Many of my conversations with clients in the last month seem to have a common theme. Specifically, the issues can all fit under the umbrella of questions surrounding the timing of larger financial decisions. This update will take the form of a Q and A. the “A” part is purely my opinion based on respective risks and opportunities as I see them now. I have been wrong a few times in my life. I hope this helps give you a little more input for those big-picture decisions you’re trying to make.
Q: Is now a good time to buy or build a house?
A: Timing real estate transactions is really tough but there are some solid macro variables to consider that should help. We need to consider the general environment for supply and demand for a house. From the supply side, with a few exceptions, most real estate markets in the US are still undersupplied which tends to add pricing support for both existing and new homes. The rental market is equivalently tight, with corresponding high rents, driving shoppers to look but not likely finding much. Pricing for purchases (or building) is no longer attractive, however. We are just plainly at the top of the price range across practically every major metro area in the country. Not that there is a specific range but we don’t need to be real estate genius’ to know that “housing”, in terms of the absolute price of the house, is high. I make this statement both as a historical basis as well as the percent of total household income needed to service the debt on homes + taxes + insurance + replacing that darn furnace.
Several popular cities are proud of the fact that their housing prices have just recently exceeded the all-time highs set in 2006. The key word here is “several”. Many others are just now breaking even with values set eleven years ago. There are also 1.4 Million Americans that are still underwater on their mortgages from their purchase prices. Poorer parts of the country, specifically in the south, are just not moving at all, which brings me to the demand side of the equation.
In desirable markets, affordability is back on the scene as the number one variable on a real estate deal. Lending rates bottomed across all types of loans in 2012, five full years ago. However, the increase in mortgage rates on a 30-year loan is still only up about 8%. For short-term loans of 5 years, rates have gone up 195%! So, affordability has not really had a big negative factor from a cost of money perspective unless you’re building a house with short-term construction loans or on some sort of variable note with a short amortization. Millennials are finally joining the home parade and buying their first smaller homes while baby boomers are well into their downsizing phase of their lives. So we’re not surprised to see strong demand in smaller, more affordable homes, while bigger homes are starting to sit on the market unsold for a while. Rate sensitivity always hurts the bigger home buyer/seller more than others and rate increases are coming strong and steady now from the Fed. From a demand perspective, there is a real chance that larger home prices may start to peak out in the coming months despite the shortage of supply.
All in, I don’t see the catalyst for any major real estate disasters given short supply, mixed demand, and cost of money considerations. It would be prudent, however, to set low expectations for future price appreciation from here forward. Clearly, the big gains are behind us with plenty of headwinds to further price appreciation. I’d set a target of 3% average annual growth rate from real estate prices for the next 5-7 years as realistic. For the record, this is a higher growth rate than I suggested in 2006 when I said,
“ Real Estate is DEAD MONEY for the next 10 years at best”
-October 2006 ASFA Annual client meeting presentation.
I was wrong, it was 11 years and I took a lot of flack for saying that publically.
Q: I have a lot of cash still (or will have some cash soon), is it too late to add to my investment accounts?
A: Generally, I would answer no to this question as we’re still finding a fair amount of cheap stuff to buy, even in an overbought stock market. Airlines, energy, value, internationals, telecom, banks, select retail and some financials all offer valuations well below “market” and together stand to benefit more than other sectors from the new tax reform. We still have more things to buy than cash to buy it within in our models, which have been nearly fully invested for the second half of 2017. So no, it is not too late to add cash to investment accounts as long as you strictly follow this list of do’s and don’ts.
DO be very selective about buying new things. Concentrate on value or securities that have more attractive valuation metrics, or high free cash flow, or high shareholder yield, or a dividend yield above 2.5%, or high Return on Equity. In some cases, you can find stocks that offer several of these variables. These are names you do not know and tend to be in the mid-cap or even small cap universes.
DO be patient about your purchases. Try to wait for pullbacks in price to longer-term uptrends. We don’t buy things in downtrends, right? Mid-February might offer a nice entry point as our cycle work is suggesting a reasonable pullback in prices by then.
DO be deliberate about your total holdings, making sure that you are not consciously or unconsciously just buying into one sector, like technology. We’re after a diversified portfolio of growth or value stocks all trading at discounts.
DON’T buy an expensive mutual fund that can be purchased for a fraction of the cost via an identical ETF.
DON’T Buy an index fund and assume that you will have a happy and easy double-digit ride just like 2017. As market returns based on a successful tax deal are being pulled forward into the final days of 2017 in a near frenzy of buying, we are simultaneously ratcheting back our expectations for 2018 to probably low single digits for the year with an above average risk of a tough bear market starting in the second half of 2018. Risk management will matter in 2018 much more so than it did this year.
DON’T buy Bitcoin or any of the Bitcoin-related “investments”. Most investors could not even tell you what a Bitcoin is, what it’s purpose is, or how a Bitcoin comes into existence. But everyone wants a piece of the action right? Who doesn’t want to get rich quickly, it’s just so… easy. For the sake of enlightenment, let’s replace the word Bitcoin with the name, Pirate Ninjas. Now Bitcoin sounds like something almost real, maybe even something we might want or could use at some point in time. But we just don’t feel the need for Pirate Ninjas, do we? Would you pay $18,000 for a single Pirate Ninja? That would be silly. Bitcoin (and Pirate Ninjas) are in a price bubble. It will end badly, this time will not be different.
I’ll continue this thread of Q and A as our conversations continue.