Monday, August 31, 2009

Is real estate a good hedge against inflation?

Given the size of the federal bailouts to prevent the U.S. economy from lurching into a full-blown Depression and a federal deficit that will rise to about 13% of GDP during the current fiscal year, the chorus of voices concerned with runaway inflation just down the road grows larger every day. So is that a good or bad thing for the housing market? It’s actually both.

Writing in an August op-ed piece for The New York Times, investment sage Warren Buffett, CEO of Berkshire Hathaway, argues that although he supported the financial intervention engineered by the federal government to prevent an economic collapse, the side effects from trillions of dollars sloshing around -- and still largely protected in the coffers of risk-averse banks -- will soon need to be monitored closely.

To be sure, finding buyers for U.S. government debt is a complicated process in the best of times. Even assuming that both foreigners and citizens continue to funnel all of their extra cash into Treasury bills, that still leaves another $900 billion needed to underwrite the $1.8 trillion in debt being issued this year alone -- $900 billion of which will most likely fall out of Washington’s money tree at the Federal Reserve.

With legislators not about to incur the wrath of voters already frustrated with lower home values and retirement accounts, it’s unlikely they’ll be serious about raising taxes or cutting spending to fill the void. Instead, they have a third option which requires no official vote, nor can it be easily used against them at election time: let inflation take care of it!

The problem is that inflation is a double-edged sword which can slowly yet deliberately eat away at the wealth of its citizens, especially if that wealth is directly tied to the value of the U.S. dollar. Yet for owners of ‘real’ assets – such as commodities, gold, and real estate – inflation can both boost the value of the asset while chipping away at the fixed-rate debt used to finance it.

In the case of real estate, the inflation hedge is really more about the type of debt used – preferably a long-term mortgage with a fixed interest rate – than anything else. But add in the impact of rising prices on rents, and suddenly investing in real estate for passive income and enjoying the various tax write-offs becomes a tried-and-true method (and one used extensively in the 1970s) to build wealth while paying off debt that becomes worth less and less each day.

Of course to address rising inflation, the Federal Reserve will eventually have little choice but to hike interest rates, which could counteract the advantage of real estate’s strength as an inflation hedge. Moreover, the housing inflation of the 1970s was made possible with concurrent increases in wages; given a global economy which has kept a tight lid on wage income, it’s also possible that we’ll see higher prices for oil, food and commodities as home prices continue to stagnate.

For now, the best advice for households is to conduct their own financial analyses and determine how to defend their assets in an inflationary environment while also looking out for advantageous investments, such as selling off bonds and converting variable-rate loans such as those used for credit cards, cars and home equity lines into fixed-rate alternatives.

For those with extra cash to spare, investing in exchange-traded funds specializing in gold and commodities, although more volatile, can be more profitable than the type of Treasury Inflation-Protected Securities which simply keep investors above water.

However, one group of potential homebuyers who might benefit the most from rising inflation are the baby boomers who will start retiring en masse just as interest rates on their CDs and savings accounts begin to rise. Add in the fact that Social Security payments are adjusted for inflation, and they might even forget that the actual dollars they’ve saved for a lifetime are worth just a bit less each day. And that’s where the ‘retirement home as inflation hedge’ discussion could very well have the most merit.

Monday, August 17, 2009

Latest column for Builder & Developer magazine now online

My latest column for Builder & Developer magazine is now online. For August, I discussed my book review of the Robert Shiller book "Animal Spirits" as well as my follow-up interview with him on BlogTalkRadio.com.

An excerpt:

It seems that there’s just nothing better than an old-fashioned boom-and-bust cycle in the housing market to reveal what economist John Maynard Keynes dubbed ‘animal spirits’ in the middle of the Great Depression.

Harnessed appropriately, it fuels the ‘na├»ve optimism’ that builders and developers require to place risky bets on new developments, when a constant barrage of economic externalities can derail even the best-laid plans.

But when these spirits turn dark – as they have in this ‘Great Recession,’ aggregate human psychology can prevent lenders from lending, consumers from spending and homebuyers from venturing into sales offices far beyond what traditional economics alone would dictate.

It is precisely this type of phenomenon that economists Robert Shiller (the Yale University professor and co-founder of the S&P/Case-Shiller Index) and Nobel Laureate George Akerlof (a professor at UC Berkley), discuss in their recent book, “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.”

Having recently read this book to review for the Inman News service, I also thought its lessons were appropriate for the building industry, given that it was housing which sparked the economic maelstrom in which we still find ourselves. As an adjunct to the review, I was also able to interview Dr. Shiller for a new show I’m hosting on BlogTalkRadio.com, The Housing Chronicles.

A primary thesis of the book is the failure of macro-economic theory over the past generation to properly account for these animal spirits, which can be subdivided into confidence, fairness, corrupt/anti-social behavior, the illusion of how money really works, and the stories that people and societies tell themselves to explain their place in the world.

Somewhat like the 2005 book “Freakonomics,” the authors then apply these theories to questions ranging from why countries fall into depressions to why real estate markets seem to always go through cycles.


Click here for entire column.

Can you really time the real estate market?

During the apex of the boom years, many sellers did their best to time the market in order to get their chips off the table and wait for the bottom to get back in. For both buyers and sellers, timing the market is always risky, although given the size of the run-up in prices during the boom, it's hard to fault those sellers who saw a bust coming and didn't want to lose even paper money. So how can one time the right time to re-enter the market? From a story by Peter Hong in the L.A. Times:

Just as experts couldn't precisely time the bursting of the housing bubble, no one claims to know exactly when the market will hit its bottom.

There are plenty of pundits weighing in with predictions on when the housing crisis will end, but knowing what to do is tougher than knowing what to say. For those who sold homes during the bubble, actions can be as telling as words...

Declining prices are driving home sales up over last year's levels in Southern California and statewide. Nationally, sales are still below year-earlier levels but have been inching up...

In Southern California, sales are brisk for homes priced near or below the current $265,000 median. The majority of those homes are foreclosures, so prices are often low enough to draw multiple offers from potential buyers.

Richard Toscano, who in 2004 started a popular San Diego housing-bubble blog called Piggington's Econo-Almanac, lately has been posting data showing home prices are favorable compared with incomes and rents in lower-priced parts of San Diego.

He's drawn fire from some, but others who have followed the blog for years have recently posted comments detailing home purchases. Toscano, who sold his San Diego condominium in 2002 (he said the sale was due more to a job transfer than his belief in a bubble then), is still holding off on buying for various personal reasons, he said.

But he thinks it's no longer dangerous to buy in some areas.

"We have this weird, disparate bottoming," he said. "In some areas we may be there already, but others are not nearly as close."...

As prices continue to fall at the high end and those homeowners get deeper underwater, they'll have to sell at prices well below today's levels, or get foreclosed on, which will result in the homes being resold by lenders at cut rates.

Save the date! Beacon Economics Bay Area Economic Conferences in September

Once again, MetroIntelligence Real Estate Advisors will be partnering with Beacon Economics for their series of economic forecast conferences in the San Francisco Bay Area, including authoring the sections on residential and commercial real estate for the 100-page conference books distributed at each conference.

So please do save the date!

Beacon Economics' San Francisco, East Bay, and South Bay/Silicon Valley Forecast Conferences are just around the corner:

San Francisco - September 16, Hyatt Embarcadero

East Bay (Oakland) - September 17, Marriott City Center

South Bay/Silicon Valley (San Jose) - September 24, Fairmont Hotel 4th Street Summit Center

Tuesday, August 4, 2009

"What's Next L.A.?" Economic Conference

Miss the Los Angeles Economic Conference presented by Beacon Economics last week at the Airport Marriott?

Fear not, as Beacon has provided copies of the presentations and the conference book online. Click below for the various files:

Forecast book

Chris Thornberg presentation (state and national trends)

Brad Kemp presentation
(regional trends and forecast)

John Paglia presentation (private investment)