The Float

"The New American Dream: Renting"

In this space, we've written on the widespread misunderstanding of the investment value of residential real estate. Whether it's short, anomalous bursts of rapid appreciation that warp people's sense of long-term averages, or gross underestimates of the true costs of ownership, many people have made enormous financial mistakes on the premise that owning (to say nothing of "flipping") a home is a sure path to financial security.

So we were delighted to see last Penn professor Thomas Sugrue's piece on rentership and ownership in last Friday's Wall Street Journal. As usual when we make reading recommendations, the whole thing is worth your time. But this struck us as a key passage, in many ways the key to the entire story:

Yet the story of how the dream became a reality is not one of independence, self-sufficiency, and entrepreneurial pluck. It's not the story of the inexorable march of the free market. It's a different kind of American story, of government, financial regulation, and taxation.

We are a nation of homeowners and home-speculators because of Uncle Sam.

...

It's a story riddled with irony--for at the same time that Uncle Sam brought the dream of home ownership to reality--he kept his role mostly hidden, except to the army [of] banking, real-estate and construction lobbyists who rose to protect their industries' newfound gains. Tens of millions of Americans owned their own homes because of government programs, but they had no reason to doubt that their home ownership was a result of their own virtue and hard work, their own grit and determination--not because they were the beneficiaries of one of the grandest government programs ever. The only housing programs prominently associated with Washington's policy makers were underfunded, unpopular public housing projects. Chicago's bleak, soulless Robert Taylor Homes and their ilk--not New York's vast Levittown or California's sprawling Lakewood--became the symbol of big government.

Then there's the other part of the residential real estate story we've returned to repeatedly. The fallout from the housing bubble is (and will continue to be) especially awful because unlike railroads or telecommunications or the Internet, excessive residential real estate--too many homes that are too big and too far-flung--does nothing to promote future economic productivity. Indeed, it impairs future productivity by diverting public and private resources from other, better uses. Your town could benefit from more solar power? From a more efficient grid or better schools? Sorry. They spent the money on that (largely empty) subdivision out in the fields.

Sugrue's closing lines apply to the U.S. as a country as much as to individuals and families:

If there's one lesson from the real-estate bust of the last few years, it might be time to downsize the dream, to make it a little more realistic. James Truslow Adams, the historian who coined the phrase "the American dream," one that he defined as "a better, richer, and happier life for all our citizens of every rank" also offered a prescient commentary in the midst of the Great Depression. "That dream," he wrote in 1933, "has always meant more than the accumulation of material goods." Home should be a place to build a household and a life, a respite from the heartless world, not a pot of gold.

Source

Thomas J. Sugrue, "The New American Dream: Renting," Wall Street Journal, August 14, 2009

More on Residential Real Estate's Real Returns

A week ago, we posted an item on the perception that residential real estate is often a great investment (when the residential real estate market is falling off a cliff, of course). We've always thought that perception was flawed, not in the sense that it's always and everywhere wrong (because in some places and times it can be fabulously right), but in the sense that it reflects a very narrow sense of the costs and benefits of acquiring and possessing residential real estate.

In that post, we drew on a Wall Street Journal column by Brett Arends. Apparently Arends got so much feedback on that initial item that he had to write more on Friday. And once again, he got it right. After discussing tax benefits, transaction costs, the illiquidity of the collateral, and other considerations, he closed with this:

The real benefits of home ownership are any capital appreciation, plus the imputed rent, minus the effective cost of the mortgage and property taxes, other costs, and the return you could earn on your down payment elsewhere.

That's a complex figure, and it varies widely. But if your home's appreciation is lower than the annual cost of borrowing, as it has been for many over the last 20 years, leverage is not much of a friend.

Well put.

Sources

Brett Arends, "Is Your Home a Good Investment?" Wall Street Journal, May 27, 2009

Brett Arends, "Why Your Mortgage Won't Make You Rich," Wall Street Journal, May 29, 2009

Real Returns on Residential Real Estate

As we've noted in this space (here and here, for example), with a few local/short-term exceptions, residential real estate has been a pretty lousy investment.

So we were pleased to see Brett Arends weigh in on this question in this morning's Wall Street Journal. An excerpt:

Conventional wisdom long held that home ownership was a route to wealth, and the imputed rent -- in other words, the right to live in your home -- was just part of the value you got from it. Under that widespread view, the recent housing bust was simply a temporary, though deep, pothole.

Yet for very many people, even over the past 15 or 20 years, the imputed rent may have been all, or nearly all, the real value they actually got from their home.

Indeed. And as Arends notes, the bust ain't over. Consider the key elements of this morning's report on sales of existing homes:

• Sales rose 2.9% from March, but declined 3.5% from April, 2008. 
• Median prices fell 15% from a year ago, but readers should handle these numbers with care. See this item from Calculated Risk for more on the math of medians and means. 
• Fully 45% of sales were distressed properties.
• Foreclosure filings rose to a new record, 32% higher than a year ago.
• Supply picked up, with inventories rising to 10.2 months from 9.6 in March.
• Inventories of homes priced at or above $750,000 have reached a 40-month supply.

So...no. Across a full market cycle and in most places, residential real estate hasn't been a very good investment. When prices are rising, the magic of leverage makes it seem like the best investment around. But as millions of "homeowners" and "investors" have learned, the flip side of leverage is pretty ugly, especially in a relatively illiquid asset class like real estate.

None of this means buying residential real estate is unwise. It just means that the benefits--a place to live, forced saving through an amortizing mortgage, the potential for at least some real appreciation--should be kept in proper perspective.

Sources

Brett Arends, "Is Your Home a Good Investment?" Wall Street Journal, May 27, 2009

Bob Willis, "Home Resales Rise on Drop in Prices," Bloomberg, May 27, 2009

Extrapolating Atlanta

A couple weeks ago, the Journal ran a story on commercial real estate development in Atlanta. The first two paragraphs tell the story:

A one-mile stretch of Atlanta's upscale Buckhead neighborhood shows why commercial real estate is emerging as an obstacle to pulling the U.S. economy out of recession.

Separate developers in Buckhead are building four speculative office buildings at the same time with virtually no leasing activity. The 35 recent condominium projects will help give Atlanta a 40-year supply at the current sales pace.

40 years! Of course the hope (and reasonable expectation) is that the "current sales pace" isn't the future/permanent sales pace. At market bottoms (or depths, anyway, since the bottom might not be in in some of these markets), linear extrapolation might not make much sense. But it sure can create some eye-popping numbers.

Source

Alex Frangos, "In Atlanta, Irrational Building Exuberance," Wall Street Journal, April 22, 2009

Shadow Inventory

We don't pretend to know whether the March lows will mark a true bottom in this bear market in stocks. But we're darn sure we haven't gotten to the bottom in residential real estate (to say nothing of commercial). In today's San Francisco Chronicle, Carolyn Said sees a "shadow inventory" of homes, properties banks have foreclosed...and then held off the market. See the image below.

Then see this summary of the recurring, still-cresting waves of mortgage resets. Note that the biggest spike is in the ugliest category, the notorious option-ARMs, where loan values have actually climbed for many borrowers (due to their payment of less than the standard interest due), even as home values continue to fall:

Calculated Risk isn't quite sure of Said's analysis, but whatever the particulars might be, the reality is that inventories are still too high for many (most?) markets to reach any sort of price equilibrium any time soon.

Source

Carolyn Said, "Banks aren't reselling many foreclosed homes," San Francisco Chronicle, April 8, 2009

Small Enough to Fail

Today's Tom Toles...

Let's Not Get Carried Away

The recent rally in equities has returned a certain sense of non-Armageddon to the markets. That's clearly a good thing. But before anyone gets too pleased with all this "better-than-expected" data, let's be serious about what's happening out there. A few relevant items:

• New home sales and durable goods orders were a little better in February than they'd been in January. Super! Durable goods were 22% lower than in February, 2008, and new home sales were also much worse than a year ago. And ohbytheway...inventories remain wildly elevated and prices are still falling fast. See this from Calculated Risk. 
• Traders appear to be optimistic about the Geithner Plan. We hope it helps, and it just might. But there's a lot more ugly stuff lurking out there...in the dank* corners of banks' off-balance-sheet vehicles.
• Mortgage equity withdrawals, and the consumer spending they support, are effectively zero. In the long run, that's a good thing, because it should improve household balance sheets. In the short run, it gives consumers less room to maneuver. 
• The mother of all state economies, California, appears to be heading from bad to worse. 
• The outwardly successful IBM will eliminate a non-trivial number of jobs in the U.S.--from its especially successful business services unit. 

Let's be clear here. We welcome good news, and some recent reports have indeed been less-horrific than "expected." And we know that Wall Street often moves in relative terms, with underlying expectations providing the backdrop against which traders and investors operate in the short term. But as we noted in a recent post, the likeliest outcome is a slow-growth environment for some time to come.

Bottom line: This is a bear market until it proves otherwise.**

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* This is not a typo.  We could have gone with "dark," but dank is one of our favorite words. Always has been.

** And yes, we kow markets often move in advance of the broader economy (let alone the release of certain types of economic data, which often lag the underlying things they're trying to measure). That may be what they're doing here. But in the absence of demonstrated, robust leadership by stocks and industries--as opposed to snapback rallies of the most beaten-down securities--we'll remain a little bit cautious.

Gary Shilling on a Slow-Growth World

Here's another worthwhile item: a recent newsletter from Gary Shilling, as reproduced and distributed by John Mauldin. Shilling's a long-time deflation worrier who's now (finally/more or less) right. So you might read his deflation discussion in the context of a guy trying to prove just how right he is. Not that there's anything wrong with that!

Regardless, we think much of his analysis of a slow-growth world is right on the mark. It's long, but worth a few minutes when you have the time.

It's All About Inventories

It's one of those permanent truths: In residential real estate, it's all about supply and demand. Which is to say it's all about inventories.

If you care about this stuff, take a couple minutes to digest this item from Calculated Risk. The entire story is there in a few data points and charts.

Still Blowing Sunshine...But Not Quite as Much

When the real estate bubble began to burst, one man stood above all others in the harsh light of public ridicule: David Lereah, chief economist at the National Association of Realtors. For many months, Lereah denied what anyone willing to see did see, that after a few years of utterly ridiculous appreciation--and absurd assumptions about future appreciation, assumptions that define bubble psychology--residential real estate had rolled over.*

In the January 12^th Wall Street Journal, Nancy Keates described Lereah's efforts to rehabilitate himself and his reputation. We think Lereah and his organization were a big part of the problem, but we also have some sympathy for him as an individual who got caught up in a larger systemic problem. If it hadn't been Lereah blowing the realtors' self-serving sunshine, it would have been someone else.

Alas, at the end of her story, Keates quotes Lereah's successor at the NAR, Lawrence Yun. Here's the passage:

His successor at NAR, Lawrence Yun, however, says things might be looking up. In his latest news release, Mr. Yun says that although the pending home-sales index based on contracts signed in November fell 5.3 from a year earlier, with a "proper real-estate focused stimulus measure," home sales could rise more than expected, by more than 10%, to 5.5 million, in 2009.

And here's the problem: What the market needs isn't more sales as such, it's stable prices. As sales have risen primarily due to falling prices, we can safely conclude that the market is still very much in a clearing process, with grossly elevated inventories and ongoing depreciation in property values.

As it happens, today's Journal features some relevant news (emphasis added in bold):

Existing-home sales rose in December as buyers took advantage of discounted prices in distressed housing markets.

Home resales rose to a 4.74 million annual rate, a 6.5% increase from November's revised 4.45 million annual pace, the National Association of Realtors said Monday. November originally was seen down by 8.6% to 4.49 million.

NAR economist Lawrence Yun said sales in distressed markets were very high amid foreclosures; of all sales in December, about 45% were distress sales at discounted prices.

The median home price was $175,400 in December, down 15.3% from $207,000 in December 2007. The median price in November this year was $180,300. The 15.3% drop was the largest on record, the NAR said.

"It appears some buyers are taking advantage of much lower home prices," Mr. Yun said, adding the market is far from balanced as buyers hold an edge over sellers.

We'll give credit to Mr. Yun for that last point. It's fair to call this a buyer's market. But in a deflationary environment, more than anything else, it's a patient buyer's market, as tomorrow's prices are likely to be even better than today's. And that's the problem. It's inventories and prices that matter, not sales numbers per se.

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* For old times' sake, here's a short collection of Lereah's serial claims that the bottom was in.

Sources

Nancy Keates, "Realtors' Former Top Economist Says Don't Blame the Messenger," Wall Street Journal, January 12, 2009

Jeff Bater, "Home Resales Rise as Prices Tumble," Wall Street Journal, January 26, 2009