YOUGHAL, IRELAND – "In the news yesterday was a report about a major real estate purchase. Blackstone Group bought Home Partners of America and thus acquired its 17,000 rental units. We don’t know the particulars of the deal. But the average monthly rent for a three-bedroom apartment, for example, is about $1,200. That gives a gross rental income of about $14,000 annually, per unit. So Blackstone could expect about $250 million in annual rental income from the 17,000 units owned by Home Partners of America.
Shrewd real estate investors look for properties they can buy for about eight times gross rental income. So, if the units rent for average amounts… Blackstone’s purchase price – $6 billion – is far too much. The grey-haired real estate veteran must shake his head. How is this going to work out, he must wonder? How can Blackstone afford to pay three times the going rate? What does it know that we don’t know?
Ka-Boom! Buying real estate is a classic way to prepare for an inflationary storm. Especially if it is built of brick and block and won’t blow away in the howling winds. In an inflation, the dollar goes down, effectively lowering the real cost of fixed, low-interest rate payments. Construction costs go up, making existing buildings more valuable. Rents can be raised to keep up with rising costs. Improvements can be put off. And as more and more people try to protect their capital by moving into real estate… prices tend to rise.
Our colleague Dan Denning has an update: "The median existing home price in America is now $350,000, according to the National Association of Realtors. It’s the first time it’s ever hit that level. Even more impressive (or alarming) is that median home prices have grown by nearly 24% in the last twelve months – the fastest pace on record. Boom! Boom. Boom. Ka-Boom!"
ATM in the Bedroom: If another big real estate whirlwind is approaching, perhaps we should spare a moment to look at the last one. The author of the current property price increases, as well as those of the last bubble, can be found in the Eccles Building, home of the Federal Reserve.
In the first financial crisis of the 21st century, the monetary savants at the Fed cut interest rates in order to buck up the financial system after the collapse of the Nasdaq. New York Times columnist Paul Krugman outlined the plan in 2002: "To fight this recession, the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, [Fed chief] Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
We’ll come back to Mr. Krugman tomorrow. Today, our scorn is reserved for the Fed. Alan Greenspan, then chair of the Fed, did as Mr. Krugman bid him do. He lowered interest rates. Financial assets went up. So did real estate. By 2005, the real estate market was in such bubble territory that houses practically lifted off of their foundations.
Legend has it that people with no visible means of support were able to buy $1 million houses – without providing lenders any proof of income (no-doc mortgages). Then, they got “cash back” at closing that left them with money in hand… as well as a new house. Then, as house prices rose, they were able to go to the ATM machine in their bedrooms and “take out” even more cash. “Equity,” they called it.
The Roof Fell In: Here at the Diary, we laughed at the bubble… mocked the buyers… applauded the sellers… and, to the annoyance of our dear readers, looked down at the whole affair with a lofty and disapproving air. But we weren’t making $33 million a year. Angelo Mozilo, CEO of Countrywide Financial, was. His company wreaked havoc – with its EZ mortgage terms – all over the nation… and got rich doing it. “Real estate never goes down,” said one and all.
But it wasn’t long before the typical home buyer owed too much money on the typical house, on which the lenders had lent too much… and which the next typical buyer couldn’t afford to buy. Then, the roof fell in. Real estate did go down, after all. From April 2006 to October 2010, the median new house price fell from $257,000 to $204,200. Mozilo retired. And four million families lost their homes.
Crashed and Burned: Dear readers will find in this parable many of the themes we have been describing in these pages of late. The Fed’s fake interest rates misled lenders and borrowers alike. It made the assets of the rich – stocks and bonds – pricier, thus making their owners richer. But while it made houses pricier, it made most people (excepting those who had bought years ago and were ready to cash out of the housing market in order to die or go live on Mars) poorer.
Investors could volley their stocks back and forth at whatever prices they wanted. The trouble was that, for ordinary people, houses were a big part of the real world. Not just financial assets, they were places to live and part of their cost of living. And they had to pay for their houses out of their incomes. As prices rose, incomes failed to keep up. Finally, the average family could no longer afford the average family house. Prices fell. The lenders’ collateral disappeared… and the whole financial hullabaloo came to an end.
Thereafter, the Fed repeated its Krugmanian mischief… cutting interest rates and hiking up asset prices again. This time, 2009-2020, stocks and bonds responded quickly, while real estate prices moved more slowly. Once burned, buyers were shy about touching overpriced houses.
Bubble Territory: But in the COVID-19 crisis – the third big financial blow-up of the 21st century – the feds followed Krugman’s advice even more aggressively. Dan has the figures Just under two years ago, the Fed’s balance sheet was at $3.7 trillion and steadily declining. Since then, the U.S. central bank has printed $4.3 trillion to buy mortgage-backed securities and government bonds at the pace of $120 billion per month. Its balance sheet is now over $8 trillion and climbing. And now, real estate prices are entering bubble territory again.
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