One of the most tedious aspects of the bursting of the property bubble has been the endless bleating that lower house prices are universally bad news.
In fact, lower house prices can be good news for at least two important reasons:
- If you don’t own a house, lower prices mean you (or your children) are more able to afford a home.
- Lower house prices mean extra money to go into more productive and economically useful assets.
You can repeat these facts to homeowners and financial journalists, but the truth bounces off their skulls like moral justice off a banker’s back.
But perhaps they will listen to Warren Buffett?
In his 2009 shareholder letter, the World’s Sometimes Richest Man has channeled the dreams of every first-time buyer, as well as warning there will be no quick return to insane house price inflation.
Buffett writes:
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.
It’s a testament to Buffett that he says this despite owning the US’s largest producer of manufactured houses, Clayton Homes.
Fewer houses – better than sex!
Describing the current state of the housing industry as ‘a shambles’, Buffett says it is paradoxically good news that US housing starts fell to just 554,000 in 2009, the lowest level in 50 years.
Again, note the difference between Buffett’s views and mainstream opinion!
Buffett writes:
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.
Buffett explains there were only three ways to cure the 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.
3) Reduce new housing starts to a number far below the rate of household formations.
Our country has wisely selected the third option.
Buffett says it will be another year or so before the residential housing market has been put to rest. And he thinks some problems will persists with high-value houses and those in certain localities where overbuilding was rampant.
(Image by: iLoveButter)
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Though I’ve paid off my house and would be looking to trade up, paradoxically winning from a decent house price crash in the UK, I think some of Buffet’s reasoning doesn’t apply here.
We seem to be creating households at a higher rate that places to put them, partly from more people living alone, partly by population increase, and partly by not actually building enough homes to keep up with demand. There’s a lot more spare land in the US than in the UK.
So while UK house prices will fall because of the credit cruch, and they’ve already fallen by about 30% due to the devaluation of the pound by that much, the potential seems more limited here…
But good for Buffett anyway, for giving the disparate potential winners from fallicng house prices a voice!
The same thing is so with stocks. The best price for any asset is fair price. Once prices rise so high that the only way to get to fair value is through a crash, a crash becomes a good thing.
Crashes still cause lots of damage, however, both in the housing area and in the stock area. Lots of people who thought that they possessed more wealth than they really did because their houses had temporarily increased dramatically in value are not going to be spending as much as they otherwise would have for many years. That’s going to hurt the economy.
Looked at in isolation, the housing price drop is a good thing. But we would all be a lot better off if we had never permitted housing prices to rise to such insane levels in the first place. Bubbles kill.
Rob
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“but the truth bounces off their skulls like moral justice off a banker’s back.” haha – love it!
I really enjoyed this article, and always enjoy hearing Mr. Buffett’s no BS opinion. Would like to be that calm collected, and perhaps wealthy, when I reach that age.
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@Ryan – Agreed, he’s a hero of mine. I’ve been watching him on CNBC tonight with my hot chocolate, recorded from earlier. Well worth reading The Snowball if you’ve never done so.
@Rob – Broadly agree. One day I’m going to buy a few investing books from the 50s – 70s and see if it felt like bubbles were always happening then (Nifty 50 in the the 1960s etc). I know they are a long-term feature of markets going back to the tulip days, but we seem to need to be on permanent bubble guard in recent years.
@ermine – Thanks for your extensive comment. As a counterpoint, I guess I’d ask why would that supply of housing issue not also have pushed up the price of rents? Rents have risen over the past 15 years, but to nothing like the same degree as house prices. From memory they’ve more closely tracked salaries. That to me suggests a minor/major speculative element in house prices, removed from supply/demand. But then I thought that more than five years ago!
Did the residential market in the UK get killed also? Were some parts wroth than others?
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> why would that supply of housing issue not also have pushed up the price of rents?
I guess, though it’s only based on what I’ve seen of the rental market of a provincial town, that it is because the curious phenomenon of buy to let, which both increases the supply of rental properties and at the same time decreases the supply of houses available for sale.
Easy for Buffet to say, cuz he is a BILLIONAIRE!
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BTW, congrats for cracking The Top 100 on WB!
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@Sam – Thanks! I don’t agree though that Buffett is saying this only because he’s a billionaire. The man has lived in the same house since the 1960s. He’s not a high-roller by nature. I think what he is saying is pretty sensible, and as Rob implies above if people had paid attention to property valuations (including lawmakers) then perhaps they wouldn’t find themselves underwater now.
@ermine – I think your observation is valid, and I think it backs up my point (a win win! 😉 ) Buy to let is a specific example of buyers bidding up the price of property, even as they lower returns (both by reducing the yield on their higher purchase price, and also through oversupply of property bringing rents down further).
If the UK had a shortage of housing, rents would have stepped up alongside property prices. What the UK may have is a shortage of investment opportunities, in the popular mind, due to low interest rates and successive bear markets (though as ever I think the latter makes stocks good value). That may have semi-rationally filtered into house prices, but I think it could/will be reversed with rising rates and markets. Only time will tell…
Easy to say for Buffet….because he probably doesn’t have sex anymore!
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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.
Our country has wisely selected the third option.
I do love the deadpan humour 🙂
But he has a point – “cash for clunkers” was a very dubious way to spend taxpayers’ money. Of course the housing situation is not quite the same in the UK, since supply is tighter (though as you have so convincingly argued, not tight enough to justify current prices!). As a not-yet-housed soon-to-be-graduate I would appreciate a fall in house prices.
P.S. This fascinating article from the Economist should be required reading for anyone wanting to understand the reasons for the credit boom: http://www.economist.com/business-finance/displaystory.cfm?story_id=E1_TQPGVDGR
It turns out that in America most home equity withdrawal (mortgage borrowing by people who already had houses) was for consumption, and that borrowing only ballooned in areas where housing supply was constrained; cities in the plains or with freer planning regulations did not suffer either a house price bubble or a credit bubble.
This might explain the huge rise in personal indebtedness in the UK: essentially the whole country was like a heavily zoned US city, with little availability of new housing to prevent a speculative boom, which in turn fuelled unsustainable consumption growth.
@Niklas – Yep, same situation in the UK. From memory, MEW (the UK equivalent – mortgage equity withdrawal) peaked at nearly 10% of post-tax income here in the UK. Actually typing that I can’t believe it’s true, so I’m going to go check with a quick Google! 🙂
I was right – 9% in 2003. We’re now in ‘negative MEW’. Might do an article on this.
Here are the stats/graph from the Bank of England.