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Guest Post: Is Housing An Attractive Investment?
Submitted by Chris Martenson contributor Charles Hugh Smith
Is Housing an Attractive Investment?
In a previous report, Headwinds for Housing, I examined structural reasons why the much-anticipated recovery in housing valuations and sales has failed to materialize. In Searching for the Bottom in Home Prices, I addressed the Washington and Federal Reserve policies that have attempted to boost the housing market.
In this third series, let’s explore this question: is housing now an attractive investment?
At least some people think so, as investors are accounting for around 25% of recent home sales.
Superficially, housing looks potentially attractive as an investment. Mortgage rates are at historic lows, prices have declined about one-third from the bubble top (and even more in some markets), and alternative investments, such as Treasury bonds, are paying such low returns that when inflation is factored in, they're essentially negative.
On the “not so fast” side of the ledger, there is a bulge of distressed inventory still working its way through the “hose” of the marketplace, as owners are withholding foreclosed and underwater homes from the market in hopes of higher prices ahead. The uncertainties of the MERS/robosigning Foreclosuregate mortgage issues offer a very real impediment to the market discovering price and risk. And massive Federal intervention to prop up demand with cheap mortgages and low down payments has introduced another uncertainty: What happens to prices if this unprecedented intervention ever declines?
Last, the obvious correlation between housing and the economy remains an open question: Is the economy recovering robustly enough to boost demand for housing, or is it still wallowing in a low-growth environment that isn’t particularly positive for housing?
Factors Affecting Housing Demand
The demand from investors can be roughly bifurcated into two distinct camps: those buying distressed homes to “flip” them for a profit as market conditions improve, and those buying homes and multi-unit buildings for rental income and future appreciation.
The “flippers” are counting on continued demand by non-investor buyers, such as first-time buyers. The rental housing investors are counting on continued strong demand for rentals from those who lose their homes to foreclosure and must now rent, as well as from household formation resulting from population growth.
Both lines of reasoning are implicitly based on continuing Federal and Federal Reserve support of the housing market via first-time buyers’ incentives, such as low-down payment FHA and VA-backed mortgages, and the Fed’s continuing support of mortgages via low interest rates and the roughly $1 trillion in mortgages that the Fed purchased in 2009-10.
The assumption behind any forecast of improving demand and higher prices is that private demand for housing and mortgages will slowly replace government-stimulated demand.
If either of these conditions deteriorates -- that is, if government support of the housing/mortgage markets declines due to the rising pressure to trim fiscal deficits, and private demand does not appear to replace it -- then the forecast of steadily improving markets weakens.
While direct government support of the housing market via ultra-low rates and guaranteed FHA/VA mortgages is well-known, the rental housing market is also implicitly supported by government transfers; i.e., cash distributed by the federal government in Section 8 rent subsidies, extended unemployment benefits, etc.
These transfers now make up an unprecedented share of household income, as this chart shows:
(Source)
Common sense suggests that the pressure to trim unprecedented (in peacetime) Federal deficits -- roughly 8%-10% of the nation’s gross domestic product (GDP) for four years running -- will eventually impact all government spending, including transfers and housing/mortgage subsidies.
Combine the prospect of declining government transfers with the deterioration in household disposable income since 2007, and the household income picture darkens considerably.
Why these factors matter to investors is self-evident: If households receive less income, then they will be less able to afford either a mortgage or high rent.
The fact that inflation has outpaced disposable income should also give real estate investors pause. If rents have by and large kept pace with inflation (rental markets are local, so any national figures are generalizations that may not apply), then this divergence between income that has flat-lined and rents that have risen with inflation suggests a future convergence: Either incomes rise to align with higher rents, or rents decline to align with flat-lined income.
Though most believe the Fed has the power to counter deflationary forces, it is worth recalling that in the early 1930s, rents declined by roughly 40% as demand and incomes fell. Prudent investors should ponder the possibility that incomes won’t rise to align with higher rents but that rents will decline to align with flat-lined income.
(Source)
The general expectation in the real estate market is that whatever declines in home and rental prices could happen, have happened. This is reflected in this composite chart of the home price futures market:
(Source)
Clearly, the futures market is anticipating a bottom in home prices in mid-2012 and a gradual improvement in home valuations from then on.
On the “not so fast” side of the ledger is the possibility that both home valuations and rents have been artificially inflated or propped up by government intervention and stimulus, and that the positive effects of those gargantuan transfers of cash and risk have run their course.
Though the Fed has publicly stated its goal of keeping interest rates near-zero until 2014, investors should ask what might happen when that prop under the housing market is removed; i.e., what possible consequences might flow from higher mortgage rates?
Some believe that housing demand will surge as rates start to rise, driven by potential buyers who were waiting for the bottom in prices and rates to re-enter the housing market. Once the bottom is clearly in for mortgage rates, as this line of thinking goes, these buyers will flood back into the market.
Others worry that rising rates could crimp affordability, especially if housing prices resume their climb, as anticipated by the futures market.
Though the general assumption is that the Fed can engineer super-low rates essentially forever, investors should be wary of assuming that an omnipotent Fed can control the mortgage market. The Fed only sets the Fed Funds rate; it does not directly set mortgage rates. Its only other lever over mortgages is direct purchases of mortgages and mortgage-backed securities in order to prop up the market, and many observers believe there are now political limits on what the Fed can do. In other words, the Fed could theoretically buy another $1 trillion of mortgages on top of the $1 trillion it already owns, but the unprecedented expansion of the Fed’s balance sheet is already drawing criticism.
Thus the future trend of mortgage rates is an unknown. If housing values take another dive, then the availability of mortgages may decline even if rates stay low. Buyers of mortgages will have to factor in the risk of default and/or declining rental income, and that calculation is especially sensitive when the rate of return is already paltry.
The thesis for higher demand for housing and rentals is based on these assumptions:
- The economy is on a sustainable uptrend of growth
- Employment is also on a sustainable uptrend
- Inflation will remain low
- Household income will soon resume an uptrend
- The Federal government will continue issuing unprecedented amounts of cash transfers to households
- The Federal government will continue to fund housing subsidies and mortgage guarantees
- The Federal Reserve’s plan to keep interest rates low for the foreseeable future will also apply to mortgage rates
- The MERS/robosigning Foreclosuregate issues will all be settled without disrupting the housing market
- The bulge in inventory will be liquidated as new supply (i.e., newly built homes) stays well below demand (sales)
- New household formation will drive demand for rentals and homes
While it is widely assumed that new household formation parallels population growth (which is remarkably consistent), the following chart reveals that household formation is more correlated to recessions and periods of prosperity.
(Source)
We can see that peaks in household formation correspond rather well with peaks in economic growth, while the valleys correlate with recessions or periods of slow, uneven expansion.
While household formation has returned to the trendline, the long-term trend is clearly down. Other than the euphoric outlier of the housing bubble, the series displays the classic signs of a downtrend — lower highs and lower lows.
If the US economy turns out not to be decoupled from the sagging global economy, then this chart suggests another bout of recession could cause household formation to fall below its 2008 nadir. That would not be supportive of demand for housing, either home purchases or rentals.
Conclusion
The picture for housing is decidedly uncertain, and confirmation of the ten trends listed above will be needed to establish a clearer forecast.
In Part II: Key Insights for Those Buying Real Estate as an Income-Generating Investment, we inspect the specific factors that most frequently determine whether a real estate investment is successful or not.
Too often, when buying real estate for its income-generating potential, small investors make costly underestimatations or miscalculations that materially handicap the returns on their invested capital. In this type of sector, being forewarned is forearmed.
Click here to access Part II of this report (free executive summary; enrollment required for full access).
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Homes have become LIABILITIES, not assets.
Your Liable for Taxes
Liable for maintenance
Liable for insurances
Liable to sidewalk maintanance
Liable for water
Liable for power
Liable for the yard work
Liable for the tenants
Hell Id soon enough live under a rock than buy a house again.
If the Govt gets out of my business and lets me own the property Fee Simple without taxes etc.... then MAYBE just MAYBE I would buy more property.
What good is it to "own" land/homes when in reallity its really just "renting" from the govt + bank!
Mortgage + taxes = Rent = We are all slaves in one giant shit tax farm, its sickening.
You don't / can't own anything in this world, not even your damned body anymore, what with the govt telling you what you can and can't eat and what medications / vaccines you MUST put into your body and what other shit they put in your water/food to keep you stupid and docile.
I know I am going to play Captain Obvious here, but anyway:
Housing is a product just like anything else. When its price goes up, those who want to sell (which, in US, is the financial system & some - let's not be afraid to use this word - private speculators ) see gains, while those who want to buy ( who incidentally in large part are the American middle class, i.e. the little guy ) take a loss. It's as simple as that.
And MSM is wholeheartedly taking the side of the sellers. It continously drumrolls how a 'healthy housing market' ( read: high prices ) is essential to everything. I wonder when they equally start cheering rising oil prices? Food prices? ( 'rising prices of broccoli signify improving economic conditions, inverst in broccoli NOW!' )
I recently bought a 3 bedroom, 3 bath 2,000 sq foot place out in the country on 10 acres. It needs some paint and carpet but for the most part is in good shape. The land is good, about half hardwoods and half pasture. It sits at the end of a 3 house lane and it borders a 300 acre duck and deer hunting property, a few hundred acres of timber management land is across the road.
I only paid $54,000 for the place. The kicker is,, F****ing GMAC hasn't sent me the title yet. I paid for it outright in January. I'm thinking of getting a real estate attorney.
What state is it in?
Georgia
I recently bought a 3 bedroom, 3 bath 2,000 sq foot place out in the country on 10 acres. It needs some paint and carpet but for the most part is in good shape. The land is good, about half hardwoods and half pasture. It sits at the end of a 3 house lane and it borders a 300 acre duck and deer hunting property, a few hundred acres of timber management land is across the road.
I only paid $54,000 for the place. The kicker is,, F****ing GMAC hasn't sent me the title yet. I paid for it outright in January. I'm thinking of getting a real estate attorney.
I should say something about this. I know of a friend who followed Peter Shiff's warnings and sold his Miami Beach condo for big bucks in late 2006. Then he bought a new 3 story townhouse in FLL and put 50% down. It went from $750K to $166K right now because of Knauf Chinese drywall. At least half a million dollars I (oops he) put down is like frigging gone, poof and he's underwater big time. A house is a good investment? Mine (oops his) lost 85% in 4 years. Most people would say it was stupid for me to buy a house when I knew the market was going down, but I put 50% down expecting that to be the worst it could get and I was close to retirement. Someone wrote that bad things you expect to happen take longer than you expect them to happen, and when they do it's much worse. This poor friend had 80% of his nest egg in mining stocks and the other 20 in physical gold/silver. In late 2008, I got slammed again. Then he opened a goldmoney account and bought a pallet of silver...all frigging in at $13 an ounce. Back to the house thing, he can't walk away because of these assets and he now is an ex-pat in Thailand and getting a judgement against my checking account would be a pain to fight. The dirty secret about walking away from underwater houses in FL is the loan servicers WILL come after you and WILL add enormous fees and WILL auction your house off for pennies on the dollar and charge Freedie for the difference. The only smart thing he did was buying that pallet of silver for less than $13 per ounce. Rent and buy silver. Fool me once, not my prob. Fool me twice, yes my prob.
Long ago I bought a place for 384K that dropped to 130K. I gave up the collateral and "strategically defaulted" (went from single with no medical bills to married to a spouse with major medical bills and four children). I have zero regret or guilt either about walking away. The bank made 36K a year from me while I was in that dump too. Eff em'! Right now I'm doing as you said: Renting and buying silver!
The only safe RE bet is flipping. make your money on the buy from the bank or at auction. Has to be cheap enough to sell at real market prices. Must have the cash to buy them because others are shut out of the game now w/ no access to speculative or improvement loans.
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