Buy a House… Then Buy Another

Reddit

Investment ideas are cyclical. They go dormant for a while, then revive, like fashions or cicadas – obeying their own curious rhythms. During the past few years, rare was the investment thinker who said you should buy a house. Housing was in a bubble that was deflating.

But the investment seasons turn. Today some smart investors are once again saying you should a buy house. John Paulson is one of them.

You may know him as the man who turned the greatest trade of all time. Betting against the housing market, he netted a cool billion dollars for himself in 2007. One fund he managed rose 590% that year. Today, he is one of the richest men in America.

His advice today is very different. “If you don’t own a home, buy one,” Paulson said. “If you own one home, buy another one, and if you own two homes, buy a third and lend your relatives the money to buy a home.”

That’s a strong endorsement. It sounds similar to the advice another investor gave his audience in 1971, at the dawn of one of America’s biggest housing bull markets. The investor was Adam Smith (George Goodman) on The Dick Cavett Show. Here is a snippet from that conversation:

Smith: The best investment you can make is a house. That one is easy.

Cavett: A house? We were talking about the stock market. Investments…

Smith: You asked me the best investment. There are always individual stocks that will go up more, but you don’t want to give tips on a television show. For most people, the best investment is a house.

Cavett: I already own a house. Now what?

Smith: Buy another one.

It was good advice. In the 1970s, US stocks returned about 5% annually, which failed to keep pace with inflation. Still, it was an up-and-down ride. In 1974, the stock market fell 49%. But here are the average selling prices for existing homes in the 1970s as inflation heated up:

1972 – $30,000

1973 – $32,900

1974 – $35,800

1975 – $39,000

1976 – $42,200

1977 – $47,900

1978 – $55,500

1979 – $64,200

You can see that housing held up pretty well. And think about the effect of a mortgage on 80% of that house in 1972. That would mean $6,000 in equity, a sum that went up fivefold in eight years. It’s hard to find a better inflation fighter than that. Granted, today’s market is different, but still.

Apart from this, you might also reflect on the fact that it is quite absurd today to think that anyone can buy an average house for any of these prices – and that, too, is the point. The average price today is $257,500 – even after the great collapse in the last few years.

“If you have a 7% mortgage and your house is worth half a million dollars,” Adam Smith writes, “you may gripe about shoes and lamb chops and tuitions like everybody else, but your heart isn’t in it.” Your heart won’t be in it because you’ll be in fine fettle with your house.

Of course, you can do a lot better than 7% today. For the first time, the rate on 30-year mortgages slipped below that on the 30-year Treasury bond. You can get a 30-year mortgage at little more than 4% today.

Factoring in mortgage rates, housing affordability is back to where it was in September 1996. Then mortgage rates were 8% and the average price of a home was $171,600. As Murray Stahl writes: “One can actually buy a home for a monthly payment that is not very many dollars different from the monthly payment one would have needed in September 1996, when rates were significantly higher.”

Adjusted for inflation, Stahl points out that the payment for an average-priced home today is about 30% lower than it was 14 years ago.

The advice of Paulson and Smith starts to make sense now, doesn’t it?

Essentially, real estate is a way to buy now and pay later. And the case for housing extends to other property types, too. Owners of quality real estate are getting deals on mortgages that we are unlikely to see for a generation.

In my investment letter, Capital & Crisis, I haven’t recommended a real estate stock since 2006. That may soon change. I’ve spent quite a bit of time looking over blue chip real estate stocks. Real estate, after a long absence from the menu, is back on.

Regards,

Chris Mayer,
For Daily Reckoning Australia

Editor’s Notes:
Chris Mayer studied finance at the University of Maryland, graduating magna cum laude. He went on to earn his MBA while embarking on a decade-long career in corporate banking. Chris has been quoted over a dozen times by MarketWatch, and has spoken on Forbes on Fox.

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
Reddit

Comments

  1. Wow, that’s confusing!

    An American writing for an Australian audience… “The average price today is $257,500 – even after the great collapse in the last few years”. Except we haven’t had a collapse.

    Again… “Factoring in mortgage rates, housing affordability is back to where it was in September 1996. Then mortgage rates were 8% and the average price of a home was $171,600. As Murray Stahl writes: “One can actually buy a home for a monthly payment that is not very many dollars different from the monthly payment one would have needed in September 1996, when rates were significantly higher.”” But we already have interest rates (in Australia) at 8% even if the US is 4%. Doesn’t that mean if rates go back to a more “normal” level you will be truely “screwed”? or maybe you can fix the rate for 30 years in the US?

    Another… “Adjusted for inflation, Stahl points out that the payment for an average-priced home today is about 30% lower than it was 14 years ago.”. Yes, but all investments look good when we use the “officially cooked CPI numbers”. Add an extra 1% to inflation every year (government politicisation of CPI) and… hmmmm… not so good… only 15% lower. Again, what happens if interest rates go up?

    This article doesn’t translate well. Would suggest you re-publish with the Australian audience in mind while pointing out difference in US and AUS markets.

    BoombeeShark
    January 11, 2011
    Reply
  2. agree with other writer – article not related to Australian conditions at all – whose advise shoud we take – Kris Sayce says Aust properties overvalued and due for a crash whereas your article says rush in to but – whose advise should we take

    bill dunstan
    January 12, 2011
    Reply
  3. Besides… with all the problems with providing title for mortgage backed homes over there and continued RE deflation, I’d be inclined to wait it out. They won’t find the bottom of that sagging market until the market starts buying up all those millions of foreclosed homes… and who would risk your deposit on something that can perhaps not even belong to you afterwards.

    People buying homes in that environment might also consider a bridge I have t sell…

    Chris in IT
    January 13, 2011
    Reply
  4. The current mortgage and robo-signer fiasco in the USA will blow over. Some people fear that previous owners may legally regain titles to already sold properties, but I have a hard time imagining that is possible. There isn’t a sane judge in the USA who will turf out the new owners (who are paying the new mortgage) and install the previous owners (who probably weren’t paying the mortgage for months or even years).

    Freeloaders and strategic defaulters shouldn’t get free houses under any circumstances.

    Reply
  5. Boombeeshark: “An American writing for an Australian audience…” (?)

    The issue is really that we’re _not_ Mayer’s intended audience. There has been no attempt whatsoever to ‘translate’. It’s arguably impossible to do so.

    The article is helpful solely to reflect on where US housing _may_ be right now.

    I suspect that the gulf between east coast and west coast Oz property markets may begin to show disparity, too. May all our problems be capital gains issues…!~ ;)

    Reply

Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au