Opinion

The Great Debate

An emerging opportunity in U.S. housing

April 22, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Deep breath. Ok, here goes: For the first time in a very long time U.S. housing might actually be a reasonable buy on a five-year view.

As a long-time housing bear and someone who believes there is still considerable pain to come in the U.S. economy and banking system that is quite a hard thing to say.

However historically cheap long-term fixed-rate financing (less than 5 percent on a 30-year mortgage) and the prospect of some nasty inflation a year or two out, both courtesy of current Federal Reserve and government policies, make owning a real asset that is debt financed a lot more attractive than would have been the case just three or six months ago. For full coverage of the U.S. housing market click here.

What I am not doing is calling the bottom of the housing market; there are still reasonable falls to come on top of the 20 percent or so declines we have already seen nationally.

Futures show an expected decline of about 4 percent on the Case-Shiller 20 City national index between May of this year and May 2010 and a recovery to current levels only in 2012. I actually think it might get a good bit worse than that; there are still substantial repossessions that need to filter through, unemployment will surely rise from here and an economic recovery, when it comes, will likely be pretty weak. This is not an argument about the housing cycle turning and leading us, as it has so many times before, out of recession.

Having said that one very important thing seems clear: the Federal Reserve will do what it takes, and very possibly a good deal too much, to stop deflation.

Indeed, there is a reasonably high risk that inflation will get away from the Fed or that buyers of Treasuries take a pass. This inflation will be very handy for those who’ve leveraged up to buy housing.

Economist Tim Lee of Greenwich, Connecticut-based pi Economics, a long time “deflationista”, now thinks that while deflation may still have the upper hand, current policies will inevitably be inflationary.

“The amount the Fed is doing will be enough to cause inflation, and I think that’s even if economic growth is fairly poor,” Lee said in an interview last week.

Broad money supply in the U.S. is rising at a more than 14 percent annual clip, the fiscal deficit will be about 13 percent of GDP this year and the Fed’s balance sheet has ballooned.

A REASONABLE ALTERNATIVE

And while housing won’t exactly thrive in a period of high inflation and low growth, it may perform reasonably well compared to the alternatives. Government bonds will get whacked by inflation and stocks may do a bit better than bonds over the medium term though they will suffer as the quality of earnings declines.

Stock market investors now are conflating the end of the very steep declines in the economy with a return to productive investment and a sustained rebound that will drive profits. That might be an optimistic reading. Stocks do offer some protection against inflation but they are far from a perfect hedge.

It is also heartening that investors are returning to many of the hardest-hit real estate markets in the U.S., such as Florida. These are people who do not rely on a lot of leverage and are happy to take the very positive cash flow from rents.

Mortgage rates are at an all-time low despite the absolutely terrible performance of recent vintage mortgages. This partly reflects the very low interest rate environment, but also is a function of the Fed intervening directly into credit markets in order to drive down rates to below where they very likely would be if investors demanded the kind of premium you would expect given recent experience. It also remains true that if things become really terrible, you can always walk away from a loan in the U.S., though it is pretty unlikely that this comes into play for a borrower who puts 20 percent down now.

Remember too that stabilization in the housing market is an absolute precondition for a recovery in banking and the economy generally, and it is clear from the steps the Fed and government have taken, in driving rates down and keeping the taps of government insured loans flowing, that they understand this and will act on it.

They will likely not be successful enough to save some of our largest banks, and all too successful from the standpoint of staving off deflation, and for someone borrowing at five percent interest for 30 years to buy a house in a part of the country which is not dependent on financial services, they may be very successfulindeed.

It almost certainly won’t look that way in a year, but could well in five or seven.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –

Comments
16 comments so far | RSS Comments RSS

Very interesting article. I have been looking into investing in the US for ages ( buy to rent market)and have hopped from city to city; Chicago, Detroit, Houston. Researching all the house prices, and watching them fall in value. Recently checked out Detroit, and they are extremley cheap, the upside, downside is the area they are located !! Still buying a 4 bed house for $15k is not too bad a risk

Posted by Lawrence Adler | Report as abusive
 

What you say makes sense especially as high inflation is coming. However, I think that you are probably a year early in your call.

Posted by D Rumsfeld | Report as abusive
 

So you are saying that housing is one of the better investment opportunities because high-inflation will strike.I wouldn’t actually call that an investment, it would be more a means to store your wealth that will make you lose less than if you’d store the wealth in other forms, especially money.Maybe you are right. But certainly only if you can afford to buy without mortgage.

Posted by Robynne | Report as abusive
 

you are right, Sir, at two conditions:a) having the mony to put down, even 10%b) having a sure job for the mortgageand unfortunately i’ve none of this conditions

Posted by t.geithner | Report as abusive
 

Well James, you’re right about not calling a bottom. Even those adverse to market-timing knows one cannot time the bottom this year. Therefore why buy now? Knowing full well the money will be locked up for 5 years without income, subject to further downside risks. It cannot even be used to store value. Surely there are other asset class that will perform better than buying US housing now. Unless, of course, one buys on emotion – that most beautiful dream house now on the market for a killer price. :-)

Posted by The Real Deal | Report as abusive
 

Well, I agree that it’s too soon to call a bottom in the housing market. However, I do think now is a good time to buy. I am buying, however, my time frame for any real appreciation is 7-10 years out. If your not willing to hold the asset for that length of time I wouldn’t consider it.

Posted by GJames | Report as abusive
 

I agree with your general argument.A couple of points of discussion: you can’t just look at ‘broad money supply’ sans debt as a precursor of inflation. Debt is money, too. If debt is now being destroyed faster than the Fed and Treasury can shovel corporate losses over into the public losses column – which is their main tack – then we really have a decrease, not a net gain.Second is that it is important always to remember that inflation and deflation affect different people differently. Inflation may help a young wage-earner who is making house payments, but may decimate the savings of a retiree who bought a place in the sun.

Posted by wally | Report as abusive
 

We’ve always had rental properties and even bought some during the peak of the market. Rentals haven’t suffered a lot (Orlando, FL) and it appears that existing home sales have picked up, which of course is due to lower prices and decent mortgage rates.I think the market would pick up even more if the feds actually required the banks that we bailed out, to actually lend money as opposed to hanging onto it to make their books look better.

Posted by Elton | Report as abusive
 

DO NOT BUY REAL ESTATE. This is a complete wipeout. At best we are half-way through the sell-off and VALUES WILL FALL ANOTHER 30%-40%. I study this for a living and submit that we not see today’s values for another 20 years. WE ARE IN THE MIDDLE OF A MASSIVE DEMOGRAPHIC SHIFT AND SIMPLY DO NOT NEED AS MUCH SPACE AS WE HAVE. Real estate is in part a manufactured good and we have way too much capacity.

Posted by David Dent | Report as abusive
 

Paying off 4.5% 30 year mortgage with rent and 50 cent dollars is too good to pass up. Check you individual markets but in my market the remaining foreclosures are not worth buying. If you can find a deal that will rent for the cost of the monthly payment (or close) buy it NOW.

 

If you are buying a house to live in, you should do it now. Recognize that the market price of your house might decline by 10% or 15% over the next three years. After that the price should increase by an average of 1.5% to perhaps 2.0% per year. As to the amount of equity you have in the purchase, something on the order of 20% to 30% would be rational. If you wait a year, you’ll probably do better on price and poorer on the interest rate.

Posted by Sigmund Krieger | Report as abusive
 

uh …… lemmme clue you guys in on something ……. if we have humongous inflation coming ( and we do , just look at this St Louis Fed graph out today here : http://research.stlouisfed.org/fred2/ser ies/SBASENS ) , then you will see interest rates go to moon …. and if we get back to 8-9-10% mortgage rates , be rest assured prices for real estate fall into crapper in short run as costs of buying a house go to moon . Bernanke is going to lose potentially 100′s of billions in his quest to corner the market in US Treasuries .

Posted by divvytrader | Report as abusive
 

Long-time landlord here (not an accidental one) and investors need to realize that external factors can kill you:1. As an evil landlord, local government sees a big target on your back, and will raise property taxes, fees, licenses, etc, while paying consultants to study affordable housing.2. Gov again. What will the neighborhood you buy in be like in 10 years? What will values, rent be? What kind of people will be your renters?3. How are rents going to increase if wages are stagnant, Gov is subsidizing new competition with below normal mortgages and cram-downs, and household formation is declining with demographics and unemployment? For me, taxes and insurance have increased more than rents for years.4. The GSEs. New FNM and FRE (and soon FHA) guidelines say the GSE’s may rent their foreclosures instead of listing them in a bad market or sending them to auction. Soon your own taxes will be going to subsidize FNM and FRE so they can undercut you in renting out their foreclosures. As soon as people realize that FNM and FRE wont evict them for non-payment of rent either, nobody will want to rent from me or any private landlord. By 2010, the Fed Government may be the biggest landlord. You wont read this on the MSM either.

Posted by dave | Report as abusive
 

Well as always we have the glass half empty, glass half full views. Which basically means that people don’t know what the future will bring.It basically comes down to taking a punt in the property market, and if you can buy a nice house in a nice area for £10k ish, that will give you a good return, Buy it.

Posted by Lawrence Adler | Report as abusive
 

Keep Dreaming.Maybe if we all click our ruby slippers together…maybe we can get the american middle class to come back…

 

If you look back in history for inflation periods, the incomes went up and prices went up and real estate very slowly went up. However, the ability to pay back became easier with increased income. Inflation will drive up interest rates which will weigh on real estate values.

 

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