03/04/11 Laguna Beach, California – Chairman Ben Bernanke promises to “promote inflation.” We take him at his word…and so do the commodity markets. The Reuters/Jefferies CRB Index of commodity prices has soared 80% from its lows of early 2009 – touching a fresh two-and-a-half-year high yesterday.
But even if commodity prices weren’t soaring (yet), we would take the Chairman at his word. After all, trusting a central banker to promote inflation is like trusting water to flow downhill.
Inflation is not good for very many things, but neither is it all bad. For example, inflation is great for debtors who are trying to cheat their creditors. Inflation is also great for the folks who happen to own the stuff that’s inflating.
The traditional winners during inflationary cycles are hard assets like gold and real estate. The traditional losers are long-dated bonds and, of course, the currency in your wallet. Every cycle is different, but we have no reason to doubt that the upcoming inflationary cycle will produce the typical distribution of winners and losers. Hard assets will win; the currency in your wallets and purses will lose.
If, therefore, inflation is taking root in American soil once again, how should the forward-looking investor prepare?
“Buy gold,” is the time-honored answer…and we would not quarrel with it. But an alternative answer, especially this time around, might be: “Buy a house.”
Consider the table below, which tracks the price history of specific houses in the United States that were standing in 1913 – the year the Federal Reserve came into existence – and are still standing today. While this sample of homes is not scientific, it does illustrate housing’s value as an inflation hedge. On average, this collection of American homes produced the identical annualized return as gold.
Obviously, the actual returns on housing would be lower than that of gold, since housing is subject to taxes, maintenance, etc. On the other hand, have you ever tried to raise a family inside a gold bar?
Maybe compromise is the best course of action: Buy a house and then put some gold bricks inside. That’s right, we said, “Buy a house.”
As faithful readers would be well aware, we have not always been so sanguine about the US housing market. From early 2005 through early 2007, your California editor published numerous columns predicting the demise of the housing bubble.
May, 2005: Affluenza
May, 2005: Houses and Spouses
June, 2005: The After-Life
October, 2005: No Way Out
May, 2006: Homeless
August, 2006: The Housing Bust Begins
October, 2006: A Housing Bubble White Paper
January, 2007: When Realtors Become Waiters
Your editor also took to the airwaves to offer his gloomy observations and grim expectations for the housing market.
In May of 2005, he showed up at CNBC studios to take part in a segment about the housing market entitled “Bubble: Fact or Fiction?” Your editor argued the “fact” side of the debate, while Jerry Howard, the CEO of the National Association of Home Builders (NAHB), argued the “fiction” side.
Unfortunately, as we noted in our essay “Outside Day Reversals and the Return of the Housing Market” in Wednesday’s edition of The Daily Reckoning, Mr. Howard’s forecast did not pan out. The residential housing market began to implode almost as soon as the two of us unhooked our microphones and stepped away from the CNBC cameras…and that’s no fiction.
Four months after this CNBC interview, your editor put his home in Pound Ridge, New York, up for sale…and waited. The wait seemed like an eternity. Seven months later, the wait ended…favorably. A few days after escrow closed, in May of 2006, your editor published the following remarks:
Ben Bernanke and Alan Greenspan both agree that the housing boom is over and that it will begin an “orderly” decline. We agree that the housing boom is over and that home prices will begin to decline, but we aren’t so sure about the “orderly” part.
Throughout the seven months that prospective buyers streamed through your editor’s home, it became increasingly clear that the prospective buyers were becoming increasingly price-sensitive…and picky…and arrogant. Before our very eyes, literally, we watched the balance of power in the housing market shift from seller to buyer…
A home is a wonderful thing to own; but it is also a wonderful thing to sell…especially when prices are slumping and buyers are disappearing…
In October 2006, when we published a white paper, entitled simply, “Housing Bubble,” we observed:
By now, everyone knows the housing boom has busted. Even the National Association of Realtors admits as much… The only issues worth pondering, therefore, are how low prices might fall and/or how long the bust might last. Without trying to be too specific, we’d guess that prices will fall a lot and/or that the bust will last a long time…
Without easy credit, and lots of it, real estate could never have achieved its epic valuations. Credit not only enabled first-time buyers to “stretch” a bit, it also enabled and emboldened speculative buyers, speculative builders, second-home buyers, second-home builders and every other variant of housing market participant/speculator.
But because financing became so exotic, and speculative participation in the market became so great, the simultaneous unwinding of both will be as pleasant as hanging out with your in-laws during a root canal…
We all know what happens NEXT. But we just don’t know how bad it will be.
Please allow your editor to offer a prediction:
- Home sales continue plummeting
- Prices begin to plummet
- Exotic loans begin to squeeze over-leveraged homeowners
- Prices plummet some more
- A bull market in housing begins in 2020…or maybe a little sooner.
As a post-mortem to the Housing Bust White Paper, we published a column in January, 2007, entitled, “When Realtors Become Waiters.” To lead off this column, we remarked, “Out here in the Golden State, jokes like the one below are becoming all too common:
Question: What’s another name for a California real estate agent?
Answer: A waiter.
Home sales volumes in California are sliding sharply…
Why should we care what happens in California? We should care because California epitomized the excesses of the late great housing bubble. It was here in California where quirky, high-risk mortgages flourished; it was here where the median home became unaffordable to 84% of the average residents; and it was here where actors became waiters, then became real estate agents…only to become waiters again.
What happens in the California real estate market, therefore, might anticipate what will happen in the rest of the country…and that’s probably not good news… The increasingly dire conditions of the mortgage industry suggest that a genuine recovery remains a delusional hope. The willingness to lend and the willingness to borrow are both in retreat. This is how cascades start…
Over the near-term, therefore, do not be surprised to hear an occasional California diner call out, “Hey waiter! Could we please see a menu…and a copy of your newest listings?”
Four years have elapsed since your editor published the column above. During that timeframe, home prices have dropped substantially…and they continue to drop. But now that the bubble has burst, and the housing market is devoid of hope, your editor has become slightly more hopeful.
Undoubtedly, the housing market will continue to produce ample pain and suffering in the months ahead…along with ample anxiety in the years ahead. But it is possible, if not likely, that the pain and suffering will yield a highly satisfactory reward.
Read on…
Eric Fry
for The Daily Reckoning
Eric Fry
Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research — institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
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The annualized return in the chart is JUST the appreciation. If you buy a rental property that has positive cashflow, AND holds it’s value to inflation, the return could be a lot more. Even better if you are able to negotiate a discount with a motivated seller.
As a secondary consideration, many properties that cashflow positively can show negative returns because of depreciation allowed by the IRS (most houses are not worth $0 after 27.5 years).
But, since most cashflow rental properties are not the most asthetically pleasing, and most people don’t want to put in the effort of being a landlord (a customer service business), many forego the additional profit.
In comparison, as an object, housing is static whereas gold is portable. Dealing in housing ignites more administrative cost, municipal rent and rates, consistent maintenance and etc. Unlike stock which you could dispose within minute in an online bourse, a house may turn haunted if left for sometime. For a dynamic investor, especially where fund is a scarcity, a mere 4 or 5 pc return is not something worth mentioning; besides buying a unit as shelter. Gold is nearest to cash when liquidity is concern. Hassle free, dispose or acquire at your wish.
The chart is horribly misleading.
You don’t list cities like Detroit.
If you bought a house in some parts of Detroit you would have lost 100% of your “investment”
You also don’t address the huge glut of homes that will remain available on the market today and on. Couple that with the facts that one, we will probably never see lenders give out such easy money for the purchase of these many, many properties again…two, in twenty years, once the baby-boomer generation has dwindled, the glut will only continue with demand, and most importantly…three, WHEN the US dollar loses it’s reserve status, and demand is almost completely wiped out due to the depression it will cause, most of America will be lucky to have a tent, let alone a home—so there goes the neighborhood along with your narrow theory! No, sadly I don’t see how we will possibly get a rise in home values for quite some time to come! That is unless we just bulldoze 50% of them first! In that case, count me in!
That said, farm property and other undeveloped property purchases might actually make some sense.
Why you should not buy a house:
The so-called recovery is a fraud. Uncle Ben is simply trying to reinflate the blown out tire that is our economy using the printing press. But he hasn’t fixed the hole, and there is no tread left.
Not much to run on, for those who argue that the current state of affairs will generate SUSTAINABLE demand for housing at current prices. We’ll soon be 1/3 underwater, and I’ll bet we don’t wind up far from 1971, at least in inflation-adjusted terms.
No, the correction in housing is generational, and has a long way to go to adjust to market conditions.
On the other hand, silver is stll a bargain.. and we’re still waiting for Bill’s farmland retreat article…
I’m with the Mogambo and BBB on this one.
Until Wall Street is forced to endorse capitalism and the law, the existing policy of socializing the losses while allowing the profits to be privatized will remain and the housing and foreclosure crisis will continue depressing housing values, it is not a good time to buy or own a home.
For an alternate solution, go to http://unitedinprosperity.org to sign the petition removing the taxpayers from paying for unregulated capitalistic mistakes of Wall Street and negative equity homeowners.
The solution protects the current holders of outstanding mortgages in the return of their capital and homeowners by sharing the financial loss based on the law.
Mr Fry has some smart readers I’d say, both optimistic and not so optimistic! Good comments to ponder.
Susan, I’ll sign your petition as soon as the FNMA/FHLMC scams are shut down. The government should clean house before they start beating up the private sector for merely complying with bad policy going back to the Carter administration.
Besides the glut of homes coming on the market from the foreclosure debacle, there is a demographics-driven avalanche coming. In the Eighties the Boomers drove prices up when they came of age to be homeowners. Now they are empty nesters and are selling the 4-br 2.5bt colonial because taxes and utilities are too much.
Prices will go down.
According to information on Boom/Bust blog, the housing market won’t reach bottom until 2015 at the earliest, and likely will be closer to 2018. So there is no hurry to buy a house or real estate at this point, as there is further drop in value to come. Better to invest your money is Agency REITs like AGNC CYS that are yielding near 20% in dividends, minus the headaches of owning property, that will lose more value yet.
4.44% on housing. 4.44% on gold. What was the average annualized return on the DOW from 1896 to 1984? Maybe all long term ROI’s are about the same.