I Hereby Declare a Housing Recovery

by JT McGee

I spend a lot of time looking at cyclicality and interest rate policy. I think the two are completely and entirely related, as anyone who has taken an economics 101 class would also think.

Over the last two years I’ve blogged here American housing and interest rate policy has been a big focus. I’ve written (incorrectly) about how I thought the Fed wouldn’t raise rates until 2012 because of rate resets. I’ve written about the price to rent ratio, and why I think housing is tremendously undervalued.

I’ve written about the economics of local real estate and what factors affect local housing prices. Or about how housing bubbles could be completely avoided if people weren’t irrational and were willing to consider the relative difference between rental prices and purchasing prices. I’ve said some controversial things, too, like how I think retail and commercial property in high cost areas will be converted to residential property, potentially crushing some local market premiums.

Most recently, I covered a survey that showed more Americans wanted to buy a house in the next 6 months than ever before.

And most importantly, I’ve written about how we all work for the housing sector as 75% of all economic growth in the 2000s had to do with housing and home equity withdrawals. The housing sector literally drives the American economy.

So, I really like housing. I’m going to keep talking about it, too.

Why Housing is Officially Recovering

The housing collapse happened for two reasons. First, short-lived demand from a credit explosion pushed prices well over and beyond the cost of replacement and the historical price to rent ratio. In short, homes were overvalued due to a short term burst in demand vastly outstripping then current supplies.

Secondly, the housing collapse happened because banks were overlevered and incapable of continuing the lending velocity necessary to sustain fairytale level prices.

That said, I think the down cycle is now over for good, and here’s why:

  1. Homes are vastly cheaper to purchase than they are to rent, and any rational person would rather own a home for less money per month than they could rent one.
  2. Homes are selling for under replacement value in many parts of the United States, which means new supplies will be constrained until prices rise past equilibrium.
  3. Employment and consumer confidence are improving. Additionally, previously unemployed Americans are crossing the arbitrary 2 years of employment necessary to get a loan.
  4. HGTV is talking about real estate more and more. (Seriously.)
  5. Big investors are backing up the truck because the spread between gross rental yields and carrying costs are ridiculously high.
  6. Shadow inventory literally does not exist. It exists only in markets where living conditions are terrible and I’m not convinced national statistics are of any value. Detroit isn’t St. Louis, or Little Rock, or Elkhart Indiana.

Just to show how affordable homes are, and why it’s #1 in my list, I have this chart from BlackRock:

Buying is cheaper than renting in 50% of metro areas as of early 2012, when rates were higher than they are right now. Houses are super cheap, yo!

Who’s Buying Homes?

Besides average Americans, investors are also snapping up homes at an impressive pace. Local individual investors see value in American real estate, but so do insitutional investors like hedge funds and asset management firms.

I learned recently from an article that Blackstone has acquired $2.25 billion in single family homes in just the last six months. Blackstone is a major private equity player and huge asset management company. As of July 2012 it had made $250 million in purchases. As of January 2013, it’s up to to $2.5 billion, which it spent to acquire more than 16,000 single family homes it intends to rent.

Whoa.

This is big news. Investors are willing to put a price floor in the market based on the spread between rental yields and the cost of capital. That provides huge support for the housing market, and it also means that if yields get bid down, prices get bid WAY up.

Front-Running of Epic Proportions

I think there’s a lot of money to be made in front-running future single-family home buyers, as I wrote about at Investor Junkie. See, if you buy real estate right now with someone else’s money, you can snap it up at a bargain price before everyone else gets approved from the bank to make the same deal.

The market for real estate is thin (people or institutions who are well financed) yet the supply of housing is huge. It won’t be that way forever…average (non-PF blog reading, budget busting people) will be back in the market soon enough. I liken this market to my favorite kind of setup in the stock market that happens when dividend paying companies stop paying dividends. Dividend investors leave, a thin market emerges, and bargains are found. The same idea is playing out right now in housing.

So why not front run them like Blackstone is doing? You have a competitive advantage in buying now if you can do so, one which should give you economic profits as ordinary buyers return at a later date.

If you can, go for it. Really, if I were in a lifestyle/financial/out of stock ideas position to lever up on real estate to buy and hold I’d be all over it in the cash flow positive Midwest where I live. In the meantime, I’ll have to be happy to be invested in Ford (which has extreme exposure to credit availability/housing), and a microcap company that buys/flips/holds real estate…I won’t be sharing the ticker any time soon (I’m buying).

All this said, I think housing has found a bottom. I know that’s a very, very dangerous thing to say given how hard it is to call a bottom, but I really think the only way to go for the next several years is up, up, and away.

Viva la bubble and Bernanke’s boom. I pity the fool who thinks this time is different.

{ 8 comments… read them below or add one }

krantcents January 22, 2013 at 19:30

I agree but real estate is still local! Construction is coming back and prices are starting to increase. In southern California there are multiple bids on modest homes that are priced over $500K. We are way past bottom and starting to recover.

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JT McGee January 23, 2013 at 09:44

Yeah, it’s absolutely local.

I think we’re way past bottom, too. But I wouldn’t have nearly as much conviction in that idea if it weren’t possible for a big player like Blackstone to find enough margin between rents and operating costs to buy up thousands of single family homes. That never, ever, happens. It also leads me to believe that there’s new price floor in the market from institutional investors looking for yield.

Good news all the way around. We need construction employment (eventually) and all the jobs that are created from a robust housing market.

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PK January 23, 2013 at 11:14

“HGTV is talking about real estate more and more.” – as an avid HGTV and DIY watcher, I noticed that after the pop, more and more homes would end the episode with “they are still looking for a buyer”, or some similar hint of declines. Of course, they also introduced more ‘renovation’ stories, where the people wouldn’t sell at the end.

Of course, HGTV is probably 1979 Businessweek 2.0, right? When they are all selling shows, it’s time to short housing.

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Little House January 24, 2013 at 10:03

The housing market it definitely recovering in my area, a suburb of Los Angeles. Homes are now averaging closer to $400K, which is still under the $550K at the peak of the market a few years back. I’m sort of kicking myself for not buying a year ago. I’m soon going to be unable to buy again if prices continue to climb. I’m still not sure how average people afford a $450,000 house on average salaries!

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Fred@Foxy Finance January 26, 2013 at 09:51

That’s rent vs buying graph is absolutely nuts, I wish I was living in America. I’m living in London and both are outrageously high at the moment. I suppose a 20% downpayment is larger than what used to be required pre crash.

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Brick By Brick Investing | Marvin January 26, 2013 at 18:54

One of the big questions I have is if outlook for housing is so bullish, what happens when interest rates eventually have to rise?

I would imagine that once interest rates go up the prices of homes will decline because the majority of Americans only look at monthly payments rather than the actual price of a home. So with that said I believe we will have another bear market in housing in terms of nominal prices as the average Joe will not be able to afford the monthly payments.

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Nunzio Bruno January 26, 2013 at 19:36

Great post and I absolutely agree. I have also been trying to show my students some of the very same arguments you have in the macroecon classes I teach :) One of the best points that I think get over looked is indeed the stuff like HGTV – if major outlets are starting to champion the housing market then more traditional news media and market participants will be trickling over a lot sooner than you think :)

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William @ Drop Dead Money January 28, 2013 at 10:26

Part of the reason rents are high is people who lost their homes through short sales, foreclosure or bankruptcy can’t qualify for home loans for a certain period of time. Those people are therefore forces to rent. As time passes, more and more of them will be able to qualify for home loans and they’ll start buying. So, rents now are high and home prices will continue going up, making it profitable to rent now and sell later.

I hereby agree with your declaration of a housing recovery :)

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