Is it time to buy US property? US investment expert Dr Steve Sjuggerud of the True Wealth financial newsletter reckons there are bargains galore. Regular MoneyWeek columnist James Ferguson isn’t so sure. Here they make the case for and against investing in US housing.
I’ve lived in Florida for most of my adult life. I’ve never seen bargains like I’m seeing right now. Last month, I attended an auction for two properties less than a block away from the beach in St Augustine, Florida. They were empty building lots in a residential neighbourhood, 200 steps from the sand. You could build your dream house here – your second home in Florida exactly the way you want it. What would you have bid – £200,000, £150,000? What’s the least you’d be willing to pay?
Both lots sold for less than £25,000 each.
Would you believe I didn’t even win the auction? I was only willing to bid about half that. Why? Well, I didn’t need these lots. And I expect I will find even better opportunities. They’re everywhere. The median price of a home in Florida today is less than £100,000. That’s a home – and in Florida, median probably means at least three bedrooms, two bathrooms, a garage, a yard, and more.
It’s an extraordinary time to be a buyer of US real estate in general, and Florida real estate in particular. You may never have such a great opportunity to buy here in the rest of your life. Here’s why.
For one thing, you’re looking at a ‘half-off’ sale in many desirable places. Home prices have fallen by a third nationwide, peak-to-trough in dollar terms (according to the Case-Shiller home price index). But in some ‘bubble’ cities, such as Las Vegas and Phoenix, prices are down by more than 50%. Meanwhile, in Florida, property prices in Miami fell 49% peak-to-trough – and many smaller beach towns here fell by even more.
Secondly, financing is very cheap. Mortgage rates are currently the cheapest in history (or certainly since the Federal Reserve’s records began in 1964). As a personal example, I have a 2.74% interest rate from Bank of America on a home equity line of credit – Bank of America will lend me up to $500,000 at 2.74% interest. I haven’t tapped it yet. But if I bought those St Augustine properties with that money, I believe I could have sold them for significantly more than they went for at that barely advertised, distressed-sale auction. The return on my own money would have been near infinity. My only ‘out of pocket’ expense would have been the lowly cost of the 2.74% interest for a couple of months.
Thirdly, US housing is more affordable than ever. Affordability is a simple concept. But most people get it wrong – they often quote a ratio of house prices to income. This comparison is near-useless. It’s not apples to apples. For example, the interest payments on my parent’s 20% mortgage from the early 1980s were an entirely different situation to my 2.74% Bank of America interest rate today.
The actual price of a home isn’t people’s main concern when they buy a home – it’s the monthly payment. So affordability isn’t about the house price to income ratio, it’s about the payment. “Can I afford that monthly payment?” That’s the big question. That question can be answered by knowing three things: the price of the house; the mortgage rate (as these two determine your monthly payment); and your monthly income. All three are in favour of the US homebuyer now.
So we’ve seen the average house price cut, in many cases, nearly in half. Beyond that, the cost of financing has been cut by a third during this decade alone. Meanwhile, household incomes have held up reasonably well. So it’s no surprise that the NAR Housing Affordability Index (which goes back to 1970) shows that housing is more affordable than ever in the US. So US housing is now easily affordable. But why is now the right time to buy? There are four good reasons.
Four reasons why now is the right time to buy
Record low building activity
Housing starts are at their lowest level in recorded history, and a shortage of new homes has historically always led to a rise in prices. It’s simple supply and demand – when home builders build too many homes, prices peak soon after. And when they don’t build any for a while, prices start to rise again. You can guess when the most recent peak in new homes started – January 2006. Prices peaked within six months. Before then, building activity (housing starts) bottomed out in 1991, 1982, 1975, 1969. And following the rules of Economics 101, prices started rising (often dramatically) soon after. Housing starts are now at their lowest level in recorded history.
Banks are desperate to sell
“Just make any offer,” my friend – a US bank chief financial officer (CFO) – told me recently. “Chances are, the bank will take it.” Banks are in the business of making loans, not owning property. But they made tons of bad loans, and now they’re stuck with thousands of properties. They don’t want to be in the property business, they want out of it. With so few buyers, they have to be willing to consider any offer. As my bank CFO friend says, “Chances are, they’ll take it.” It’s easy to find bank-owned properties and government-owned properties. Just type “REO” into Google, and you’ll find plenty of banks and their listings. Pick your place and price.
The government wants higher prices
You wouldn’t believe the effort the US government is putting into propping up the housing market. Undoubtedly, it will succeed. If housing falls, Americans will feel broke, they’ll blame their politicians, and those politicians won’t get re-elected. The incentives are comical: government-guaranteed mortgages, tax credits of up to $8,000 for first-time home buyers, tax-free capital gains of up to $500,000; and many more. But it gets much bigger than this – you could argue that the whole government bail-out is about saving homeowner equity.
US property is hated
As an investor, I’m seeing what I love. It’s a rare situation, but incredibly important if you can recognise it. It’s when people’s emotions are clearly at odds with the reality of the numbers. The numbers for housing are great right now. But after three years of losses, people are sour on housing – it’s perfect. I prefer to be a contrarian. Three years ago, everyone in the US said: “You can’t go wrong in real estate.” Now everyone thinks you’ll never make money again. I’ll take the opposite side of both of those trades.
David Dreman is a legendary contrarian investor. In 1980, he literally wrote the book on the topic. It’s called Contrarian Investment Strategy. In it, he recommended going heavily into stocks. Today, Dreman recommends US residential real estate: “If inflation hits hard, the chief culprit of the bear market – real estate – is likely to be one of the best investments in the years ahead. Buy a home if you don’t already have one or a second home if you can afford one.” Time to buy a house (or two!) in America – preferably in Florida.
Steve’s top buying tips
• Don’t buy north of Orlando if you want to be warm in winter. Most foreigners don’t realise that Florida temperatures vary so much from north to south. Palm Beach County and South? Great. You’ll need a sweater just a few days in winter, and you can get in the pool nearly every day. But Jacksonville? It’s way colder than you think! You won’t get a suntan, and you can’t use your bathing suit.
• Avoid Miami. You want to pull off the highway to fill up your car and worry if you’ll make it out of that neighborhood alive? Then move to Miami!
• If you want a cheap home near the ocean, try the southwest coast. Ft. Myers, Naples, anywhere over there – that’s where the most real estate speculation and overbuilding went on, so it’s where the biggest bust has been. That’s where to get a super deal – just find the town you like (personally, I prefer the Atlantic Coast, but I’m a surfer, and that’s where the waves are).
• If you want a great deal, get on a plane. Do all the homework you can from home. But for the real deals, you should spend time here. Figure out which towns you actually like. And talk to realtors about foreclosures and other special deals. Nothing beats doing this in person.
• To read more from Steve, sign up for his free daily investment email DailyWealth
It may be a good time to buy, but investors risk getting burnt
by James Ferguson
Is it time to get back into US housing? On many measures the answer is yes. The Case-Shiller house price index has risen for two months in a row, the first gains since July 2006. Consumer sentiment is improving and unemployment at least rising a little less rapidly than it was. Meanwhile, new orders for manufacturers have bounced strongly as customers rebuild inventories, so much so that GDP may well grow surprisingly robustly in the second half of 2009.
And as Steve notes above, houses look good value. Nearly half of all existing home purchases made recently have been at foreclosure auctions, where the average drop has been around 45%. And affordability – boosted in part by tax rebates – is at levels not seen since the 1970s.
On top of this, the type of buyer has changed for the better. Before the recession, roughly half of all US mortgages qualified as ‘prime’, meaning they would be insured by the government-backed mortgage agencies Fannie Mae or Freddie Mac. That proportion has risen to 80%. So four mortgages in five are now plain vanilla, owner-occupied, blue-collar, middle American loans. In other words, the speculators, flippers and developers are out and ordinary American families dominate the market once again. That has to be a good sign.
And with Fannie and Freddie daring to lend where others fear to tread, the US has managed to keep the level of home sales up at almost pre-bubble levels. The average number of existing home sales over the last year is down a third from the peak. But it’s still only 6-7% below the norms of 1999-2000, before the bubble took off. This in turn has enabled US house builders to clear their record inventory overhang at a phenomenal rate. Completed new houses for sale peaked at 200,000 in early 2008, 60% higher than any past cycle peak. Yet that inventory has fallen by 80,000 homes in just 18 months; an unprecedented feat.
So, houses are cheap again, the economy’s looking up and the overhang of new homes has improved more rapidly than anyone could have dared predict. It must be time to plough back in, right? Well, unfortunately not – at least not if you’re an investor looking to make money.
For starters, there’s a big difference between a new bull market and one that simply isn’t falling any more. Consider what happened last time. Most housing market measures troughed at the end of 1990. By 1992, house prices were rising again and for the next six years averaged growth of 2.9% a year. Over that same period, the average inflation rate was 2.8%. So for the seven years following the 1990 trough in US house prices, there was no gain in real terms. Remember: it’s only a very recent conceit that houses are investments rather than quite useful, sometimes slightly leaky, things to live in.
Why US home ownership has gone into reverse
Another issue is that the rising trend in home ownership in the US went into reverse even before the peak in prices. There are two main reasons why this will continue.
Lending will be restricted in coming years
Few Americans seem to be aware that Fannie and Freddie were always going to need rescuing by the state one day, because they offer two things that no private lender ever could. They allow 30-year fixed-rate mortgages to be refinanced at a lower rate and for no early repayment penalty; and they give ‘non-recourse’ loans; so if house prices fall, Americans are used to being able to simply hand back the keys without being pursued for the debt. That means that Fannie and Freddie were always going to go bankrupt just as soon as either long-term rates rose or house prices fell. The fact that neither of these things happened between 1982 and 2006 is what lulled everyone into such extreme complacency.
But there’s a new determination, shown at the G20 meeting last weekend, to start addressing the lack of bank capital and the excess of risk that fed the credit bubble. Fannie and Freddie serve a purpose right now, with so few alternate lenders around. But having been rescued by the taxpayer at vast expense, their futures in their present form must be in doubt.
Trouble is, it’ll be years, literally, before the banks want to lend for residential mortgages again, so any constraints on Fannie and Freddie, now they control 80% of the market, will make a real impact. This leads us to a more fundamental problem. The US banks, by my estimation, have already stored up $150bn or so of unrealised losses on their loan books.
This is bad news for the economy. The recent upbeat economic data has been driven by one-off inventory re-stocking. Once that’s run its course, there will be precious little follow-through. Why? The correlation between the growth in private sector credit and GDP is long and strong. So if banks aren’t lending, you can’t expect the economy to grow, nor the price of assets which rely on credit.
Americans don’t want to – or can’t – borrow any more
On top of this, households don’t want to borrow. For the last few years, Americans convinced themselves that taking out a mortgage to buy a house was the best long-term investment; that borrowing was somehow saving. The crash put paid to that notion.
They’re now putting money in the bank again. From saving between 7% and 12% of everything they earned in the 1960s, 1970s and 1980s, the savings rate dipped as low as 1% during the housing bubble. Already it’s back to 5% and rising fast. Yet some Americans can’t save more even if they’d like to. The recession has already claimed almost seven million jobs, a new post-war record, yet it comes after the jobless recovery of the 1990s and early 2000s.
After a while, unemployed people drop off the official statistics because they no longer qualify for unemployment benefit. Although unemployment has just hit 9.7%, the true percentage of un- and under-employed in America is now put at more than 16%.
It’s small wonder that home ownership, which had risen from 64% throughout the late 1980s/early 1990s to top 69% in the wonder days of the NINJA mortgage (no income, no job or assets) has now sunk below 68% and is still falling. This fall could prove to be more than just cyclical as America’s position on the world stage is gradually eclipsed by Asia.
A cheap US residential property will not necessarily lose you much money. The problem is that the absence of a negative is not a positive. I can’t see what will drive house prices higher for a long time to come. Indeed, I believe it’s a mistake even to consider residential property as an investment until the banking crisis has been resolved – and that’s a good five years away.