Hedge fund manager John Paulson says buy US homes
Posted on 05 December 2010 with 1 comment from readers
The hedge fund manager who made billions betting against subprime mortgages is now advising people to buy homes in the US as a hedge against inflation and a falling dollar.
John Paulson is a man to follow with your check book. He reckons that if you own one house in the US you should be buying a second, and if you own two then buy a third. Why is he saying this?
Well, certainly US housing looks cheap on a relative and absolute basis after almost five years of falling prices. Last month saw a surprise 10 per cent surge in sales of pre-owned homes, and perhaps this is the bargain hunters moving in.
1970s precedent
If you look back at the 1970s the price of US homes roughly doubled in a decade of high inflation. That makes housing a hedge against inflation and a falling dollar. You can also leverage that gain with a mortgage where the value of the principal will be eroded by inflation, while the value of rental income will go in the opposite direction.
What of the danger of higher interest rates? That clearly needs to be taken into consideration so that buyers today are not overstretched tomorrow. But mortgage rates are presently very attractive and rate rises seem distant and should not be too high for sensible buyers who do their sums correctly.
For is this not the time that you want to buy into any market? Prices are depressed, and most people have turned against the market. There is certainly no mad crowd trying to push prices up, rather the reverse.
Will the market get flooded by repossessions? That is the other main objection to Paulson’s argument. It is true that house prices are unlikely to take off like a rocket with unemployment high and growth rates low. Equally house prices already reflect depressed demand and a depressed view of the marketplace. What if the reality is a little bit better?
Should US investors therefore be opting for real estate over stocks? It is arguable that something of a bubble has formed in US stocks after the 20 month rally, while house prices remain on the floor. This is not the UK where house prices are still near to their highs and due for an ‘age of austerity’ correction.
Interest rates
As Chris Mayer, editor of Capital & Crisis told ArabianMoney: ‘Remember that interest rose all through the 1970s and yet housing prices continued to climb. I agree interest will not stay low for too much longer. But I am not convinced this means housing prices will fall. Replacement values will go way up – in other words, the cost to build a new house will rise as inflation rises and I think this will put a kind of floor on housing values’.
That said the key to obtaining a safety margin in real estate is always location. US investors should look to buy both value and location. For a popular location will help with future cash flow in any rental property, and in a big crash like the one we have just witnessed the best locations often get cast down with the worst.
Fortune favors the brave and yet it can hardly be foolish to buy US housing at or near the bottom of a cycle, providing that you take an almost inevitable interest rate rise into consideration. Could it be the same in Dubai? Let us save that argument for another day.
1 Comment posted by readers:
In a period of high inflation, in the USA you can end up living NEARLY FREE in a house with a 30 year fixed rate mortgage at today’s low rates.
My father was a World War II US Navy veteran. (He was a medical assistant who spent the War stationed in SAN DIEGO instead of getting sent to land on Iwo Jima, because he played the clarinet in the Navy base band. The commanding officer got him pulled out of the invasion to keep his band intact, the day before he was scheduled to ship out. Those music lessons paid off!) Anyway, he got a GI government loan at about 4.25% interest, for 30 years, in 1958. He died at 60, in 1978 (heart attack from heavy smoking) before the loan expired in 1988. But in 1988, the final payment for my mother was still the same roughly $140, that it was in 1958! The electric bill was nearly that much! Inflation favors the debtor a LOT.
People who rent often don’t realize that if inflation takes off, so can their rent. Only your insurance and taxes can go up if you own. And they will go up, if you rent.
But the most important factor in real estate investing is still location. Other factors can never be ignored. Timing is also critical. I just read an article in the New Zealand Herald that said that the high end coastal properties in some areas of the North Island have decreased in value by 50%. I’ve read that quite a few very wealthy Americans are buying property in New Zealand just in case the US debt collapses the dollar, and a revolution occurs. It is far enough from everywhere to be reasonably safe from invasion, has the rule of law, plenty of land to grow food, and a small, well educated population.
In the future ,investors may have to factor gasoline rationing into the real estate investment decision. You may not want to be on your rural estate IF you still need to get to a job in the city. We shall see how the electric car develops. It probably won’t be much of a problem for the wealthy. The big rural estates outside L.A., Silicon Valley , and New York City will hold their value. Pick one up when they bottom. That is what the Paulsons of the world are doing. Waterfront in Hawaii is nice too. And unlike Florida, Hawaii doesn’t get hit by hurricanes too often. I want the house used in the Magnum P. I. TV series. But not the tax bill.