypothetical family).

They own a successful company in Seattle Washington that they’ve steadily built up over the past 20 years.

They have a few locations around the North West and net $1.5m per year, on average.

They plan to sell their business in a few years and are shooting to make $15 million on the sale.

The family has done extremely well.

But they have a large tax problem, and Florida can help.

How Tax Dynamics Drive Real Estate

If they sell their business, the state of Washington is going to grab 7% on the proceeds of the sale.

So rough math, that’s about $1m in taxes to the state.

They work with a great wealth manager and start discussing what to do as they understandably aren’t keen on paying that kind of money to the state.

Their advisor suggests moving their residency to Florida as there are no state capital gains there.

They already love taking vacations down their and would love to spend more time there to get away from the rain.

The light bulb goes off – “So we buy a $1m place in Florida and spend 6 months there, we can save $1m in taxes, we basically get the place for free.”

“Yes” says the advisor.

“Hmm, ok, interesting.”

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Ok, so that is just a microcosm of what is happening in Florida right now. The Johnson family isn’t too concerned about paying an extra $200,000 for a property when it can help them save $1,000,00 in taxes, and also help them ease into retirement by spending more time in the sun vs the rain in Seattle.

This is playing out every day in Florida – people are moving for tax reasons.

They are “overpaying” for real estate to saving a lot more on their tax bill.

So, while yes, the real estate market in Florida is expensive, the reasons why go deeper than just historical precedence.

The Complexity of Market Forces

This is precisely how the markets work – they are far more complex than meets the eye, people buy, sell, and hold assets for reasons that do not seem logical at first, then when looked at a deeper level, things start to make sense.

I’ve given this example so many times through my career but if someone needs a new vehicle, they are going to sell their assets to buy that new vehicle, regardless of what is happening in the markets. It may not be an optimal time to sell, but if you need a car to bring your kids to school, well, you are just going to buy one.

The key mindset to understand, as an investor, is there are layers to understanding the markets.

In our Florida example, layer one would be “it’s over valued”. Layer two would be the tax arbitrage that is happening.

When I am personally looking at the markets, I am always taking in what is happening and seeking to find the deeper trends and movements that justify what is happening.

This deeper level look helps us looks through the noise and find the true source of market moves that can at times defy our understanding.

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I hope this deep dive helps you understand the markets while also giving you a push to always go deeper and look for truth in the markets.