Why You Should Buy an SFHRP!

What is an SFHRP?

It is an out-of-favor asset class that has attracted the attention of David Ackman, a hedge fund manager with a fondness for contrarian investments. “The best investments we have made are the ones no one else would touch,” Ackman explains. That’s why he’s so hot on SFHRPs.

SFHRP is Ackman’s acronym for “Single Family Home Rental Property.” They are cheap, he says. They are a buy.

Ackman argues that SFHRPs possess the identical investment attributes that strongly performing stocks typically possess. Says Ackman:

We believe we’ve identified an investment with:

1)    A low valuation – The lowest valuation in at least a generation.
2)    Forced sellers – A large number of distressed transactions.
3)    Extremely attractive financing available – High loan-to-value, low-rate, fixed-rate, long-dated, non-recourse debt, pre-payable without penalty.
4)    Favorable long-term supply dynamics – Short-term oversupplied market, but long-term supply is controlled.
5)    Favorable long-term demand dynamics – Demographically driven demand growth.
6)    Out-of-favor – Currently, this is a somewhat shun the asset class.

Ackman’s bullish perspective flies in the face of the pervasive pessimism about home-buying. “Experts Say Housing is a Lousy Investment and it Always Will Be,” an August 2010 headline on Yahoo! Finance declared. “The US Housing Market is Headed for a Complete and Total Nightmare,” another financial news service predicted. And just last week, a CNNMoney headline warned: “Why Home Prices Could Fall Even More.”

“There’s a substantial risk of home prices falling another 15%, 20% or 25% more,” chimes in Robert Shiller, a Yale economist and half creator of the Case-Shiller Index of home prices.

No question about it; housing is out of favor, which is why Ackman is licking his chops. But the doom and gloom surrounding the US housing market does not persist for nothing. It persists for a reason…or rather, for many reasons. Therefore, any would-be bullish analysis of the housing market must begin by considering the main reasons why the gloom might persist for a while yet.

Reason #1: The housing market simply sucks. There’s no sugar-coating it. “Home prices in a majority of major US cities…have fallen to their lowest levels since the housing bubble burst,” the Associated Press reported last week, “and analysts expect further declines this year… In December, prices fell for the sixth straight month and for the eighth time in the past 11 months. Foreclosures are also expected to increase as the year goes forward.”

Reason #2: Inventory continues to swell. “There’s just way too many homes out there relative to demand and we’re not going to see that change anytime soon,” says Joshua Shapiro, chief US economist for MFR Inc. Lenders continue to repossess massive numbers of homes, even though they are trying not to. Despite foreclosure moratoriums, workouts and government-subsidized refinancings, the monthly foreclosure totals remain extremely high.

Percentage of All Mortgage Loans in Foreclosure

Glass-half-full types will note that foreclosures, while still extremely numerous, have declined from peak levels. Unfortunately, this modest improvement may be short-lived. After a temporary dip in “Foreclosures Started” early last year, this metric is bouncing back up toward record highs.

New Foreclosures Started Each Quarter, As Percentage of Mortgage Loans Outstanding

At the same time, “negative equity” continues to rise – a trend that contributes to rising defaults and foreclosures. According to a recent report from Zillow, home prices in the fourth quarter of last year plunged 5.9% compared to the fourth quarter of 2009. As home prices fall, negative home equity inevitably rises. Not surprisingly, therefore, negative home equity surged in the fourth quarter of 2010. 27% of borrowers are now “underwater” on their mortgages, according to Zillow, up from 23% in the previous quarter.

Rising negative equity does not guarantee rising defaults and foreclosures. But “underwater” homeowners tend to lack the mortgage-paying enthusiasm of their above-water counterparts. Net-net, the enormous volume of foreclosures – completed, newly started and prospective – is weighing heavily on the housing market.

Ratio of Foreclosures to Home Sales

As a result, the ratio of foreclosures to home sales remains extremely high. As these foreclosed properties continue to flood the market, they continue to depress prices. More troubling is the fact that this ratio has been trending higher during the last six months.

Reason #3: Demand refuses to recover. Household finances are in tatters. The dual bear markets in housing and stocks since 2007 have erased a whopping $12 trillion of national wealth – a sum nearly equal to one year of US GDP. On the other side of the balance sheet, meanwhile, we Americans have been struggling mightily to reestablish some kind of balance…by reducing our debts.

If the wealth doesn’t return, getting rid of debt is the only way to regain or improve solvency. Unfortunately, wealth disappears much more easily than debt. Compared to the $12 trillion of household wealth that evaporated during the last two years, only $1 trillion of debt has disappeared from consumer balance sheets – a decrease of only 7.4% from the peak consumer debt reading.

So even though homes are cheaper, prospective homebuyers are less capable of buying a home than they were a few years back.

Reason #4: Mortgages are much more difficult to obtain today than they were during the boom years. Lenders aren’t lending as generously. Consequently, borrowers aren’t borrowing as ravenously. The volume of purchase-mortgage originations continues to slide…and shows no sign of rebounding. There are stories of legions of individuals who wish to buy a home – and who legitimately possess the wherewithal to do so – but are unable to obtain a traditional 30-year mortgage from anyone.

Applications for a Home-Purchase Mortgage

Painfully aware of these trends, homebuilders’ confidence in the housing market languishes near all-time lows. The National Association of Homebuilders’ Index measures three categories of housing market activity: Foot traffic from prospective buyers, current sales and builder expectations for home sales during the next six months. Taken together, these metrics reflect little sign of a rebound.

Home-buyer Traffic vs. Consumers Who Plan to Purchas a Home in the Next 6 Months

Given these dire data points for the housing market, is there any reason to buy a house? Maybe.

Although the chart above shows that homebuilder confidence remains at low ebb, the chart also shows a sharp recent uptick in the percentage of consumers who say they plan to buy a home during the next six months. Mortgage lenders may not accommodate those plans, but at least the number of prospective buyers is on the rise.

Admittedly, signs of a recovery in the housing market remain sparse at best…and home prices do not lack for reasons to fall even further. But the housing market is not without hope, as we will see in tomorrow’s edition of The Daily Reckoning.


Eric J. Fry
for The Daily Reckoning

The Daily Reckoning