How Not to Invest in Real Estate

It has been nearly two weeks since I allowed myself the pleasure of writing about SmartMoney. That is certainly a streak to be proud of, but it cannot goTwo-story_single-family_home on forever. I am only human.

The problem is that there are just so many things at SmartMoney that I would enjoy discussing. How to pick only one?

There is Taming the Cost of Traffic Tickets, currently the most popular post on the site. It lists five things you can do to reduce your expenditures on traffic tickets, none of which is to avoid getting traffic tickets.

And yesterday brought Recession’s Surprise Impact on Credit Scores. Apparently, the average FICO score fell during the recession, bottomed out in 2009, and now, three years into the recovery, is back to where it was in 2007. Which is a surprise. Also, the article had the insightful warning “increasing a FICO score could be harder than lowering it.” Good to know.

But the story I choose is Is It Time to Buy Into Real Estate? I knew it was the winner from a single word in the opening paragraph.

To most people, U.S. real estate still stinks. More than a third of all mortgages are under water, with their holders owing more than their houses are worth. Home prices continue to fall in many areas of the country, and thousands of foreclosed homes are still waiting to be sold. Yet an investor no less than Warren Buffett recently said that if he could, he would buy up a couple of hundred thousand single-family homes.

In case you missed it, that word was “Yet.” The real estate market is in a shambles, prices are depressed and a legendary value investor wants to buy. Who’d a thunk it?

More substantively, although the article tells us that investors with “short memories or long time horizons” think houses are a great buying opportunity just now, and mentions that some economists agree, it never really circles back to address that first sentence, that most people think real estate still stinks.

That is just the sort of clash between popular perception and reality that a high circulation personal finance publication might be expected to resolve, or at least discuss.

Whatever the proportion of US homes under water (and there are no hard numbers on that topic, everything you see is an estimate) it is lower than it was a few years ago. Yes, there are places where house prices are down lately, but saying that they are “continuing” to fall is misleading. Compared to 2006-09, prices are everywhere stable. And although there are still foreclosures, their number is drastically reduced from the recent past, as illustrated by a chart in the FICO surprise article mentioned above.

To be fair, despite the title, the article is not about whether or not now is a good time for a consumer to buy real estate in the conventional sense, that is, by buying a house to live in. It is about how an investor could buy real estate in other ways, assuming that he thought real estate was a good buy just now, for whatever reason.

Having missed the question that is obviously more relevant for most of its readers, SmartMoney then misses the important bit from what Warren Buffet said. The key phrase is “if he could.” That the Sage of Omaha sees the fire sale prices on single family homes and wants in is not really news. What is worth considering is that he cannot act on this impulse.

Unlike stocks, bonds, and most of the rest of the investment world, investors and speculators do not have an obvious way to participate in houses. Put another way, unlike stocks, which are bought and sold primarily by professionals who do it everyday for many years, houses are bought and sold by amateurs who will generally enter into only a few transactions during their lifetime. Buffet can pick up the phone and buy billions of dollars worth of a great many things, but a few hundred thousand houses is not one of them.

For me, this is the single biggest difference between the market for houses and the market for conventional investments. It explains why the price charts for houses and stocks (or bonds, or crude oil, etc.) look so different. If a stock becomes badly mispriced, either unreasonably cheap or unreasonably expensive, there are well bankrolled professionals standing by who will take advantage of the situation and push prices back towards reality.

Not so with houses. As prices climbed beyond reason in the early part of the last decade, the Warren Buffets of the world could not take the other side and go short houses. Instead, the price rises just increased consumer enthusiasm, which spiraled prices up further. (Some sophisticated investors could short mortgage bonds backed by those houses, but in the event there were too few bears and the vehicle too indirect to have much impact.)

So what does an investor who, very plausibly, believes houses are cheap right now do to take advantage of that insight? SmartMoney gives five stock suggestions, which it labels “Smart Picks.” Some of them may have merit as investments, but all bear, at best, an indirect relationship to house prices.

There are three REITs on the list. One owns apartments in Texas. Another owns shopping malls. The third owns no real estate at all, but rather government sponsored mortgage backed bonds. Rounding out the list are a broker and manager of commercial property (office buildings) and an ETF made up of home builders.

Warren Buffet might look at that menu of second-choice options and pick one or two as the best he is going to do, or he might just take a pass and look for other mispriced things he can take advantage of.

But if you are not burdened with billions to put to work, and are just an ordinary person looking to shepherd ordinary wealth, which is to say if you are SmartMoney’s target audience, you do not need to go through all this. Just buy a house and live in it. Already got one? Trade up. Or decide you already have plenty of exposure to the house market, thank you, and pass. Too bad you do not have a popular magazine to help you through that.

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