A sign that may make a comeback in 2011 (Photo: Rick Wilking/Reuters)
A very successful hedge fund manager is making the case that housing prices may rebound sharply in 2011. He may be right.
The guy’s name is Bill Ackman and his hedge fund is Pershing Square Capital, which had $3.5 billion under management in mid-2010. He has spent most of his career investing in consumer and retail businesses. But he made a killing in the late 2000s by spotting early problems in the credit markets and betting against bond insurer MBIA. Basically, he was early to recognize that Wall Street’s system of credit default swaps was just a shell game–shift risk around, not eliminating it. Now Ackman says he is believes residential housing could be the next great investment. He has a presentation called, “So… How to Make a Fortune.”
Nonetheless, Ackman’s call that housing will rise has been met with a lot of skepticism. Market strategist Gary Shilling says housing prices will fall another 20%. Ezra Klein, the Washington Post’s popular blogger, says Shilling is clear and comprehensive. Felix Salmon says Ackman’s thesis is based on two points, both of which have major problems. Daryl Jones of Hedgeye on sister publication Fortune.com says Ackman and other housing bulls are wrong. In today’s Journal, Peter Schiff, the strategist and failed Senate candidate, says housing prices are still too high. Lastly, Dr. Doom, and NYU professor, Nouriel Roubini says housing is already double dipping and will continue.
So Ackman clearly has the contrarian point of view here. Here’s why he could be right:
Much of the argument that the bears make is that housing prices still look inflated compared to where they were before the bubble. Schiff says housing prices should have risen 3.3% a year from 1998 to 2006, by historical averages. Instead, they rose just over 19%. So if housing prices are to revert to where they where before the bubble, they should fall another 20%. But Schiff’s and other’s emphasis on prices is misplaced. It’s not prices that matter when deciding if an investment should go up our down. It’s valuation. And by valuation housing looks attractive. One measure of that is the ratio of housing prices to average incomes. That ratio got as high as 3.6 during the boom. It now is about 2.7, according to the National Association of Realtors. And that is the 20-year average. So at the very least real estate prices don’t look strikingly overvalued. Another measure is the NAR’s Housing Affordability Index. The 20-year average for that measure is 133. The index now stands at 185, meaning housing is 40% cheaper than it has been on average for the past two decades.
Felix Salmon argues that the affordability ratio is misleading right now because mortgage interest rates are so low. When they begin to tick up, housing affordability will plummet. The problem with that logic is that interest rates tend to follow the economy. When the economy gets better, interest rates go up. But one of the key arguments for why the housing market might fall is because the economy will remain in a funk in 2011. There will continue to be a lot of people out of work in 2011. Well, if the economy remains in a funk, then interest rates won’t rise. Simply put, you can’t argue that high interest rates and high employment will conspire to bring down housing. Those things, generally, don’t occur at the same time. If interest rates do rise, that will because more people have jobs. And when more people have jobs, more people buy houses. So if and when we do have rising mortgage rates, housing prices are likely to rise or already be rising again. Not the other way around.
Lastly, Roubini says that the robo-signing, document-losing mortgage mess will significantly hurt the housing market in 2011. I agree that the banks have severely screwed up the foreclosure process. But my story, where I went out and successfully found one of these so-called missing mortgages, proves that the mess is not as bad as Roubini and others think.
Here’s my bottom line: Housing was certainly in a bubble. We know that now. And part of the reason was loose credit. And that’s not coming back anytime soon. But as with all things that end in bubbles, there was a good reason for why housing prices should be worth more than they were as well. The US is generally a wealthier nation than it used to be. And studies show that as people get richer they spend not just more, but a larger portion of their wealth on housing–so more of more. Also, there are more of us. And land is fixed. Local laws make housing even more fixed. For those reasons housing prices deserved to go up, though obviously not as much as they did. So the idea that housing prices and valuations deserve to plunge to where they were before the bubble, or even far below as some argue, is silly. Like all things, housing prices will go up again, and like everything else, it will probably happen when few expect.