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The Best Value Play in AmericaBy
Saturday, February 18, 2012
"A house is entirely rigged in the homeowner's favor."
– Peter Lynch, One up on Wall Street
Peter Lynch's 1989 book has 2½ pages in which he recommends that his readers buy a house. I feel as if I could reprint those pages today and they would still apply. Investment ideas truly do come back in season if you wait around long enough.
To get a street-level view of the U.S. housing market, I caught up with Aaron Edelheit. He runs the American Home Real Estate Co., which focuses on buying and renting homes in the southeastern U.S. It started in 2009.
I think you'll enjoy what he told me, and I think it's important you hear it. No one is telling this story. Instead, it seems, people would rather sulk about the low-growth U.S. economy and cling to stale investment attitudes brought on by the housing bust. Or worse, moan about what the government should do.
Meanwhile, the greatest housing opportunity in a few generations patters in on little cat feet.
"This is the best time ever to buy a home," Edelheit said. "We'll never see this kind of environment ever again. I hesitate to say never, but..."
It's true, I think. Lest you assume he's just talking his book, think again. Edelheit, a talented stock picker, told me he was winding down his equity management firm to focus on U.S. housing.
When opportunity knocks, you answer the door. Edelheit took the darn thing off its hinges. But consider what you can get with a housing rental today. You get to put 25% down. Someone else pays your mortgage, and you get extra cash flow. "The returns are silly," he said.
"There is a huge disconnect between the cost of renting and buying," Edelheit continued. "At distressed prices, it's ridiculous." Aaron told me his firm is picking up homes for $50,000-$60,000 and putting $11,000 into them. The mortgage comes to about $250 per month, and he rents them out for $1,000 per month. You do the math.
"You have to sit back and say, 'Why is that? Why is this happening?'" Edelheit said. He had a ready answer. "It's because the whole lower end of the market – I'm talking about middle class, not slumlord stuff – just got wiped out. They literally got blown out. And they won't be buyers for a long time because their credit is destroyed."
When most people think of $50,000-$60,000 homes, they probably think of hard-pressed areas that look like Baghdad after a visit by the U.S. Marines, or maybe crime-ridden areas thick with drug-addled gangs. No so, Edelheit told me. "This is why it is so important to give investment tours. These are good neighbourhoods with pools and tennis courts. When you go there in the daytime, there is nobody walking around the street, because they all have jobs!"
Edelheit is proud of what his company is doing, and rightfully so. He provides a useful product at a good price.
"We put in new carpeting and paint. We are essentially retrofitting old homes into brand-new homes. We're providing three- to four-bedroom homes in good communities for $1,000 a month. It's a real value to the tenant. It's an incredible opportunity for investors."
Edelheit is building a real company, a long-term platform to do this work. He has a 20-person organization. He just brought on a CFO. And he's invested thousands in software to run the business. He has $24 million invested in around 300 single-family homes now. Investors in his partnership will soon see the first tangible rewards of owning this portfolio. "We expect to start paying dividends in April at an annualized rate of 8% net. That includes our estimate for maintenance and vacancy... and it's unlevered." It's hard to go bankrupt if you have no debt.
There is not much competition just yet. Mostly just mom-and-pop shops and one-off investors. Where I live, though, I'm already seeing cash buyers and multiple bids on distressed property. The deals won't last forever.
Edelheit offered his view: "I see a two- to three-year window in terms of the pricing that exists now. We have probably three–five years before we get through all the issues of the bubble. I mean, our average acquisition cost is about $29 per square foot. Those are ridiculous numbers. I recognize that. That's not going to last. If you are in a growing city and a good neighborhood, that kind of number should never exist."
Like a honey pot, those numbers invite competition. And it's coming. There are firms raising significant amounts of capital to take advantage of the opportunity. Meanwhile, first movers have it to themselves.
Edelheit told me he's looking at creating a flip fund, in which the idea is buy, fix, and flip, instead of rent. In some markets, you can buy a home for $150,000 that is not in insurable condition – meaning a buyer can't get an FHA loan on it. You put $50,000 into it and turn around and sell it as a completely renovated home for $250,000. "All the buyer has to do is put $50,000 down. They don't have to do anything to it themselves," Edelheit says. "So we think there are a lot opportunities and inefficiencies."
Plus, consider the environment. The Federal Reserve recently said it's going to keep interest rates close to zero until 2014. It's spreading around the monetary equivalent of dry tinder, which could catch fire one day and cause 1970s-style inflation. Meanwhile, you can borrow at around 4% fixed and get paid to wait for a recovery.
"The best part is the risk-reward," Edelheit finished up. "If you are buying into a growing city, it is really only a matter of time. The downside is de minimis. I've really tried to figure out how to kill this and can't."
I have tried too and I can't think of a way to kill it either, save for improbable scenarios like a giant meteor blowing a hole in the Earth. You know you've got a pretty good idea when you have to get that creative.
Put simply, U.S. housing is the best value play in America. If you own a house, look to buy and rent another, or invest in a partnership, such as Edelheit's, that gets you exposure to this asset class.
Some things, by the way, have changed from Lynch's 1989 book. Lynch thought one reason people usually did well on their homes was that they owned them for an average of seven years. By contrast, people flip stocks in less than a year on average and do less well.
The reason was instructive, Lynch thought. "It takes a moving van to get out of a house," he wrote, "and only a phone call to get out of a stock." This was 1989, after all. Now you don't even have to talk to anybody.
Good investing,
Chris Mayer
Further Reading:
Steve Sjuggerud also believes U.S. housing is an incredible deal right now. Catch up on his arguments for buying here...
"With housing more affordable than ever, and mortgage rates lower than ever, we have incredible upside potential."
It's finally happening in America. Right now is the moment to make your deal. But this moment will pass... quicker than you think...
"You are foolish if you don't do everything you can to take advantage of this," Steve says.
Market NotesIT'S STILL A BULL MARKET IN PIPELINE STOCKS The market wants pipeline stocks. That's the idea behind our chart of the week.
Back in early 2009 – near the bottom of the great credit crash – we noted how income-seeking investors should consider a position in "MLPs," short for "master limited partnerships." This sector consists of firms that own and operate energy transportation assets, like pipelines. To entice people to invest in America's energy infrastructure, the government has granted MLPs special tax breaks, which require them to pay out most of their income to investors.
In our original note, we pointed out how this beaten-up sector was offering 10% yields. Over the course of the next several years, we updated you on how "the pipes" were trending higher here and here.
Like most assets, pipeline stocks suffered a selloff in late 2011. But as you can see from our two-year chart of the benchmark Alerian MLP index, pipeline stocks are roaring back. The index just broke out to a new multi-year high.
Yielding around 6% on average, MLPs aren't the bargain they were in 2009. But low natural gas prices mean plenty of demand for these "energy toll roads"... folks are still after income "plays"... and the trend is still up.
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Stat of the week
2.9%
Year-over-year earnings growth at S&P 500 companies for the fourth quarter, if Apple's earnings were stripped out, according to Barclays Capital. With Apple, earnings growth was 7%.
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