While the overall economy has been quite sluggish for much of the year, recently housing has become a brighter area. It was falling home prices with over indebted borrowers that were a chief culprit for the recent recession. The real estate collapse caused a major loss of construction jobs, though a housing recovery will only bring a portion of those workers back.
Recently the Federal Reserve announced plans to purchase another round of government securities, in particular mortgage backed ones. These purchases will help to keep mortgage rates at near record lows for the time being. With 15 year conventional loans near 2.75% and 30 year mortgages around 3.5% housing has become increasingly affordable. Of course in coastal California many people will have to obtain higher cost jumbo mortgages.
One reason recent yearly comparisons for housing have looked positive is because until recently housing activity was at extremely depressed levels. It is much easier to show significant gains when coming off of a very low base. In terms of actual housing sales for both new and existing homes we are still well below historical averages.
A good gauge to look at in terms of the health of the housing market would be homebuilding stocks. One index of homebuilders is up approximately 85% year to date, as of this past Monday. Homebuilders tend to be very volatile, and most of their stocks are still well below highs reached prior to the past recession. Nonetheless, stock prices are forward looking implying that housing will continue to improve.
Unlike the stock market, where prices can change direction quite quickly, housing tends to move in longer term cycles. In Southern California over the past several decades both up and down cycles have tended to last at least 5 years. Assuming we are starting a housing recovery now, would imply a better market for at least the next several years.
The major unknown would be how significant of a housing recovery we might have. If job growth remains weak with above average unemployment, housing prices may not recover that much. However, if a large number of people who are now renting become homeowners that would provide a significant lift to home prices.
Investing in real estate is significantly different than owning stocks and bonds. The main difference is transaction costs. With stocks and bonds there is always a ready market to make purchases and at a very low cost. In addition real estate involves management and maintenance issues.
For an investor owning real estate offers additional diversification compared to just owning stocks and bonds. Also with the real estate market turning up, the relative risks of owning real estate are diminished. However, not everyone may be comfortable owning real estate with the high transaction costs involved.
There are housing related companies, such as homebuilders where investors can have liquidity. However, homebuilding stocks are very volatile, and should not be a large portion of anyone’s portfolio. In addition homebuilders have already had significant price gains. Reit’s are another real estate alternative, which I will discuss in a future column.
