Bayesian Investor Blog

The rationalizations that I’m noticing from people who want to deny the existence of a housing bubble are becoming more obviously contrived.
Last spring, the strangest one I noticed was this Tyler Cowen post, which notes the unusual rent-buy ratios, then ignores that anomaly and devotes the rest of the post to questioning a weaker argument for the housing bubble theory.
This month I noticed someone on a private mailing list who had enough sense to realize that current housing prices probably depend on a continuation of unusually low and stable long-term interest rates expressed confidence that the “psychological consensus against inflation” would make that likely. If such a consensus existed, I would have expected to see people expressing concern that the Fed’s policy being too inflationary, when in fact I see people jumping at any excuse (e.g. a hurricane) to advocate a more inflationary policy. Plus I see politicians racing to expand the federal debt to levels that will give them massive incentives to inflate or default when the baby boomers retire.
Now Chris Hibbert comes up with some stranger rationalizations:

The worst historical cases that I know of were times when housing prices dropped 10 or 20 percent.

I thought he read Marginal Revolution regularly, but that comment suggests he is unaware of this description of Shiller’s apparently more accurate housing price history which includes what looks like a 50 percent drop in U.S. housing prices. But that deals with a national average, which gives you the kind of diversification you might get with a mutual fund. Chris’s real estate investments sound less diverse – is that safer?

He then asks us to compare the reliability of real estate returns to that of the stock market, he avoids any actual comparisons, so I will make them:

you can get insurance to cover property losses

It’s hard to avoid the equivalent insurance for stocks. You’ve got SIPC protection, and publicly traded companies do a pretty reliable job of insuring their assets (e.g. eSpeed shareholders who waited a month or two when its main office atop the WTC vanished did not lose money; the biggest stockholder problem from Katrina seems to have been the indirect effect of Delta going bankrupt because unlike competitors, Delta’s credit rating was too poor for it too buy the futures contracts that would have hedged it against high fuel prices). Plus if you want more protection than real estate investors get, you can often buy puts.

you can look up rental rates and vacancy rates before you buy

You can look up dividend rates for stocks, inventory to sales ratios for the U.S. economy, etc.

tenant don’t like to move; most of the time they just keep paying the rent

Customers of Microsoft, Intel, Pepsi, etc. don’t like to switch to competitors. You can avoid stocks for which that isn’t true just like you can avoid housing for which it isn’t true (i.e. near universities).

the bank initially owns 80%; they verify that the property is worth the price

Your broker initially owns 80%, and verifies the price. At least if you buy stock futures in order to mimic the leverage of real estate. Does being limited to 50% margin make the more typical broker careless? Ok, maybe this isn’t a perfect comparison because banks can’t foreclose as quickly as brokers do when prices decline. But they are both aiming at ensuring that the customer loses no more than 100%, and what little evidence I have says that banks guess wrong a good deal more often than brokers.
Chris might still have made a not too foolish investment if he invested in apartments, which target a somewhat different demographic than homebuyers, but this comment:

The bottom line is that it’s not hard to find investment properties for which the rental income will be within a hundred dollars plus or minus of covering all your expenses

suggests to me that he has instead found one of the more speculative parts of the housing market.
Mike Linksvayer has some other valid criticisms of Chris’s post. But his apparent intuition that real estate should have the same expected return as the S&P if the two have the same risks isn’t quite right unless you use a nonstandard meaning of risk that takes liquidity into account. Real estate is more like the most thinly traded stocks (which seem to outperform the S&P) in that the risk implied by the indexes assumes you will have a good deal of patience about selling.
I haven’t yet positioned myself to profit from declines in the housing market, but expect to do so within the next week or so.