Is Buffett Right About Housing?

"I would say the single-family homes are cheap now, too. If I had a way of buying a couple hundred thousand single-family homes ... I would load up on them ... it's a very attractive asset class now."
-- Warren Buffett on CNBC, Feb. 27

Strong words from the world's most famous opportunistic investor. What should you make of them?

Keep three things in mind. One, it's true: Nationwide, home prices are the most affordable they've been in decades. Two, most of that affordability is driven by record-low interest rates that won't last forever. And three, it depends on location, location, location.

A big reason Buffett is bullish on housing is that mortgage rates are so low. "It's a way, in effect, to short the dollar because you can take a 30-year mortgage and if it turns out your interest rate's too high, next week you refinance lower," he said. "And if it turns out it's too low, the other guy's stuck with it for 30 years."

The National Association of Realtors publishes a "housing affordability index" that tracks not just housing prices, but mortgage rates, too. It shows that, indeed, home affordability is getting more attractive by the month. When Buffett talks about "a very attractive asset class," this is what he's talking about:

Source: National Association of Realtors.

But here's what's interesting. While housing affordability is setting records, home prices themselves are by no means low. Measured against median income, nationwide home prices are just now barely back to average:

Sources: S&P Case-Shiller, Census Bureau, author's calculations.

The implication of these two charts together -- record home affordability with average home prices -- should make you pause. As the saying goes, anything that can't go on forever won't. We should ask what happens when the artificial prop of record-low interest rates eventually ends and interest rates return closer to normal. When they do, home prices may fall far beyond current levels. That adds an important caveat to Buffett's call: If you can buy a home and stay put for many years, today's market looks like a steal. But if you're hoping to buy now and sell a few years down the road, tread with caution.

A quick illustration shows what I mean. When purchasing a house, buyers don't necessarily care about sticker price; what they care about is how much house they can buy at a given monthly payment. If you can afford a $1,500 monthly mortgage, and $1,500 will finance a $300,000 house, then that's your market. If, thanks to low interest rates, $1,500 can finance a $500,000 house, that's your new target price. In either case, home prices are linked to what borrowers can buy at a given budgeted monthly payment. There are other factors involved, but how much house a given monthly mortgage payment can buy is a good way to conceptualize how homes are valued.

Now think about where we are today. A 30-year mortgage averages 3.92%. In 2000, the same mortgage cost 8.5%. The difference between the two is enormous. At 3.92%, a $1,500 monthly mortgage will finance $318,000 worth of house (with a 30-year fixed-rate mortgage). At 8.5%, $1,500 a month will purchase only $195,000 worth of house. All else equal (admittedly, a bad assumption), the difference in interest rates between 2000 and today alters home affordability by more than 60%. And since 2000's interest rates were closer to "normal" than today's, the damage normal interest rates could have on current home prices should make you shudder.

Now, such worry is relevant only to those who plan on selling before long. You have to remember how Buffett thinks about real estate -- the man has lived in the same house since 1957. The average homeowner today sells after eight years. For Buffett-like buyers, price volatility after buying a home is meaningless. For those looking for an exit, price changes can be devastating. Make sure you know which side you're on. There is no shame in renting if it puts you in a better financial position. And for many, it does.

Now the standard disclosure: The nationwide housing market that analysts like me talk about is relevant to exactly no one. Measured against average income, home prices in Las Vegas are demonstrably cheap; in Seattle, they're still a little pricey; in others, it's somewhere in between. This chart, while dated, provides a decent look at home valuations by region.

What do you think about housing? Let me know in the comments section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by @TMFHousel. His latest e-book, 50 Years in the Making: The Great Recession and Its Aftermath, can be purchased on Amazon.com for your Kindle or iPad. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (28)

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  • Report this Comment On March 01, 2012, at 12:45 PM, deckdawg wrote:

    Good article. Notice that the steep incline in home prices starting around 2000 coincided with the steady decline in interest rates that started about then. The reverse is certainly likely to be true. Bill Gross wrote a letter the other day commenting on the strange things that can happen as a limit is approached ... in this case the limit being a nominal interest rate of zero.

  • Report this Comment On March 01, 2012, at 12:49 PM, sailrmac wrote:

    If only they would loan me the money at 4% fixed rates (great inflation hedge) without requiring me to use it to buy a house (declining value asset).

    Housing prices will continue to fall this year as the ending of the robo-signing scandal finally unsticks the process and causes homes listed for short sale to really be for sale (as apposed to for sale if I get the price it was worth 2 years ago otherwise I'll just keep milking the free rent). However, the loan rates are just soooo attractive. Yep, when rates go up in a few years home prices are likely to decline.

  • Report this Comment On March 01, 2012, at 12:59 PM, mdk0611 wrote:

    Good article. And since a significant part of real estate is local, I'd suggest a further basis for comparison. How expensive are rentals (apartments and houses) in the area where you are looking? And what will happent to rental prices if/when interest rates increase?

  • Report this Comment On March 01, 2012, at 1:16 PM, PaulH7171 wrote:

    Very good article, as usual, Morgan. A couple of points that I would make in reply:

    1. If someone is looking to purchase a house with cash, this might not be the best time to buy. It might be better to wait and see if prices go even lower.

    2. I'm not sure that decreasing prices are really so terrible for someone who wants to sell their house in a few years, because chances are very good that if you are selling one house, it means you are buying another.

    For example, suppose that I buy a house for $150,000. After five years I am ready to sell, but the value has dropped to $135,000. So, if I sell the house, then I will take a $15,000 loss, right? Maybe not, because if I am planning to buy another house that costs at least as much as my current house, then I probably will save $15,000 or more on my purchase price for the new house as compared to five years ago (because that house's value has probably dropped by a similar percentage). Therefore, the only way that I am likely to lose money overall is if I sell my house but don't buy a new one.

  • Report this Comment On March 01, 2012, at 2:14 PM, hbofbyu wrote:

    Hoes are a financial drain and are a place to live - not to invest. If you have cash look to the market for a return on your money.

  • Report this Comment On March 01, 2012, at 2:15 PM, hbofbyu wrote:

    Homes

  • Report this Comment On March 01, 2012, at 2:50 PM, 5000monkey wrote:

    Paul if you have 150k in cash your idea is true. If you have 500 bucks and that needs to cover your don payment and closing costs then your stuck upside down in house or looking at a short sale in which case you can't buy.

    That's exactly where we have been at for the past 4 years with declining values. It's a viscous cycle with declining values leading to more shorts sales and foreclosures which leads to lower home prices.

    The ability to afford the payment and the ability to borrow the funds are not necessarily linked and declining values actually makes it much harder to borrow the funds.

  • Report this Comment On March 01, 2012, at 2:57 PM, 5000monkey wrote:

    hbofbyu - your primary residence is a financial drain however its a fixed value over the life of the loan where as rent appreciates at least as fast as inflation. So if your mortgage payment is the same as a rental payment its a great inflation hedge.

    Rental properties on the other hand have the same inflation protection and if bought at appropriate prices will have a far larger ROI than any stock. I've got about 20 units bought now in the last 3 years and as an example. I bought and rehabed one for about 15k cash out lay and it returns about 500 a month. I dare you to find any stock that's going to consistanly return 40%+ a year. And that's before taking into consideration that my principle is being paid down $3000+ a year and my gross rental income is increasing 960/yr. But it also doesn't take into account the man hours I put in every month doing maintenance and collecting rent.

  • Report this Comment On March 01, 2012, at 3:13 PM, Merton123 wrote:

    This is probably the best time to buy a home to live in. I believe that interest rates should rise within a year or two as inflation rears its ugly head. A 30 year fixed rate mortgage and let inflation buy your house. Or to put it another way if you are making a salary having a fixed rate mortgage will save you a lot of heartache in the years to come.

  • Report this Comment On March 01, 2012, at 3:45 PM, PaulH7171 wrote:

    "Paul if you have 150k in cash your idea is true. If you have 500 bucks and that needs to cover your don payment and closing costs then your stuck upside down in house or looking at a short sale in which case you can't buy."

    I agree with the point that you're making. But I would argue that someone who can afford only a $500 down payment has no business buying a house in the first place. :-)

    Following the traditional guideline of making at least a 20% down payment would go a long way toward protecting people from ending up upside-down, even if home prices do continue to fall for several years. And then even if the person takes a loss on selling their house in a few years, they can shake it off because they still have positive equity in their home, and they know that they will pay less for their next home due to the lower prices.

  • Report this Comment On March 01, 2012, at 4:43 PM, CaptainWidget wrote:

    Really Buffett? If you had a way to buy a few hundred single family homes you'd quit your career as an accomplished investor and become a landlord?

    Or would you buy them, have a property management company manage them, and park a few million dollars into slowly depreciating assets for a net gain of $20 a month per home (if everything goes perfectly).

    Property management is a value add, it's not a given. If you don't know what you're doing, you will screw it up. If you don't believe me, watch HGTV. And it's not exactly high margin either. People with the ability and knowledge can do just fine in this market. People without the skill and knowledge, following bad advice from others, will spend a whole lot of money to break even.

  • Report this Comment On March 02, 2012, at 12:45 AM, gcp3rd wrote:

    "Rich Dad, Poor Dad" is the first time I read the sentence "your home is a liability, not an asset". As a real estate agent that flies in the face of conventional wisdom. But Kiyosaki explains it and he's right. It's a liability because you are liable for coming up with the money every month to pay for it. But every property is part lifestyle and part investment. The key on your own home is to learn about mortgages and how they work, to learn the market for housing enough to know you are buying at least a little under the market, and to know that real estate is a long term event. Plan to own at least 5 years to hopefully get some asset inflation (lol) but also to pay off some mortgage debt, preferably with 13 payments per year, or similar. Your home is more lifestyle than investment, but putting some effort in to the investment aspect can make a big difference.

  • Report this Comment On March 02, 2012, at 3:31 PM, DJDynamicNC wrote:

    -->"Notice that the steep incline in home prices starting around 2000 coincided with the steady decline in interest rates that started about then." <--

    Correlation does not equal causation, but I don't even think there's a particularly strong correlation in this case. I'd be interested in seeing interest rates over time graphed against home prices for the national market to see whether there is any validity to your claim.

  • Report this Comment On March 02, 2012, at 3:51 PM, DJDynamicNC wrote:

    Good article from Yglesias which contrasts the market for single family dwellings with multi-unit apartment rentals:

    http://www.slate.com/articles/business/moneybox/2012/03/high...

    The essential point is that people are in the market for shelter and the single family dwelling market does not exist in a vacuum, so considering the ratio between rental pricing and single-family dwelling ownership is worthwhile.

  • Report this Comment On March 02, 2012, at 3:58 PM, boogaloog wrote:

    PaulH7171,

    I understand what you're saying about putting 20% down to protect against being underwater, but that ignores the fact that many homes have gone down way more than 20%.

    I do agree with you about the new home being down about as much as the home you're selling. But you do have to be able to sell + cover the costs of selling + have 20% down for the new house. If you have a 150k mortgage on a house now worth 150k, there's no way you can sell it and buy a different 150k house and call it an even swap.

  • Report this Comment On March 03, 2012, at 7:15 AM, skypilot2005 wrote:

    Very important and true:

    "Keep three things in mind. One, it's true: Nationwide, home prices are the most affordable they've been in decades. Two, most of that affordability is driven by record-low interest rates that won't last forever. And three, it depends on location, location, location."

    +rec

    Sky

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