01/10/11 Gaithersburg, Maryland – Investment ideas are cyclical. They go dormant for a while, then revive, like fashions or cicadas – obeying their own curious rhythms. During the past few years, rare was the investment thinker who said you should buy a house. Housing was in a bubble that was deflating.
But the investment seasons turn. Today some smart investors are once again saying you should a buy house. John Paulson is one of them.
You may know him as the man who turned the greatest trade of all time. Betting against the housing market, he netted a cool billion dollars for himself in 2007. One fund he managed rose 590% that year. Today, he is one of the richest men in America.
His advice today is very different. “If you don’t own a home, buy one,” Paulson said. “If you own one home, buy another one, and if you own two homes, buy a third and lend your relatives the money to buy a home.”
That’s a strong endorsement. It sounds similar to the advice another investor gave his audience in 1971, at the dawn of one of America’s biggest housing bull markets. The investor was Adam Smith (George Goodman) on The Dick Cavett Show. Here is a snippet from that conversation:
Smith: The best investment you can make is a house. That one is easy.
Cavett: A house? We were talking about the stock market. Investments…
Smith: You asked me the best investment. There are always individual stocks that will go up more, but you don’t want to give tips on a television show. For most people, the best investment is a house.
Cavett: I already own a house. Now what?
Smith: Buy another one.
It was good advice. In the 1970s, US stocks returned about 5% annually, which failed to keep pace with inflation. Still, it was an up-and-down ride. In 1974, the stock market fell 49%. But here are the average selling prices for existing homes in the 1970s as inflation heated up:
1972 – $30,000
1973 – $32,900
1974 – $35,800
1975 – $39,000
1976 – $42,200
1977 – $47,900
1978 – $55,500
1979 – $64,200
You can see that housing held up pretty well. And think about the effect of a mortgage on 80% of that house in 1972. That would mean $6,000 in equity, a sum that went up fivefold in eight years. It’s hard to find a better inflation fighter than that. Granted, today’s market is different, but still.
Apart from this, you might also reflect on the fact that it is quite absurd today to think that anyone can buy an average house for any of these prices – and that, too, is the point. The average price today is $257,500 – even after the great collapse in the last few years.
“If you have a 7% mortgage and your house is worth half a million dollars,” Adam Smith writes, “you may gripe about shoes and lamb chops and tuitions like everybody else, but your heart isn’t in it.” Your heart won’t be in it because you’ll be in fine fettle with your house.
Of course, you can do a lot better than 7% today. For the first time, the rate on 30-year mortgages slipped below that on the 30-year Treasury bond. You can get a 30-year mortgage at little more than 4% today.
Factoring in mortgage rates, housing affordability is back to where it was in September 1996. Then mortgage rates were 8% and the average price of a home was $171,600. As Murray Stahl writes: “One can actually buy a home for a monthly payment that is not very many dollars different from the monthly payment one would have needed in September 1996, when rates were significantly higher.”
Adjusted for inflation, Stahl points out that the payment for an average-priced home today is about 30% lower than it was 14 years ago.
The advice of Paulson and Smith starts to make sense now, doesn’t it?
Essentially, real estate is a way to buy now and pay later. And the case for housing extends to other property types, too. Owners of quality real estate are getting deals on mortgages that we are unlikely to see for a generation.
In my investment letter, Capital & Crisis, I haven’t recommended a real estate stock since 2006. That may soon change. I’ve spent quite a bit of time looking over blue chip real estate stocks. Real estate, after a long absence from the menu, is back on.
Regards,
Chris Mayer
for The Daily Reckoning
Chris Mayer
Chris Mayer is managing editor of the Capital and Crisis and Mayer’s Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012 Chris will release his newest book World Right Side Up: Investing Across Six Continents.
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Uh, Chris, Have you read Financial Reckoning Day?
It is said that real estate is the basis of all wealth. A well-timed purchase and resale of a house may have made lots of money for those speculators during the last boom. The operative word there is well-timed…
I’m living in a very modest house that I personally built and fully own. My house that is very ready for solar and wind power. The construction is the best quality that I could perform and I’m proud of my work. Many, if not most houses built for speculation contain shortcut construction (in spite of the building code inspections). The point is that the recommendation to buy “a house” implies houses are as alike as a share of stock or ounce of gold–not true.
Many who buy a house think the down payment is the difficult part of home ownership. Taxes, utilities, maintenance, insurance and depreciation start from day one and don’t stop until a bigger fool is found.
When the banks are really suffering, I may be tempted to invest in real estate. I can wait.
Chris,
One one level, I share your point of view that “investing” in buying a home or several may be a way to achieve a decent return over time.
However, I have a much different point of view, noted by the previous poster-Drunk and Disorderly. That is, Property Taxes, and municipal services which are going to get way out of hand before this is over. Cook county IL is seeking to raise taxes 60% to make up for budget shortfall…and that’s just a county.
Houses are tax magnets. I get to pay a bankster an interest rate for a mortgage and get maybe 30% of it back on my income tax. Well hush my mouth! Same for property tax. The drain only abates when you reach 65 and most states freeze your rate. My mom, who’s 90 has been killing them. When she passes, if I one of us takes over the house, the tax will go from around 3K to about 12K. The millenials are more mobile, and I don’t think buy into the myth perpetrated since WW2-that home ownership is anything like a good idea.
The D&D poster also has it right as respects quality. The homes/McMansions currently available in ample foreclosure supply are crap construction. It would be better to find a home built in the 30′s, and over time upgrade utilities. Maybe if I can turn it into a church and duck the tax burden/muni fees it might be a way to go. Right now, you have better odds in Vegas.
Sounds fine if you are secure in your job. So many of us aren’t however. There may be rising inflation, but wages may NOT rise. The monetary value of the home may go up whereas the true value of it could dramatically decline if we have further economic dislocations as are predicted.
You might have a god rate on a house of rising value but with no one to buy the hopuse because they may be unemployed!
Assuming the federal government continues to spend $2T/year in deficit spending and the Federal Reserve keeps printing trillions beyond their current $12T already printed, then yes housing might be an OK investment. Especially when you consider all that unfunded spending has already pushed many stocks and commodities to decade highs as wages ( for non Wall Street or government employees )continue to fall and inflation tsunamis move forward.
Other wise, I would recommend reading the articles in dailyreckoning !
It is true that house prices surged year
after year in the 1970′s, but that is after they had not moved for a whole generation before that.
The value of my Brooklyn house is still triple of what it was in 2000 while incomes are up perhaps 20 percent at best.
National house prices are currently at fair value and it is hard to get excited about this asset class.
I agree, but I have worked it differently over the years. Buy a house put a little paint, etc. on it and resell it carrying the mortgage. I have averaged 20% gain at the sale and am able to get much better interest than the bank will pay. Your earnings can be spread over the length of the contract. The buyer is then responsible for taxes, maintenance, etc. For me it has been a win-win.