Check out The Big Picture for a good take on why the "it’s ok because interest rates are low" gambit is so ridiculous. In short, it is because it is the directional change in rates from the time you buy the asset, and not the actual level of rates at which you buy the asset, that matters:
To risk assets, the cost of capital is like the wind. It is the change from the start of the race that matters, the more headwind the more trouble, and the more wind one can summon to their back, the faster the ship sails.
I highly recommend reading the whole thing.
Yesterday, by coincidence, I thought of another way of looking at rates as an excuse for low prices. The rate on the 30-year mortgage is now higher than it’s been since mid-2002. Yet, since that time–a time when rates were the same as they are now–San Diego home prices have more than doubled.
So how does the fact that rates are fairly low from an absolute standpoint explain that? It doesn’t.
I read the Barry’s article
I read the Barry’s article this morning, and it makes perfect sense. I never got the “it’s low interest” story, because people are not locked into those low interest rates. About 80% of recent homebuyers have loans which will go up.
Not enough people understand the difference between a rate and a rate of change.
I discovered this contrarian
I discovered this contrarian posture already a few yars ago, that falling (and not low) rates make house prices go up since their mortgages drop and people are roughly willing to pay similar monthly payments. Just take a look at the famous 10-year yield chart. It’s probably a given that real-estate investors did better from 1982-2002 than from 1962-1982. There are two more arguments why I would not mind taking a 15% loan if houses were cheap.
1. The one-way street of refinancing. If rates drop, I can refinance my fixed mortgage, while conversely no bank would call in my loan if rates were to rise.
I could further go to the extreme and risk a variable rate in which case I don’t even have to refinance. Risky? This brings me to the second point.
2. Also the difference to inflation matters. A 15% loan is not risky if inflation is 13% and my house and future salary are expected to rise at that rate too. This makes it a real 2% interest rate which I would call normal for other nominal rates, too. Again, as long as the house is cheap when other buyers are deterred because of the high nominal interest rate.
What do I get for this wisdom? My family members tell me that I have no clue about finance, and that I will never get to anything in life since I don’t buy some real-estate now!
Gee, if those family members
Gee, if those family members are so smart with money, they must be millionaires! Are they?
Did those same relatives lose money in the stock market in 2000? If yes, they are not equipped to give you advice. If no, then on to the next question: did they buy gold when it was still $300/oz? In other words, find out how good their track record really is, and make them realize they are not qualified to give investment advice.
They are well off since they
They are well off since they were all moderately into real-estate in the U.S. and Europe. But what worked in the past doesn’t have to work forever.
Of course, I mentioned gold to them back in 2000. Initially, I bought it as diversificaton since everything else seemed too good to be true. Later I bought more because I learned that everything else really didn’t seem to have any value. I even got my investment club buddies on board. Here is our track record: Liberty Valley, username and password are “guest”.
Fortunately, I was able to take away some of my relatives’ retirement money and manage it for them. They are still unimpressed, but I hope they will appreciate some day in the future.
Wow – you beat the S&P since
Wow – you beat the S&P since you started in 2003, and got into PMs early on. Good calls. So, where do you see this all going? What about China? All export-oriented countries suffered when US business investment cut back in 2000-01, and will suffer again starting in 2007 when we go into our consumer slowdown/recession. I don’t have faith in any equities. I see you’re heavily into PMs. Did you sell your Rubio’s stock? I finally did – it got stuck at $10.
I don’t want to divert too
I don’t want to divert too much away from the housing topic, but wanted to wrap up the last questions. I don’t know enough details about China and other Asians, but I am certainly with you and suspicious of the US consumer fueled “growth miracles” China and India, enough not to put any money there. But I am vagely interested in the neighbors such as Malaysia and Taiwan. The right way to decide on such an investment is in my opinion simply the valuation (i.e. low P/E) and to make sure the earnings haven’t (!) increased too much during the past years. This gives you a save entry point and then you can look at the other factors trying to estimate future trends. This is valid for any investment, e.g. housing, housing stocks, etc…
I saw there was a posting related to shorting the homebuilders. While I wouldn’t call it a no-brainer, I certainly think there are three factors against them. 1. The reduction in sales volume reducing their earnings. 2. Following that, a margin contraction that includes getting out of inventory, financial leverage, etc… 3. The speculative trend following forces (like in any financial asset) that will compress multiples again.
This is a clear example why a low current P/E is not enough if it is based on unsustainable earnings, and if P/Es can go even lower as they have in the past.
(And to wrap up Rubio’s as well, they don’t even full-fill the low P/E criterion, as we found that management compensation pretty much eats up all of the left-over earnings, and therefore we sold quickly without any gains.)