Warren Buffett´s US Housing Outlook 2010

Buffets Predictions for US Housing…

Investors and property agents were jumping for joy last week when billionaire Warren Buffett predicted that U.S. residential problems will be largely behind us within a year or so.

On page 11 of his annual letter to shareholders, the great man opined that the US housing industry was currently in a shambles for two reasons.

The first, and most obvious, was that during the prolonged boom, housing starts ran at about 2 million annually, while household formation amounted to about 1.2 million annually.

After a few years of such large imbalances, the USA unsurprisingly ended up with far too many houses.

Jokingly, Buffet offered three ways to adjust the imbalance:
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1. Blow up a lot of houses, a tactic similar to the destruction of autos that occurred with the “cash-for-clunkers” program.

2. Speed up household formations by, say, encouraging teenagers to cohabitate, a program not likely to suffer from a lack of volunteers.

3. Reduce new housing starts to a number far below the rate of household formations.

Housing Starts Now at Record Lows
With housing starts at 554,000 last year, the lowest since records began in 1959, Americans are well on their way to correcting this imbalance. As Buffett stated, “our country has wisely selected the third option, which means that within a year or so residential housing problems should largely be behind us, the exceptions being only high-value houses and those in certain localities where overbuilding was particularly egregious”.

His second reason for the current distress in the US Housing market was due to the large gap in mortgage availability and interest rates offered to people who purchase site built homes vs factory built homes. This is a particular bugbear for Mr Buffett as his company owns an big factory home builder called Clayton Homes .

Far be it from me to read too much into the latest message from the worlds´ most celebrated investor, but I can imagine that he must constantly be toning down his messages to the general public due to his unique influence on the markets. If he came right out and said “you know what folks, 2010 is a pretty good time to purchase undervalued real estate because the market is well on its way to correcting imbalances during the boom years” there would probably be stampedes of investors trying to snap up available inventory all over the country.

If there were stampedes of investors all of a sudden, no doubt some of them would be pounding on the big doors of the beautiful clubhouse in Mosaic at Mall of Millenia . At the moment, properties in this resort start at just €44,000 ($60,900) have 97% occupancy and we have 7 units with double digit net yields.

It is probably worth mentioning that we mean real double digit net yields. Perhaps unsurprisingly, and no doubt in their excitement to promote a new product, some agents forget to include all the monthly costs before advertising how great the rental returns are.

No matter where you buy in the USA, you will get your real net yield when you subtract HOA fees, real estate tax, rental management fees and home insurance from your average monthly income. Anything else is misleading. In a lot of states (but not Florida), you´ll have to account for state tax as well.

What if Mr. Buffett´s prediction is right?
Let´s assume for a moment that his prediction of a US housing recovery sometime in 2011 is correct and let´s also bear in mind that people who have betted against him in the past haven´t done so well.

Is it better to wait until 2011 and start investing in property once prices start recovering? Or might it be worth using some money sitting in a (very) low interest savings account to purchase well priced high quality properties while they are still available?

It´s been a crazy 18 months in the real estate business, but as the Sage of Omaha himself said “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it”.

Translation: These fluctuations caused a flood of motivated sellers to appear. They won´t stay so motivated indefinately.