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Here is Your Top-Performing Investment for the Next Five Years

Is gold your best performing asset for the next five years? Is it high-growth technology stocks? Energy stocks? Or maybe biotech shares?

How about French collectable postage stamps or vintage racing cars?

Nope, you're not even close. I'll give you a hint: You're probably sitting in it.

Yes, the best performing investment you will own for the next five years will most likely be the home you live in.

Psshaww you may say. Perhaps even balderdash! However, if you look at the crucial data that drives this long-ignored sector, my conclusions are unassailable.

If fact, you can pretty much count on your home to appreciate at a 3% to 4% annual rate until well into the next decade, and much more if you are fortunate enough to live on the red hot west coast.

Net out the copious tax breaks that still come with home ownership, and your take home will be even higher than that.

This beats the daylights out of stocks (SPY) (1.84% yield), 10-year Treasury bonds (TLT) (2.85%) and approaches junk bonds (HYG) (5.74%) in terms of the potential returns.

For a start, the Federal Reserve's go-slow policy on interest rate rises is hugely pro housing.

The conventional 30-year fixed home mortgage can now be had for a bargain 4.5%. And many finance their properties with the 5/1 ARMs that I have been recommending, which are currently going for only 3.25%.

Worried about what happens in five years when the interest rate is reset? Just refinance during the next recession, which will almost certainly happen well before then, and you'll probably get a lower rate than you can get now.

That is, assuming you still have a job.

The good news for those homeowners who rely on the floating rates of an adjustable rate mortgage is that this is not a low interest rate decade, but a low interest rate century.

Another positive is weekly jobless claims of 222,000 at 43-year low, and a decade low unemployment rate of 4.0%, meaning that a lot more people have the income with which to purchase homes, far more than only a couple of years ago.

Not only will this be a low interest rate century, it will be a low energy cost century as well. If solar energy costs continue their dramatic rate of improvement, around 50% every four years, it will nearly be free by 2030.

Not only will free energy provide a big underpinning under home values. It will also increase the value of suburban homes where commuting is a major factor.

It gets better.

You know that Millennial of yours who's been living in your basement since he graduated from college?

Go downstairs and take a look. Chances are he probably moved out when you weren't looking, turning his prodigious gaming skills into a high-paying coding job.

What's more, he's now dating a girl. You know, the one with the nose ring, the streak of purple hair, and tattoos up and down both arms?

That leads to family formation. And you know what? The most important trend affecting the economy that no one knows about is that THE UNITED STATES IS ABOUT TO ENJOY ANOTHER BABY BOOM!

That's why new household formations are likely to jump from the current 1.2 to 1.5 million a year in the coming decade.

However, only 1 million homes a year are being built, thanks to the halving of construction capacity in the aftermath of the Great Recession. Subtract from that 250,000 houses a year that get demolished.

Does anyone hear the words "short squeeze"?

That means 85 million Millennials will be chasing the homes of only 65 million Gen Xer's. Here in the San Francisco Bay Area they are showing up at weekend open houses and paying cash for beautiful $3 million homes with great views, writing the check right on the spot.

Americans aren't the only ones buying homes. Some 8% of all the real estate sold in the U.S. in 2017 was to foreign investors, largely Chinese and Hispanics, according to the National Association of Realtors. That is an all-time high. They view U.S. real estate as a great asset protection strategy.

Are you convinced now? Are you ready to jump into the real estate boom and participate more than just through your residence?

Fortunate, there are a number of ways you can achieve this.

You can also go into traditional new homebuilders, such as KB Homes (KBH), Pulte Homes (PHM), and DH Horton (DHI). Another option is to take a basket approach by picking up the iShares U.S. Home Construction ETF (ITB).

See you at the next open house!

April 18, 2018

Diary, Newsletter

Global Market Comments
April 18, 2018
Fiat Lux

Special Residential Real Estate Issue

Featured Trade:
(WHY THE HOMEBUILDERS ARE NOT DEAD YET),
(DHI), (TOL), (LEN), (ITB), (KBH)

Why the Homebuilders Are Not Dead Yet

Diary, Newsletter, Research

It was as if someone had turned out the lights.

The homebuilders, after delivering one of the most prolific investment performance of any sector until the end of January, suddenly collapsed.

Since then, they have been dead as a door knob, flat on their backs, barely exhibiting a breath of life. While most of the market has since seen massive short covering rallies, the homebuilders have remained moribund.

The knee-jerk reaction has been to blame rising interest rates. But in fact, rates have barely moved since the homebuilders peaked, the 10-year US treasury yield remaining confined to an ultra-narrow tedious 2.72% to 2.95% yield.

The surprise Canadian limber import duty has definitely hurt, raising the price of a new home by an average of $3,000. But that is not enough to demolish the entire sector, especially given long lines at homebuilder model homes.

Are the homebuilders gone for good? Or are they just resting.

I vote for the later.

For years now, I have begged, pleaded, and beseeched readers to pour as much money as they can into residential real estate.

Investing in your own residence has generated far and away the largest returns on investment for the past five years, and this will continue for the next 10 to 15 years.

For we are still in the early innings of a major real estate boom.

A home you buy today could increase in value tenfold by 2030, and more if you do so on the high-growth coasts.

And while I have been preaching this view to followers for years, I have been assaulted by the slings and arrows of naysayers predicting that the next housing crash is just around the corner - only this time, it will be worse.

I have recently gained some important new firepower in my campaign.

My friends at alma mater UC Berkley (Go Bears!), specifically the Fisher Center for Real Estate and Urban Economics, have just published a report written by the Rosen Consulting Group that is blowing the socks off the entire real estate world.

The implications for markets, and indeed the nation as a whole, are nothing less than mind-blowing.

It's like having a Marine detachment of 155 mm howitzers suddenly come in on your side.

The big revelation is that only a few minor tweaks and massaging of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 could unleash a new tidal wave of home buyers that will send house prices, and the shares of homebuilders (ITB) ballistic.

The real estate industry would at last be restored to its former glory.

That's the happy ending. Now let's get down to the nitty gritty.

First, let's review the wreckage of the 2008 housing crash.

Real estate probably suffered more than any other industry during the Great Recession.

After all, the banks received a federal bailout, and General Motors was taken over by the Feds. Remember Cash for Clunkers?

No such luck with politically unconnected real estate agents and homebuilders.

As a result, private homeownership in the US has cratered from 69.2% in 2006 to 63.4% in 2016, a 50-year low.

Homeownership for married couples was cut from 84.1% to 79.6%.

Among major cities, San Diego led the charge to the downside, an area where minority and immigrant participation in the market is particularly high, with homeownership shrinking from 65.7% to a lowly 51.8%.

Home price declines were worse in the major subprime cities of Las Vegas, Phoenix, and Miami.

There were a staggering 9.4 million foreclosures during 2007-2014, with adjustable rate loans accounting for two-thirds of the total.

Some 8.7 million jobs were lost from 2007-2010, while the unemployment rate soared from 5.0% to 10%. The collapse in disposable income that followed made a rapid recovery in home prices impossible.

As a result, real estate's contribution to US GDP growth fell from 17.9% of the total to only 15.6% in 2016.

That is a big hit for the economy and is a major reason why growth has remained stuck in recent years at a 2% annual rate.

While the ruins were still smoking, Congress passed Dodd-Frank in 2010. The bill succeeded in preventing any more large banks from going under, with massive recapitalization requirements.

As a result, US banks are now the strongest in the world (and also a great BUY at these levels).

But it also clipped the banks' wings with stringent new lending restrictions.

I recently refinanced my homes to lock in 3% interest rates for the long term, since inflation is returning, and I can't tell you what a nightmare it was.

I had to pay a year's worth of home insurance and county property taxes in advance, which were then kept in an impound account.

I was forced to supply two years worth of bank statements for five different accounts.

Handing over two years worth of federal tax returns wasn't good enough.

To prevent borrowers from ginning up their own on TurboTax, a common tactic for marginal borrowers before the last crash, they must be independently verified with a full IRS transcript.

Guess what? A budget constrained IRS is remarkably slow and inefficient at performing this task. Three attempts are common, while your loan sits in limbo.

(And don't even think of asking for Donald Trump's return when you do this. They have NO sense of humor at the IRS!)

Heaven help you if you have a FICO score under 700.

I had to hand over a dozen letters of explanation dealing with assorted anomalies in my finances. My life is complicated.

Their chief goal seemed to be to absolve the lender from any liability whatsoever.

And here's the real killer.

From 2014, banks were forced to require from borrowers a 43% debt service to income ratio. In other words, your monthly interest payment, property taxes, and real estate taxes can't exceed 43% of your monthly gross income.

This hurdle alone has been the death of a thousand loans.

It is no surprise then that the outstanding balance of home mortgages has seen its sharpest drop in history, from $11.3 trillion to $9.8 trillion during 2008-2014. It is down by a third since the 2007 peak.

Loans that DO get done have seen their average FICO scores jump from 707 to 760.

Rocketing home prices are making matters worse, by reducing affordability.

Only 56% of the population can now qualify to buy the mean American home priced at $224,000, which is up 7.7% YOY.

Residential fixed investment is now 32% lower than the 2005 peak.

Also weighing on the market was a student loan balance that rocketed by 400% to $1.3 trillion since 2003. This eliminated a principal source of first-time buyers from the market, a major source of new capital at the low end.

Now for the good news.

Keep Dodd-Frank's capital requirements, but ease up on the lending standards only slightly, and all of the trends that have been a drag on the market quickly reverse.

And yes, some 2.3% in missing US GDP comes back in a hurry, and then some. That's a whole year's worth of economic growth at current rates.

Rising incomes generated by a full employment economy increase loan approvals.

Foreclosure rates will fall.

More capital will pour into homebuilding, alleviating severely constrained supply.

More investment in homes as inflation hedges steps up from here.

The entry of Millennials into the market in a serious way for the first time further increases demand.

Promised individual tax cuts will add a turbocharger to this market.

There is one way the Trump administration could demolish this housing renaissance.

If the deductibility of home mortgage interest from taxable income on Form 1040 Schedule "A" is cut back or eliminated to pay for tax cuts for the wealthy, a proposal now being actively discussed in the White House, the whole party is canceled.

The average American will lose his biggest tax break, and the impact on housing will be huge.

A continued war on immigrants will also hurt, which accounted for one-third of all new households from 1994-2015.

You see, we let them in for a good reason.

Assuming this policy self-inflicted wound doesn't happen, the entire homebuilding sector is a screaming "BUY."

On the menu are Toll Brothers (TOL), DH Horton (DHI), and Pulte Homes (PHM).

You can also add the IShares US Home Construction ETF (ITB), a basket of the leading homebuilding names (For the prospectus, click here.)

To read the UC Berkeley report in its entirety, entitled Homeownership in Crisis: Where Are We Now? a must for any serious real estate professional or investor, please download the PDF file for free by clicking here.

The bottom line here is that after a three-month break, the stirrings of a recovery in homebuilders may be just beginning.

Where It's Hot

It's Always Better on the Coasts

Real Estate Bidding Wars Go National

Newsletter

Two years ago, there was an open house listed in the San Francisco Chronicle in my neighborhood for $1.8 million. It offered a cavernous 6,000 square feet, five bedrooms, a generous den I could use as a home office, a gourmet kitchen, and a spectacular view of the entire bay area. It was a slow Sunday, so I went to check it out.

The home offered every imaginable upgrade, including a four-car garage, elevator, and beveled glass windows in the 1,000-bottle temperature and humidity controlled wine cellar. Nobody cared. The building was deserted except for a lonely and depressed listing agent. The only visitors had been a handful of other real estate agents.

The seller gave up, pulled the listing, and rented it to a visiting Oracle executive for two years. I heard the agent got so fed up dealing with people in bad moods that she left the industry.

Last weekend, another open house was advertised for the same exact house. I thought I would drop by and see how the market had changed. There was not a parking spot to be found on the street. After quite a hike, I made it to the house, only to be told to wait in line to gain entry. The rooms were as crowded as a Tokyo subway car at rush hour. I briefly lost the kids in the shuffle. And this was at the new listing price of $3.5 million. Yikes!

I asked a younger, slimmer, better looking listing agent if there had been any interest. She answered abruptly that there had been three all-cash offers since the morning. Unless I wanted to pay over the asking price, I shouldn?t waist my time. Double yikes!

The bottom line of this little interchange is that the recovery in the residential real estate market is real, has legs, and will have a major positive impact on the US economy. The implications for the rest of us are huge.

The turnaround came much earlier than many analysts expected, and has proceeded with an amazing ferocity. Demographic data suggest this wasn?t supposed to happen until 2022, when most of the Baby Boomers have retired and a new generation of homebuyers appears. Home mortgages, especially jumbos, are still hard to get. The banks are still laboring under a stock of 5 million foreclosed homes. Some 20% of homeowners are still underwater on their mortgages and are unable to trade up or out.

It appears that the prospect of the end of the ultra low interest regime offsets all of this. The Fed is certainly putting the pedal to the metal, with 3.5% interest rates charged for 30-year mortgages. Everyone knows these are a once a century occurrence, hence the bubble 2.0. Buyers are ducking credit issues by paying all cash for 50% of recent closing. Hedge funds, private equity funds, and other long-term investors are still generating 30% of purchases, as they see this a one great big yield play.

We learned as much yesterday when the January S&P-Case Shiller data was released. It was a blowout report, with the 20-city index showing an eye popping 8.1% YOY gain in prices. This is three-month-old data, and February and March are expected to be stronger still.

The basket cases of yesterday are delivering the headiest gains, with Phoenix up +23.2%, San Francisco, +17.5%, and Las Vegas, +15.3%. The foreclosure capital of the United States only a year ago, Atlanta, showed a robust +13.4% improvement.

The residential real estate market is not without its shortcomings. First time homebuyers have been conspicuously absent, accounting for only 30% of new deals, instead of 60% during the last cycle. They are, no doubt, being shut out by credit issues. What will happen to the millions of homes that institutions bought, once their have substantial capital gains? My bet is that they sell to realize profits, capping further appreciation.

The snapback in new construction has been even more dramatic. Monthly new housing starts have soared from the low 300,000?s to 800,000 in the last three years, a jump of 167%. That?s still a fraction of the 2.2 million peak we saw in 2006. Surviving homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) so dramatically shrank their cost basis during the dark days that they are unable to meet current demand.

The obvious benefit for the rest of us is the addition of 50-75 basis points to the US GDP growth rate this year. We?ll get a better read with a future GDP announcement, which could bring in a preliminary Q1 number as high as 3%. That will most likely take us to the Fed?s target of a headline unemployment rate of 6.5% sooner than later.

There is a greater advantage for we stock investors. Some two thirds of the home equity lost since the 2008 crash has been recovered. The total value of the US housing stock has bounced back from $10 trillion to $17 trillion. That creates a huge ?wealth effect? that steers more individual investors back into risk assets generally, and shares specifically. Should anyone be surprised that the Dow average is grinding to new all time highs every other day?

Not a day goes by when you don?t hear of shortages of workers in the building trades, such carpenters and plumbers. As a result, the shares of this sector have been the best market performers over the past 18 months, with some issues rising sevenfold. Whatever you do, don?t rush out and buy these stocks. They have run too far, too fast, and the risk/reward is terrible here. You missed it. I missed it.

Better just to bask in the glow of a home that it rising in value daily, and a retirement portfolio that is doing the same.

What Am I Bid?

Don't Get Caught in the Next Real Estate Bubble

Newsletter

Before you place a down payment on that next home, consider that you are voluntarily becoming dependent on government welfare, reliant on massive subsidies, and may become the next ward of the state.

Don?t kid yourself that the housing market has become anything but another bubble driven by artificially low interest rates and lax lending standards. Without the wholesale privatization of profits and socialization of losses, the current ebullient real estate market would instantly cease to exist. That cruel ending may be a lot closer than you think, as well.

Some 95% of all home mortgages are now bought by the US home mortgage agencies, Fannie Mae and Freddie Mac. That is up from only 35% in 2006. Never mind that both of these institutions are in conservatorship, which is a polite way of saying they are bankrupt, having burned through all of their capital during the housing bust.

Without this source of government funds, there is absolutely no way banks would be lending anywhere near the amount they are, as the spreads have become too minuscule to make it worthwhile. But by selling loans to the government they can offload their risk and skim off handsome fees along the way.

This is why the balance sheet of the Federal Reserve has grown to a mind boggling $3.8 trillion, on its way to $5 trillion, but we are measuring no real growth in the money supply. The money is simply moving from one government account to another, untouched by human hands.

The current pattern of modest appreciation in the most oversold markets, like Miami, Phoenix, and Las Vegas, will continue, as long as the Fed is giving us money for free and the government is bearing all the credit risk. When that ends, things could turn very ugly, very fast.

Most of my hedge fund friends expect ten-year Treasury yields to be back above 4% in two years. That would take the rates for the conventional 30-year fixed rate home loans from 3.50% to 6%, or more. Double the cost of carry on a house, and you halve the affordability. The effects on the secondary market would be devastating.

While many have nice paper profits on houses they bought over the last two years, that all becomes very academic if you can?t sell. The number of homeowners currently delinquent or in foreclosure would soar from the current 6 million to 16 million. That would be piled on top of the 30 million hapless homeowners, who, despite the bounce, are still underwater on their mortgages.

This is not some wild conspiracy theory that I picked up on the Internet. Since congress is in a cost cutting mood, the chances of Fannie Mae and Freddie Mac getting sufficient recapitalization are small. The home mortgage tax deduction is also on the chopping block. At the very least, we can expect it to get pared back to mortgages of $500,000 or less. That would seriously boost the real after tax cost of homeownership, especially on the high priced left and right coasts.

Of course, the good times will continue as long as the Fed is spiking the punchbowl. Buyers are strongly motivated by existing home prices that are half of the new cost of construction, as well as a fraction of 2006 peak prices. As my friends say in New Orleans, where great deals are still to be had, ?Laissez les bons temps rouler? (let the good times roll).

Current guidance says they will maintain ultra low interest rates until the unemployment rate falls below 6.5%, down from the present 7.8%, which we could see in two years. Those driven more by demographic data, like me, don?t see such a turnaround for five more years.

I am not seeing another crash here. A more likely scenario is that we continue to bounce along a bottom for several more years. Tell me how bullish prospective homebuyers will be after we see a 2,000-point plunge in the Dow, which could come as early as this summer.

What this does illustrate is how grotesquely expensive the homebuilding stocks have become, like Lennar (LEN), Pulte Home (PHM), and KB Homes (KB). These stocks are up as much as 700% in 18 months. This entire piece is in response to a question I got yesterday, Should I be buying the homebuilders here. My answer is a full throated ?NO!?

The only bull market you can really count on is the one for rents, which will accelerate, once the long term decline in homeownership resumes.

Looking for Shorting Opportunities Among the Homebuilders

Newsletter

As we continue flirting with a final top in equities for the year, I am stepping up my search for the best ways to participate on the downside. At the very top of the list are the homebuilders, one of the top performing sectors since the October, 2011 bottom. The performance of individual names has been absolutely blistering, with Pulte Homes (PHM) clocking a 245% move to the upside, beating the (SPX) by 210%.

You do not need to engage in any sophisticated financial analysis to see how expensive this group is. Spend a day visiting open houses put on by the big companies, like Pulte Homes (PHM), KB Homes (KBH), Ryland Group (RYL), Toll Brothers (TOL), and Lennar (LEN), as I did yesterday. Then scan the real estate pages of your hometown newspaper with a calculator in hand. You will quickly find that new homes are selling for double the cost of existing homes on a dollar per square foot basis.

This is a lot to pay for that black granite kitchen counter, built in vacuum system, flashy gas barbeque in the back yard, and solar panels on the roof. You may also notice that the homes are shoehorned so tightly on to their plots that you will become too familiar with the intimate details of the lives of your prospective neighbors. In fact, new homes are trading at the biggest premium over used in history.

I am loathe to bet against those lucky ones selling to the 1%, or anyone who earns close to them, whose wealth and spending power are expanding exponentially as I write this. That knocks out Lennar (LEN) and Toll Brothers (TOL). I am very happy to short stocks of companies saddled with selling on an increasingly impoverished 99%.

That trains my sites over to Pulte Homes (PHM) and KB Homes (KBH), the old Kaufman & Broad. (KBH) has already fallen 38% off of a poor earnings report. At least Eli Broad had the decency to give away most of his money after selling out at the market top. The Los Angeles art world is all the richer for it. That leaves Pulte (PHM) as the next overripe piece of fruit to fall.

I know that many of you have been getting calls from real estate brokers insisting that the bottom is in and prices are on their way up. I get the same calls from stock brokers too. Here are the reasons for you to let those calls go straight to voicemail.

There is still a huge demographic headwind, as 80 million baby boomers
try to sell houses to 65 million Gen Xer?s, who earn half as much money. Don?t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%.

Fannie Mae and Freddie Mac, which supply 95% of all the home mortgages in the US, are still in receivership, and are in desperate need of $100 billion in new capital each. Good luck getting that out of Washington, which is likely to be gridlocked for at least another five years, and maybe more.

The home mortgage deduction is a big target in any revamp of the tax system, which would immediately yield $250 billion in new revenues for the government. How do you think that will impact home process?

There are undeniable signs of life in best prime markets, where the pent up demand can be substantial. Here in the San Francisco Bay area you are seeing bidding wars for anything that is commuting distance from Apple, Google, and Facebook, or the rest of the booming tech world. Real estate is more local now than it ever has been.

The best case scenario for home prices is that we continue bumping along a bottom for as long as ten more years, when the demographic picture shifts from a huge headwind to a major tailwind. The worst case is that this is just another bear market rally and that we have another 20% on the downside.

Show me the Rally

Yes, But Does It Have Solar?