02/11/11 Gaithersburg, Maryland – In a recent Daily Reckoning column, “Buy a House…Then Buy Another” I told you about John Paulson, the billionaire hedge fund manager who switched from betting against housing to now telling people they should buy a house…or even two houses.
Bill Ackman, the successful hedge fund manager behind Pershing Square Capital Management, is another case in point. He, too, saw the housing bubble before it popped. He made a now famous argument as to why the stock of MBIA, which guaranteed the slop coming out of the mortgage factories during the bubble, was going to crumble. And it did, netting Ackman more than $1 billion. MBIA was, at the time, one of the five biggest financial institutions in the US.
But now, like Paulson, Ackman is bullish on US housing. He recently made a compelling case focused on five key areas. Let’s take another look at the case for housing and add more meat to the bones.
First, housing is cheaper now than it’s been in a generation. The median income is now 78% above what it takes to qualify for a fixed-rate loan on 80% of the median purchase price. Mix that with housing prices that are 30% off their peak nationally and low mortgage rates and you get a cocktail of affordable housing.
The second key part to the argument is to look at the number of forced sellers. As a buyer, it is more favorable to you if you buy from people who have to sell. Makes sense right?
In housing, about 30% of sellers are in foreclosure or approaching it. These are national figures, so in some markets, there are more forced sellers than others. “Buyers benefit when conventional sellers compete with distressed sales,” Ackman says. “Las Vegas is an extreme example, where distressed and nondistressed sale prices have nearly converged.”
Ultimately, this process is good for the home market. As Ackman points out, “Overpriced and overleveraged homes will be transitioned to new, stable owners at more reasonable prices and on more favorable financing terms.” From such stable bases, new bull markets are born.
Third, we look again at financing terms and costs. Blue chip companies don’t get the deal you get when you buy a home. You can borrow at about 5% fixed for up to 30 years, putting down only 20% (3% for FHA loans). You have no prepayment penalties – so you can, if rates fall, refinance. But if rates rise, you can sit tight. And you can deduct the interest from your taxes. It is a sweetheart deal.
Rates, by the way, haven’t been this low since the Freddie Mac survey began.
This also makes for a great inflation hedge. Housing, as an asset class, performed extremely well during the inflationary 1970s. Today’s borrowers have similar upside. Ackman demonstrates how even small price increases multiply the equity in your house, assuming conventional 80% financing and a 10-year holding period:
People who are skeptical of housing think prices won’t rise anytime soon. But as this exercise shows, you don’t need much of an increase. Even a 1% annual increase over a 10-year period gives you 2.7 times your money. Anything better and your upside soars!
So far, the case for housing is familiar and easy to grasp. Now we get to the fourth and fifth pieces of the argument, which clinch the case, in my view: the long-term supply and demand for housing. Let’s start with supply.
What can we say about the supply of houses in the US? There is a lot of it right now, which is what weighs down pricing. This is what creates the opportunity for buyers. But there is more. “Builders have sharply reduced their construction capacity, increasing lead times when the market does recover,” Ackman says. “It can take three-seven years to get land permitted in many of the more desirable markets.”
This means that we can’t turn on a switch and get a lot more houses. As with mining, it is important to consider how long it will take to bring new supply to the market. As investors, we want new supply to come slowly.
The number of housing starts is lower than at any time in at least the past 50 years. New construction is about half the long-term average. Again, good news for investors in housing, since this means that new supply is growing very slowly.
Now let’s turn to demand. Demand for new housing is depressed. Home ownership rates are back down to pre-bubble levels. But housing demand – based simply on demographic trends – should rise inexorably for years to come.
You take the growth in households – driven by population growth – and apply a home ownership rate. Demographically, the US is still a growing country. By 2030, there will be 370 million Americans. Even using the long-term average home ownership rate means we’ll need 1.1-1.2 million new single-family homes per year.
Here is another chart that puts supply and demand together and captures how depressed things are. The chart shows housing starts. The dotted line shows you projected annual demand of about 1.2 million homes per year. So you can see the big gap as the market digs into existing supply. At some point, housing starts will rebound. This could happen as early as this year…
The prime beneficiary of any rebound would be the homebuilders. There are several interesting possibilities in homebuilder stocks, such as Lennar (NYSE:LEN) or MDC Holdings (NYSE:MDC). I don’t think we need to rush to buy any of these just yet, but they are on the radar.
There will be other beneficiaries of a housing rebound, too. There are all those depressed building supply stocks. There are the many little local banks that finance housing. Each has been an area we’ve sought to avoid, but they have become promising fishing holes.
The risks seem low. We’ve already seen the bubble collapse. A second collapse is unlikely. The market is adjusting to a more normal level. All is to say that as contrarian as it seems, housing is now a good bet for the long term.
Paulson and Ackman – two great investors – made fortunes betting against housing, but now they’ve changed their views as the market changed. Maybe we should too.
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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Buyer beware. As the affordability index chart included in this story graphically illustrates, the exact same argument “housing is cheaper now than it’s been in a generation” could have been made in 2008. And 2009. And again last year. And I think they’ll be even more affordable a year from now. There are 6 houses for sale within 3 blocks of me in my subdivision. At least 3 of them have been for sale for a full year. And I’m in Eastern Tennessee, an area that supposedly hasn’t been hit hard by falling home prices.
I’m waiting a bit longer before buying another house. With all the delayed foreclosures in the pipeline, I’m thinking that we MAY see the bottom by this time next year. Possibly late this year, but either way, I’m not in any hurry.
One thing to remember is that buyers are no longer able to purchase houses without a down payment.
That was one of the causes of the housing bubble. Anyone capable of fogging a mirror was allowed to buy a house no down payment needed.
How many potential homebuyers are sitting on enough cash to make that 15 – 20% down payment?
Probably not that many.
And what happens to prices if rates head toward 10% or above? The time to buy is when rates are high, not low
Hmm. Looks like the housing bubble people are cranking up for another run. Pure propaganda.
Housing will get cheaper yet.
I cringe when any writer uses “median income” to formulate a picture of prosperity!!
Whatever dope you’re smoking I hope they categorize it as a vegetable so I can participate!
Totally unrealistic or reflecting on the “real” income of most Americans today.
I did the simple interest calulation on a $100,000 property where 20% was the initial investment at a 1% annual compounded return for 10 years and that equated to $110,462.00. That means you now have a property that is worth $10,462 more than you paid for it. That’s hardly 2.7x the $20,000 down payment.
Even if you factor in the tax savings on the interest from the $80,000 mortgage and at 28% tax braket that would roughly be around $10,000 per year additional net income.
But, then you have to rent it out, and having 2 rentals myself you have to figure everything. $454 per month mortgage payment at 5.5% over 30yrs (if you can get that rate on an investment property), then let’s say $100/mo HOA dues, and another $150/mo taxes and insurance. That’s $704 per month. If you can get $900/mo rent you’re making $200 per month or $2400 per year. That’s without accounting for repairs and maintenance, tenants moving out and damaging stuff, eviction costs if necessary and a number of other expenses that can arise without notice. That’s if you handle everything yourself. A property management company will get the first months rent and 10% per month management fee. Do the math! It doesn’t add up.
I’m all for residential investment real estate, but if you’re not buying $100,000 distressed properties that are worth $150K after you’re done dumping $25K into them for upgrading or repairing you’re not going to see anywhere near the returns in this article. You would need 5% annual increases over 10 years or you will have to put over 50% down to make it worth it.
If someone could prove me wrong I’d love to know where my math is incorrect.
I already found an error in one of my calculations. The tax savings would only be around $10,000 over the 10 year period NOT per year. Sorry!
hikiwawa’s got it right…a house is nothing more than a levered bond and as interest rates go up “affordability” at current prices is going to go down. Unless of course Chris, you can convince the market to hold these rates forever.
So this kid’s got an MBA and has written a book and prospered in the boom years…is he old enough to recall what happened to housing when interest rates soared 30 years ago? Nope-but I am-and I also agree that hickiwawa’s nailed it-
http://www.thecomingdepression.net/main-street/bankruptcy-main-street/will-we-see-double-digit-interest-rates-from-the-1980s/
I’m over 60 and I’m a registered Investment Adviser and a former accountant/CFO and I can tell you it’s much too soon to buy. Sure, houses are cheaper, but there are more trends that are going to make them cheaper yet. The stock market will tank far below where anyone thinks, social moods, fear, demographics etc. along with huge unoccupied # of houses, foreclosures not peaking yet AND the likelihood of deflation, not inflation will drive bond yields down and likely mortgage rates. When things do bottom, and that’s likely 3 to 5 years yet, you’ll have plenty of time to find your dream house as prices slowly start to climb. And, did I mention, much tougher financing requirements to qualify for a loan. I usually like Chris’s column, but I’m buying his argument that houses are cheap now.
mr paulson just spent $24.5 million on a spec house in aspen.
the housing sector that depends upon new hires may take 18
years to recover.
Housing won’t reach bottom until 2015 at the soonest, wait, be patient, you’ll get two then for the price of one today.
I’ve asked Chris before if he has read Financial Reckoning Day. He doesn’t respond. Maybe there is a dog-eared copy around the office he could look through.
The predictions in the book are for lower housing prices and for reasons that haven’t even happened yet! e.g. the baby-boomers retiring and interest rate increases.
A few years ago the MG also pointed out the expense of maintaining these McMansions is going to be huge. How many people will line up to buy a 3500 ft^2 home in need of new flooring, a roof, some paint, a new kitchen and some landscaping. Oh yeah, interest rates may be 11% and taxes rates much higher.
It is strange that I say this since I just bought a house six months ago, but it is small, cost less than a 100k and I asked them if I could put 100% down. HA!
He’s apparently also not old enough to know that when Wyle E. Coyote first falls off the cliff, that little ledge he lands on- that looks like he’s hit the ground until the scene pans out- is going to snap off, fall, and then flatten him when he ultimately does hit the bottom.
The bottom line, Chris, is that as long as there is the degree of market manipulation by the bankster/corporate/gov unholy alliance we see today, you are playing their game by their rules. You might hop along a winner for a period of time- but markets in the short term will not determine the important parameters that decide whether you ultimately win or lose. Someone at a large conference table surrounded by others of your “betters” will.
The Mogambo may be funny, but his is an undeniable truth- the markets will eventually have their way in assigning value to homes, stocks, bonds etc., and right now, but for trillions and trillions in intervention, the Dow has a date with 5,000, so does gold, and in some places, so does your neighbor’s house.
My attitude: Why not wait for a period of several quarters of rising prices. What’s the hurry?
It’s not like trying to catch move in the futures market.
The cheaper Real Estate becomes in this country, the better the standard of living will become for those who buy in the future. Un-affordability is not a goal Americans should strive for.
Housing prices will continue to decline on the coasts where prices are the highest unless there is substantial wage growth, which I don’t see happening. Where I live median housing prices are well over $566k and median incomes are about $76k. It doesn’t add up.
Best housing resource on the net is here:
http://patrick.net/housing/market.html
Declination of housing prices is various in different areas and it also depends on the condition of the property and of course some other conditions. The point is that you can always negotiate the price if you want to make a good deal. The important thing is also what are your plans with this property either you want to sell it out or to live in. I recommend you to think carefully before you make any decision to buy a property.