Welcome to WallStreetOasis.com's latest This Week in Finance newsletter, where we profile the hottest investment ideas, substantive market data, incisive financial blogging, and the best under-the-radar research Wall Street has to offer.
Investments: A Real (Estate) Dilemma - To Buy or Not to Buy
During the recent housing bubble, real estate as an asset class continued the trend away from its traditional place as a store of wealth and a long-term investment to an arena dominated by short-term thinking and speculative frenzy. As prices have corrected, many have felt the pain of a return to fundamental valuations based upon supply and demand, and upon the vastly underfollowed income potential. A home, like any asset, can be valued based on future cash flows, which for residential real estate is rent. This then begs the question; from a purely financial perspective, does it make sense to buy or rent?
The New York Times has an excellent buy vs. rent calculator. Using a simple New York City one bedroom apartment example with conservative assumptions ($750,000 to buy, $2800 to rent, $800 in monthly common charges, 50bps of annual tax, 8% annual return on other investments, 4% annual inflation & rent increases), a number of things become clear. First and foremost, it is only advantageous to buy rather than rent when there is significant price appreciation, and the idea of "paying off a mortgage to build equity instead of throwing away rent money" does not hold water. With unemployment rising, Wall Street suffering, and many more foreclosures (see Blog-wrap, below) to come, supply and demand mechanics make it seem irrational to assume a recovery in home prices in the near future, or at a historically normal rate thereafter.
Another important point (if fairly obvious) is that the profit on a home will be greater with a lower down-payment (the remainder invested at the assumed rate-of-return) and a lower mortgage rate. As banks tighen lending standards, low down-payments are becoming a thing of the past, and finding attractive mortgage rates is becoming increasingly difficult. When combining all these factors with the weight of taking on massive amounts of debt, the decision to buy right now is not an easy one. Of course, the simple counterarguments to this are that Americans, if not forced to save through the accumulation of home equity, will instead spend the excess cash retained from renting rather than invest it, thus making this entire exercise moot, and that the intangible benefits of home ownership can never be represented in this type of raw analysis. These are certainly valid points. Home ownership will always remain an important staple in American life, but an understanding of the true risks and payoffs, as well as factoring in the current tide away from speculation, will have a profound effect upon this market going forward.
And if you're really bearish (or bullish) on housing, there are two new ETFs by MacroMarket that track the S&P/Case-Shiller Composite 10 Home Price Index (and its inverse), the "leading index of home prices across the nation."
Research of the Week: Data, Data, and More Data
Every week, Barron's releases its updated Market Lab page. The page has very detailed information on the stock and bond markets, as well as economic, sentiment, options market, and hedge fund performance data. My favorite section, however, is the Toolbox, where Barron's provides important investment analytics, including which sectors are moving markets, company and economic calendars, and of most personal interest, 13D filings, where activist investors (individuals, hedge funds, and private equity firms) must report and update ownership of greater than 5% of a public company, and Barron's analyzes their plans and intentions for the company - very useful in finding stocks to piggyback others' hard work on!
Blog-Wrap: Housing Crisis Not Close To Over
Calculated Risk portends the next wave of delinquencies and foreclosures - prime borrowers who used adjustable-rate mortgages (ARMs) as a tool to overstep their affordability boundaries. As adjustable rates reset higher, borrowers become unable to pay. The riskiest adjustable mortgages, option ARMs, in which a borrower can choose to pay less than the monthly interest cost, only to have that difference added back to the principal of the loan, thus eating into their equity, are yet to see the majority of their resets occur. This graph shows the coming resets, and given the difficult refinancing environment and tight lending standards, it will not be pretty for the housing market.
TWIF Notes: Warren Buffet vs. Hedge Funds
Warren Buffet is putting his money where his...well, money is, betting $1 million (all for charity) with Hedge Fund investment firm Protege Partners that over the next ten years, the S&P 500 will outperform a composite of fund of hedge funds, net of fees. Buffet, no dummy, starts with a huge advantage, as hedge fund and fund of hedge fund fees often combine to 3% of capital and 30% of performance, meaning underlying hedge funds would have to make about 18% before fees annually if the S&P 500 earned 10% per annum, just to tie. On the other hand, he's already behind as of this writing, with the S&P -4.63% versus fund of hedge funds -1.45%, as of the end of May.
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