Why The Housing Bulls Are Wrong
March 7, 2011
Hedge fund manager Bill Ackman is the latest prominent investor to jump on the housing bandwagon. But here are four reasons by housing is still not a good investment.
By Daryl G. Jones, Hedgeye
A number of notable investors presented thoughtful and well-researched ideas at the Value Investing Congress last month. The one idea that we would take the other side of, though, was one from Bill Ackman of Pershing Square Capital, which was unveiled in a presentation titled “How To Make a Fortune”: to go long U.S. housing. To state it bluntly, we think Ackman is wrong on housing.
According to several reports, his thesis on U.S. housing focuses on a few key points. First, affordability is at its highest level in decades due to low mortgage rates. Second, household formation will rebound and go back to long-term trends, which suggest growth in demand. Third, supply of housing, which Ackman admits is high, will start to decline since builder production rates are as low as they have ever been. Finally, he believes the downside in housing is limited because at a certain price, institutions could step in and soak up the excess inventory.
To be fair to Ackman this is a secondhand summary of his ideas, but we wanted to address some of these key points and highlight where this thesis falls short.
The oft-used point to support a bottom in U.S. home prices is affordability, which is underscored by the fact that mortgage rates are at historical lows. While we can’t disagree that financing costs are lower than ever, we do disagree on affordability.
First, credit standards are higher and lenders typically require larger down payments and more upfront points, which increase the “all-in cost” of a house. (If the consumer can get a loan at all.) Second, we believe, based on our supply and demand models, that home prices will fall another 15% to 30%, which implies that the U.S. housing stock is actually overpriced. Finally, and most importantly, our analysis actually shows as houses get “cheaper,” or more affordable, demand goes down.
As we’ve highlighted in the chart below, based on our proprietary census work, household formation has turned negative for the first time ever. This is attributed to the fact that individuals are getting married at later and later ages. In fact, we have seen a growth of 1000 basis points in unmarried people aged 25-34 over the last decade. As these people get married less frequently and later, it has a commensurate impact on household formation. In the shorter term, unemployment is also a key negative catalyst for household formation. If the long-term trend in the chart below tells us anything, we shouldn’t look at history as a guide for future household formation.
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