Housing Policy

Buffett: Way Too Optimistic on Real Estate Recovery

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Warren Buffett's annual letter to Berkshire Hathaway shareholders came out over the weekend. Whatever your feelings about Buffett as a TARP supporter, investor, friend of scoundrels like GE honcho Jeffrey Immelt, or general human being, the newsletter deserves its reputation as a must-read for anybody serious about business. This year's edition contains some fun TARP-related defiance:

We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses.

When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system, not a supplicant. At the very peak of the crisis, we poured $15.5 billion into a business world that could otherwise look only to the federal government for help. Of that, $9 billion went to bolster capital at three highly-regarded and previously-secure American businesses that needed – without delay – our tangible vote of confidence. The remaining $6.5 billion satisfied our commitment to help fund the purchase of Wrigley, a deal that was completed without pause while, elsewhere, panic reigned.

We pay a steep price to maintain our premier financial strength. The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.

Even a billionaire can't resist the lure of a conference box lunch.

Less persuasive is Buffett's take on the real estate market. He's focused on housing starts:

People thought it was good news a few years back when housing starts – the supply side of the picture – were running about two million annually. But household formations – the demand side – only amounted to about 1.2 million. After a few years of such imbalances, the country unsurprisingly ended up with far too many houses.

There were three ways to cure this overhang: (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 or; (3) reduce new housing starts to a number far below the rate of household formations.

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. Prices will remain far below "bubble" levels, of course, but for every seller (or lender) hurt by this there will be a buyer who benefits. Indeed, many families that couldn't afford to buy an appropriate home a few years ago now find it well within their means because the bubble burst.

While Buffett's description of the original overbuild is accurate, his prediction of "a year or so" until the market bottoms out seems way too optimistic. And I wish he were right. I live in Southern California, the epicenter of the original overbuild. I will soon have no choice but to dump a house in the DC beltway that has lost nearly 40 percent of its value since I bought it.

Maybe things look very different in Omaha, but I'm just talking about the market for existing houses. The glacial pace of getting hopeless defaulters out of their houses, and the millions of foreclosed houses that are destined to come onto the market in the next few years, make it extremely hard to believe that even existing home sales will be back to growth within a year or so. (As Bill McBride notes at Calculated Risk, it may depend on the meaning of or so.) The near-term outlook for commercial real estate is famously even more grim.

And as for when new housing starts (Buffett's interest here, through Berkshire's ownership of Clayton Homes) will again be a growth area, we'll be lucky if our grandchildren live to see that day.

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  1. When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system

    Kindly old Grandpa Buffett; why, he’s just a modern-day George Bailey!

    1. Given that he has pleged to give his entire fortune to charity, I’m going to say that he is Baileyesque.

      1. What a guy. He’s a smart one. Obviously if people stop building, formations will catch up with things. A couple years away, Im not sure about but you definitely see prices somewhat stabilized or at least at a point where there is not too much movement but Im sure its a different situation anywhere you look.
        Walt A. – Washington DC Real Estate

  2. While Buffett’s description of the original overbuild is accurate, his prediction of “a year or so” until the market bottoms out seems way too optimistic. And I wish he were right. I live in Southern California, the epicenter of the original overbuild. I will soon have no choice but to dump a house in the DC beltway that has lost nearly 40 percent of its value since I bought it.

    None of this contradicts what Buffett said. He said that the most built up areas will still be screwed and that prices will be well below their peak values*

    The near-term outlook for commercial real estate is famously even more grim.

    Commercial real estate generally lags behind residential by about 2 years. It craps out and bounces back later. So assuming Buffett is right, that means commercial real estate won’t be fine for 3 years “or so”.

    http://www.ritholtz.com/blog/2…..al-estate/

    * Did you buy prior to 2005 because that was the start of the peak?

    1. Mo, those factoids were support for my claim that I want to believe Buffett’s right — if he were, I’d be in much better shape. The stuff in the following paragraph (on the slow pace of foreclosure turnaround) is support for my believing he is wrong.

      1. Ahh, sorry. My bad for misreading you.

      2. What Buffet actually means IMHO is that real stability will have returned to the housing market in a year or so. (And there are already signs of that in certain places…)

        Of course that doesn’t mean that houses will begin to appreciate as quickly as they fell, although the places hit hardest likely might. But, in essence, he thinks the banks will have to eat their shorts for a while and take the hit while early adopters buy up the distressed real estate at Goodwill discounts.

        Sorry about the house in DC. In certain areas of the District things are really looking up. Where and when did you buy it? There is also a supply problem on the horizon for DC condominiums…

  3. “I live in Southern California, the epicenter of the original overbuild. I will soon have no choice but to dump a house in the DC beltway that has lost nearly 40 percent of its value since I bought it.”

    It’s hard to advocate letting nature have its way with homeowners after reading that–it’s a lot easier when it’s a faceless, nameless homebuyer…

    But it shouldn’t be controversial to suggest that some of the things the government’s done to try to stop foreclosure have lengthened the process of repricing all those assets and making more renters…

    I also think unemployment and immigration are effecting this too. Unemployed people are doubling up with relatives, which they wouldn’t do if they weren’t unemployed, and immigration is probably having an effect too, maybe not as much in Washington DC…

    I’ve seen estimates that vary. But I’ve seen it said that anywhere from half a million to 2.5 million illegal immigrants have left California alone since the beginning of the recession… Most of those guys were paying rent.

    1. It’s even harder to advocate it when you are the homeowner, but the truth is not a servant of my self-interest.

      1. Ahh, my bad.

      2. Oops, responded to the wrong Cavanaugh reply.

  4. “I will soon have no choice but to dump a house in the DC beltway that has lost nearly 40 percent of its value since I bought it.”

    That’s just stupid.

  5. And as for when new housing starts (Buffett’s interest here, through Berkshire’s ownership of Clayton Homes) will again be a growth area, we’ll be lucky if our grandchildren live to see that day.

    By the way, I hope many, many more people feel like you do re: real estate and the economy*. Much like the surest sign of a coming crash is exuberance and a belief that good times will roll forever (see: tech and housing bubbles), the surest sign of a coming recovery is everyone giving up on an economy**.

    * Judging by the most recent consumer confidence numbers, they do.

    ** Note: Does not apply to seriously FUBARed 3rd world economies, such as Zimbabwe.

    1. Much like the surest sign of a coming crash is exuberance and a belief that good times will roll forever (see: tech and housing bubbles)

      You mean, like the bull market since last March?

      the surest sign of a coming recovery is everyone giving up on an economy

      You mean, like the consumer confidence numbers that cratered in January?

      1. You mean, like the bull market since last March?

        A bull market != “exuberance and a belief that good times will roll forever”. Saying and believing stupid shit like, “housing prices will go up forever,” or “companies don’t need profits in the new economy,” is. Large financial and construction firms built business models on housing growing forever. That’s stupid. Markets clawing back half their losses because the worst case scenario didn’t hit, but still being 30% off the recent high is normal. Plus I don’t know any bankers that are 100% convinced it’s going to keep going like this. Only the most optimistic of bulls would be surprised by another leg down.

        You mean, like the consumer confidence numbers that cratered in January?

        Hence my footnote. Though it may be wishful thinking right now, I’m still relatively optimistic.

  6. Why do we want real estate to recover?

    Lower home prices means that housing is more affordable.

  7. Housing prices have stabilized in many areas, including parts of Southern California. I bought a house in Riverside in May of last year for $150k; last guy paid $400k in Dec 05. Last month, a house on my block with less than half the square footage of mine sold for $137k. Seems like a recovery to me.

    1. Seems like anecdotal evidence to me.

  8. Where in the DC beltway have homes gone down 40%? PG county? Every area I’m familiar has gone down at most 10%, and many areas never went down at all, they just stayed flat for the last couple years.

    1. Alexandria. And I’m going by Zillow, which my agent says is unreliable. (And she may be right. I’ve seen one place close in the neighborhood at a price way higher than Zillow is claiming.)

      1. I’m pretty skeptical about that. I know people who bought in 2006 and are selling now for a tidy profit near old town.

      2. Zillow is highly unreliable. For several years, they listed my house (a teardown purchased at the end of 2007) with the old specs and at what might have been a reasonable price in 2006. Then things went the other way, and as the number of bedrooms went down, so did the price. I’ve had realtors tell me that we dug a big hole at the bottom of the new construction per-square-foot mark, but maybe that was unrealistically high, too.

      3. Zillow thinks my garage is a second house on my lot.

      4. Zillow isn’t good anymore. The variance between Zillow.com and an actual appraisal might be 40%. LOL

  9. That’s my impression also. I’d be curious to know at the very least in what neighborhood Mr. Cavanaugh bought a house and how long ago he bought it.

  10. ‘I have answered three questions, and that is enough,’
    Said his father, ‘don’t give yourself airs!
    Do you think I can listen all day to such stuff?
    Be off, or I’ll kick you downstairs!’

  11. Take Buffet out of a suit and he could pass for a Walmart greeter. A stinking rich Walmart greeter who could buy and sell me many times over, mind you.

  12. option 4) Coax large numbers of immigrants to settle in the United States.

    Suppose we cut a deal wherein refugees from Haiti (or other areas) could get US visas, and some international agency helped pay for their housing?

  13. make it extremely hard to believe that even existing home sales will be back to growth within a year or so.

    Non-seasonally adjusted existing home sales were up 7% YoY in January.

  14. (3) reduce new housing starts to a number far below the rate of household formations.

    The problem is a lot of unemployed are moving back in with the folks, meaning household formations are going negative, too.

  15. That looks like a great way to alleviate loss incurred. A great approach to understand the depth of recovery of the loss that can happen in future. An intellectual read ! 🙂

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