Real Estate Sucker Bet
(7/8/2005)
I was on CNBC’s Closing Bell with fellow guest and old friend Brian Westbury to discuss the housing market on Monday, July 5. Brian and I have known each other since the Reagan White House. He’s a great guy and first class economist–one of the most prolific writers I know. Our topic was real estate prices. Brian reminded us tht the income, growth, demographic, and tax fundamentals behind housing are still strong. While I agree with Brian on the fundamentals, I am more worried that recent price increases are not sustainable. We both agree that stocks are a better place to invest than housing.
I think the easy money made in housing is over. Residential real estate is a sucker bet today. Real estate today reminds me of the late 1970’s, when Trammel Crowe was building skyscrapers all across America funded by inflation-hedging investors, over-reaching Savings and Loans, and high tax rates on securities.
Today, we’re riding a tiger. The economy is very strong—and I think it’s getting stronger which makes me like the stock market a lot. Housing is up more than 30% over the last year in some of the hot markets. That’s just too much for me. Demographics were there 2 and 3 years ago. I think a lot of the appreciation came from the housing markets repricing for lower interest rates. It repriced upward one more time again in the last couple of months when bonds came down to 4%. But I don’t think these price increases are sustainable. There are too many expectations of price increases in the transactions and not enough attention to cash flows and rent.
But Brian is right about the imoprtance of tax rates. Two of the hottest states in the markets are the states with 0% state income tax. People are flocking to Florida and to Nevada for just that reason. And both are also well known to be warm in the winter.
But I think it’s a dangerous time to short the home builders because when the market gets a run like this, we don’t know when it will stop. Short-term prices increases could bury you if you have a leveraged short position.
But stay away from REITs. The best investment I’ve ever made was turning $1 into $3 by selling a real estate investment to a REIT at the top of the 1990’s REIT market. REIT accounting is opaque. I think REITs are vastly overpriced right now. But REITs at least have a big dividend yield, unlike most home builder stocks. Now we’re seeing home builders using options to purchase land and home buyers using options to buy new homes. This smells a lot to me like the end of the bubble at the end of the ‘70s and again at the end of the ’80s. So I’m a little worried. I don’t want to have people risk their money by buying into the market right now, but I don’t want it people to sell their houses either.