Why You Should Buy a House

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.

Annualized Price Inflation of Specific American Houses Since 1913

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

The Daily Reckoning