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The great American investment

Pinchas-LandauEverybody knows that the real estate market in the United States is recovering strongly from the slump that followed the great boom that began in the mid-1990s and peaked in 2006. Everybody knows, because the mainstream media are full of reports saying that’s what is happening. Prices are rising strongly, especially in beaten-down places like Las Vegas.

Even more prominent is the trend to invest in American real-estate.

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Media outlets, including in Israel, are full of adverts explaining to people how they can achieve very juicy yields (by today’s shrunken standards), by buying apartments or homes in American cities and then renting them out. The logic is compelling: prices are low and the cost of finance is extremely low. Many people are attracted to schemes in wihc investors pool their resources in a managed fund, there enabling the fund manager to a) take management fees, b) leverage his own modest investment and c) obtain enormous leverage from banks and other financial institutions on the capital that he and his clients have put up, so that d) he can buy a large number of homes and then rent them. His clients should receive a decent return and he will clean up an absolute fortune.

These schemes have taken off in a big way in recent years. Some of them are run by fly-by-night hucksters, but the really big ones have been put together by the biggest players in Wall Street, including both investment banks and asset management companies. They are underpinned by the commitment of the Federal Reserve to keep borrowing costs at near-zero rates, so that money is effectively free.

But that is merely the financial underpinning. The socio-economic platform on which these schemes are constructed is the move away from home ownership to renting which has developed over recent years. The rate of home ownership in the United States has dropped back from the record levels reached at the height of the boom, of over 69%, to below 66% today – the latter being a level first seen in the early 1980s and most recently reached again and passed in the late nineties, on the way to that record. In other words, home ownership in the US has returned to pre-boom levels.

Where do all the people who used to own their homes but no longer do, and the people who never did own them – live. Granted homelessness has increased considerably, but it is still a marginal phenomenon, fortunately. The answer, of course, is that they rent. The fall in home ownership must translate into an increased demand to rent – and that has created an opportunity. The opportunity has been seized, as usual, by the monied class: wealthy individuals and institutions who manger the money of the well-to-do have plunged into the housing market, buying existing homes and also snapping up new ones. That is why the data for new home construction have shown a change in the kind of new homes being built: the share of multi-family homes has risen and that of single-family homes has fallen.

All these are well-known phenomena, for which the data is clear, consistent and credible. However, the recovery in construction and, especially, the rise in house prices, are prominent pieces of evidence in every analysis seeking to show that the economy as a whole is improving. The reason that the building and purchase of homes is so important to a macro view of the economy is not because construction is a large chunk of the overall economy – it isn’t. It was never that big and has now shrunken to some 3-4% of GDP. But home construction and purchase is a proxy for a wide range of other activity, from heavy equipment to home furnishings. More important still, homes are the biggest purchases most people get to make, and if they are buying it means they must be feeling that their situation is improving and their prospects are good.

But for the average person, especially young couples, buying an apartment means taking a mortgage. Herein lies the answer to the apparent disconnect between the evidence represented by increasing construction and rising prices, and the moribund state of the overall economy. Most people cannot buy without a mortgage and most people cannot get a mortgage, because their circumstances do not permit them to – or dissuade the bank from lending to them.

The Mortgage Bankers’ Association published a Purchase Applications Index which measures the demand for mortgages. This index peaked at over 500 in 2005 and bottomed at around 160 in 2009. By last May it had risen to about 220 – a very far cry from the mania levels, but still a promising recovery.

Then the Fed began talking about ‘tapering’ and mortgage rates rose. The Fed backed off and then came back, but the Purchase Applications index has been on a one-way ticket since last May. The latest data show it at 171, not far from the lows of 2009 – and at the same level it was at in 1995-96, before the taking off into the stratosphere. In short, there is no housing recovery, because ordinary people can’t afford to buy or even borrow to buy. Speculators play with other people’s money on the basis of cheap loans – but that can’t and won’t last.



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