The current nationwide boom in housing prices illustrates some important investment fundamentals that have little to do with housing. For one thing, a basic commodity that undergoes a price collapse will exhibit a "snapback" in values with a speed that will take most experts by surprise. It wasn't that long ago when experts were predicting a "second round" of foreclosures that would "dwarf" the original collapse back in 2008. Apparently, that isn't going to happen.
A recent article in Bloomberg Businessweek offers statistics on the recent housing boom in major U.S. markets. Year-over-year median housing prices have increased by 28 percent in San Francisco, 34 percent in Phoenix and 18 percent in Los Angeles. The number is 6.6 percent for the entire country, but that includes areas that did not experience the boom before the bust.
Meanwhile, someone making a 20 percent down payment on a house that rises by 20 percent in value has just doubled their money -- at least on paper. More common have been 300 percent returns on equity. This explains why private equity firms have purchased more than 16,000 homes that they are now renting or selling for a profit.
A rebound in prices this soon after the housing collapse is driven by a low inventory of homes for sale. This, in turn, has been caused by a four-legged stool of influences. First, foreclosed homes went on the market quickly in many places, and investors with cash bought them to rent out, which reduced supply of available homes for sale.
Next, underwater homeowners or people with time to wait for the "snapback" are reluctant to put their homes on the market, which further reduced supply.
Then, for all practical purposes, there have been no new homes built for the past five years.
And finally, mortgage interest rates are at an all-time historical low, which allows buyers to spend more on a home -- if they can find one for sale.
Obviously, this combination of factors is fueling the rise in prices we have seen recently. New home construction has traditionally led economies out of recessions, because it employs so many people all across the country. Also, the peripheral sales related to new homes includes appliances, furniture and more profit for companies like Home Depot.
Who would have guessed that Pulte Homes, one of the nation's largest builders, would be the best-performing stock in the S&P 500 Index last year?
Not many saw this coming. Most of the people I know in the housing industry were saying a year ago that foreclosures would continue to dampen the market and that it would take several more years before that bad influence had run its course. What this shows us is the extent to which several influences, as previously mentioned, all combine to create a positive sea change. It is impossible to predict the net effect of these variables, which is why we shouldn't bother to try.
What's easy for many of us to forget is that housing is first and foremost a place to live. Setting aside the obsession that a home might be worth more than we paid for it someday, anyone could argue that if we just broke even we would be ahead of the game. The net after-tax cost of mortgage interest and property taxes is probably equal to what we otherwise would have paid in rent.
Meanwhile, we have had a place to live and a forced savings program to the extent that we paid off some of the mortgage principal. That's probably all we should expect of a house.
Looking back a hundred years, long-term home prices have only increased in value by about 3 percent per year -- about the same as inflation. Thanks to the gyrations of recent years, home prices have reverted to that 3 percent norm.
For those who still claim that their house has always been their best investment, it may come as a surprise to learn that the Dow Jones industrial average, with re-invested dividends, has handily beaten home prices over the past 40 years. It remains to be seen whether we'll be experiencing "déjà vu all over again," but if home prices continue to rise, it will create opportunities for older owners to bail out and diversify.
This will leave younger folks with a window of opportunity to gain a piece of the action.
Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0506 or firstname.lastname@example.org.