Interesting comments here from an article in The Economist this past week.  They touch on the relative value of real estate vs equities:

“Anyway, to take a more cheerful line, the fall in the housing markets is creating some bargains. A recent post showed that US house prices look cheap relative to gold. The chart shows that they also look a much better bet than the stockmarket, on a long-term view. Judging by the latest plunge in pending home sales, it doesn’t appear that many bargain-hunters are interested.”

Given the 30%+ decline in housing and the incredible rebound in equities I can’t help but wonder if true value investors aren’t in agreement with the conclusions above.  Despite all the attempts to manipulate the real estate market, the government has largely failed in attempting to stabilize prices.  In other words, it’s undergone a much more natural price discovery process.  The equity market, of course, has been intervened in at every step of the way and the government has undoubtedly succeeded in propping up this market.  Various valuation metrics are at odds with regards to equities, however, it’s difficult to conclude that we’ve done anything other than engage in the same old tactics that helped create the unstable environment that existed before the equity market crash.  Given this risk and what I’d call a more natural price discovery process, it’s not unreasonable to conclude that real estate looks like a better relative value vs the broad equity markets at this juncture.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Wulfram

    Probably a little bit of both. Considering housing is such a massively leveraged and illiquid asset, I’d hesitate to purchase something like this in metro areas of the country given the tailwinds of massive shadow inventory, demographic trends, and the uncertain employment environment.

    Consider this, if you make $70k a year which is good but not great and purchase a house at 4x debt-to-income ratio, the most house you should buy is around $280k. That’s not a whole lot of house in San Diego — it buys you a ~600 square foot studio downtown. The kicker is, the median income in San Diego is actually less than that at $55k. Given that most jobs aren’t going to be stable for 30 years and that you may need to move in the future for a job; I personally would look to leverage myself no more than 3-3.5x DTI.

    Granted with a 20% downpayment a mortgage for $280k is going for only $1,200-$1300 a month. However, after property tax, insurance, HOA, and maintenance you’re still looking at around $1,400-$1,600 a month. A ~600 square foot studio should rent for around $1200-$1300 a month. By cash flow and leverage valuation methods we’ve still got some room to go before housing becomes a good investment. At least in San Diego anyways.

    We’re getting there, so people should be patient, but housing is by no means cheap yet. In some areas of the country it may be a better investment than equities. But if you’ve got the strong cards of cash and income, I don’t see the downside in waiting. Let the market finish the process of washing out insolvent weak hands before you take on the liability of a 30 year mortgage.

  • Oskar

    If I think home prices will rise. What are the options if I want to invest with leverage?

  • Wulfram

    Invest in an REIT that uses leverage, the stocks of homebuilders, or simply get a mortgage. A mortgage is a form of leverage.

    For maximum leverage, I half-jokingly recommend using a home equity line to make your mortgage payments.

  • JohnZ

    Australia only has 8-9x median income/mortgage ratio… Oh if only we could take a lesson from America and the rest of the world before the impending crash.

  • Andy

    Relatively cheap does not mean it represents good investment (value trap).

    It can go substantially lower before it bottoms.

    Unsure if it is a reliable market timing tool for investors.

    As for Australia median house price being 8X average income, it does not mean it will crash any time soon.

  • Mark

    The chart’s worthless. The actions taken the last three years has skewed and blurred data. It means nothing.

  • Mark

    Yes – how different our economic landscape would look today if the US had decided to support housing instead of the securities markets.

    What if they had merely kept the supply of housing to a minimum by printing paper to buy up most of the supply of homes and pay to maintain them. Or after buying them demolished them to permanently reduce supply.

    This was done years ago in Midland – Odessa following an oil bust. Large tracks of homes were condemned and destroyed and the housing market returned instantly to health.

    Supply must be reduced until house prices reflect replacement costs. No different than any other commodity EXCEPT that housing reflects the real wealth of a far larger portion of America than securities.

    But then – power rules, always has, always will.

  • effem

    “The equity market, of course, has been intervened in at every step of the way and the government has undoubtedly succeeded in propping up this market.”

    I can’t say I totally agree (although I am no fan of current policy). If you overlay stocks with corporate profits they are tracking almost exactly as you’d expect. To the me larger question is how are corporations posting record profits amidst a backdrop of struggling lower/middle classes? For banks, Fed policy certainly helps. But non-financial corporate profits have been just as strong. Is current policy boosting non-financial corporate profits?

  • Dr. Oliver Strebel

    Very interesting piece! However it mostly says that stocks were a much better investment than houses during the past 35 years.

    Cullen Roche: Given this risk and what I’d call a more natural price discovery process, it’s not unreasonable to conclude that real estate looks like a better relative value vs the broad equity markets at this juncture.

    Well, there are quite a lot of european stocks which are quite cheap concerning dividend yield (utilities, telecommunication, …)

    And I expect them to become cheaper in the course of the year due to the reasons which are discussed extensively on your site.

  • MS

    Just purchased two investment homes myself. So I guess I’m in the real estate represents good value camp. Interesting chart. Seems like the massive real estate bubble looks like a blip when priced in terms of equities. Don’t know what that means, but interesting.

  • Aaron

    If other businesses are anything like ours, then profits are up even as sales might be flat or down. The reason for our profits is a recession causes you to look at your expenses and cut staff/overhead etc. So our expenses our down, sales are flat, and profits are up. People are out of work though.

    That, and the low interest rates make it cheap to borrow money. More return on capital.

  • Cullen Roche

    This doesn’t mean there aren’t great values in the equity markets (and overpriced regions in RE), but this is more about the broader markets. I actually still expect RE to fall on a national level, though I am significantly more bullish than I was 3 years ago. I hope to have an updated housing outlook out soon.

  • CP

    “Various valuation metrics are at odds with regards to equities”

    True, but what all equity valuation models agree on is that stocks were dirt cheap around 1980. Consequently, the graph is misleading because it starts around that time.

    What I think is more interesting is the post 2000 period. Again, equity valuation models are unanimous that stocks were massively over valued at this point. Yet, the ratio has hardly moved since that time (in the context of historical changes). I’m surprised by that, and what it must mean is that (assuming the data is correct), either stocks are still over valued, or house prices were not as “irrational” in 2005 as everyone now assumes.

  • Cullen Roche

    Well, this is a 20 year+ issue. The market has been at permanently elevated levels since the Greenspan put was implemented. Unless it’s different this time, we should expect valuations to moderate over time. 20+ Shiller PE’s aren’t sustainable are they? Or is this truly permanent? My guess is that Greenspan and Bernanke didn’t wipe out 100 years of history just by turning the Fed into a market propping machine….

  • quark

    Shadow inventory pukes, pension funds puke and a bottom is made.

  • jeff

    I might agree the downside risk on housing is lower than in stocks and I think we are still carving the bottom in housing. Like anything in a falling market – catching a falling knife.

  • jeff

    Speaking of relative value I’ve been thinking about how to determine when major assets classes are overvalued/undervalued in a historic terms. Looking into this, one can look view asset appreciation/depreciation throughout history or yield differences from the assets minus the inflation rate.

    From Yield Difference – I would expect this to show when yields are high the assets is undervalued and when low the asset is overvalued.
    – Cash (savings rate – inflation rate plotted over time)
    – Bonds (bond rate – savings rate – inflation rate plotted over time)
    – Equity (dividend yield – bond rate – inflation rate plotted over time)
    – Real Estate (rental yield – mortgage rate – inflation rate plotted over time)
    – Gold (N/A no yield)
    – Commodity (N/A no yield)

    Real Asset Appreciation (in USD over time) would show peak and valley’s to indicate over/undervalue.
    – Bonds (Real Bond Price Index like TLT with longer history)
    – Equity (Real DOW)
    – Real Estate (Real Avg Home Price)
    – Gold (Real Gold Price)
    – Commodity (Real CRB Index)

    Also we can generate cross relative value figures such as
    Dow/Real Estate
    Dow/Bond Index
    Realestate/Bond Index
    Gold/Bond Index
    CRB/Bond Index

    I started working on this though getting rental yields and historic TLT bond price index is not readily available. One thing I noticed is that it doesn’t tell you what an equity is worth but rather historically how many Dow shares or gold to buy a home. But what is the fair value of DOW or Gold or a home – I guess that is whatever the market will bare today.

    The yield model on the other hand gives you a good way to assess value (but assumes gold and commodities track inflation but do not provide yield beyond that). Also One can make this more elegant by adding in equity income and try to get fundamental valuation like dodd-grahmam value investing etc but again that leaves gold and commodities as being “worthless”.

    Any thoughts on this method to find relative value of assets?

  • John C


    It appears to me the answer to whether we have near term deflation vs inflation holds the key. In Japan property fell (if memory serves) 75% before it bottomed – the US has arguably fallen 20-30% and Europe 10% – if asset deflation continues in the continuing balance sheet deleverging it is arguable that property still has some way to go?

    My children have recently entered the job market – both have secured work in posts below their repective post graduate education with lower than anticipated salaries (both are nevertheless grateful to be employed) but both will not be able to build capital nor afford the housing bond repayments for entry level apartments on their current salaries.

    Equities – whilst I expect a correction are still maintiaining a relative 200mda index that suggests they still have upside – 1.00 being parity and 1.15 / 1.25 being on the high side and 1.00 / 0.7 being a buy.

    It seems to me therefore we are at an important inflection point – at which either the recovery stalls and asset prices correct to there more appropriate mean or we have a continued economic bumbling with bad news offset by less bad news with asset prices holding while the recovery stutters and eventually finds some traction.

    My humble conclusion would be a stabilisng recovery with asset prices holding in a tight range for several years to come – not great for any expected or needed investment return.

  • Actionable

    This chart also said housing was cheap relative to equities during the height of the housing bubble.

    Housing is a good investment during periods of inflation. You borrow in fixed dollars and your income rises with inflation so your debt repayments go down. Also, your home value increases with inflation.

    Given the amount of excess capacity still in the economy, it will take a while for inflation to show up. Look at the 10yr treasury – it is in no way predicting inflation.

  • effem

    I think what you are saying is that the Fed has structurally lowered real interest rates over the last 20 years (I agree). So that begs the question of what would force the Fed to abandon that policy? Seems to me the only possibilities are an outbreak of inflation or an outbreak of political activism against the Fed.

  • nottpc

    It is quite easy to explain why corp profits surge now in US

    Labor cost is pressured as many jobs have been outsourced
    Those that remain don’t have bargaining power as private sectors gutted plus threat of losing your job to China or India
    Labor producticity has shot up
    Automation and technology has decreased need for humanoids
    The grand bargain has pushed retirement savings away from defined benefits to 401k which lays risk on worker not corporation
    Corp taxes as% of GDP now at record low in US as corporations whine about fictious 35% tax rate while lobbyitss at. GE make sure they pay zero%.

    On top of that earnings no longer count option expensing in non GAAP which is what is cited by media and analysts so fat cats fine with larding themselves with huge option grants and its not counted in SP500 profits as a hit,

    Cost of capital ultra low so interest exoense for borrowinf at never seen levels

    That’s all on the expense side … on revenue side I believe how 40 to 50% of SP500 sales comes from overseas so frankly who cares about the lower and middle class unless you are Walmart. Do you think Halliburton, GE, Exxonn, Tiffany, Apple et al care? They don’t need that consumer….

  • Roger Ingalls


    Not sure if the San Diego picture you paint is all that typical. I originate loans in the Seattle area, and recently helped someone that made half the median household income purchase a 2600 sft home, in an area about halfway between Seattle and Tacoma, within 5-10 miles of likely employment (not remote suburbia, is what I’m getting at). With 5% down,and no mortgage insurance, he is decently leveraged, and his payment is only about a 3rd of his income. The price was about 5x his income, but the payment was entirely manageable.

    Housing is more affordable now than it has been in nearly two decades, between the low interest rates, and fallen prices.

  • Bridge

    Bought two more houses myself. However location, location, location and great value must prevail. Also love great school areas that are built out!

  • Wulfram

    I have no qualms with the affordability of homes right now. As I noted, a $280k mortgage only runs about $1,250k a month with a 20% down payment. Just because a home is affordable does not mean that people who purchase a home now may run a real risk of becoming underwater on their purchase in the near future for an extended period of time.

    I actually think real estate makes sense for people in a certain set of criteria. Namely, if someone has a stable income, is starting a new household, and is willing to stay in the house for a long time there may not be too much of a benefit in waiting. But I would bet that we’re at least a few years off from a sustained housing recovery and have further risk to the downside, so buyers should be cognizant of the risk of continued price declines. It’s no secret that we’ve still got a large amount of shadow inventory to work through. Longer term, I think we may see demographic trends continue to be a drag on housing as boomers retire.

    Assuming a $400k property and a 1% property tax, it will take $100k in a nest egg to provide enough retirement income to pay the property tax without dipping into the principal. That’s more or less the median 401k and clearly not sustainable. I’m worried by the fact that I have seen commercials advertising reverse mortgages become more frequent, which is very sad given that they are complex products unsuitable for most people.

    I’m am however more bullish in certain areas (Seattle and Austin being prime examples) than in California. Not sure about the loan you originated, but I lived in King County briefly and didn’t find the area south of Seattle to be anything special.

  • james

    pretty obvious, a cheap dollar and pricy shares.

  • TJ

    I agree with Wulframs initial observation but would spread this much wider than San Diego in California. There are many markets just like San Diego where housing is still priced far above incomes. Even with a $70k and $30k dual income (more avg of homeowners) it doesnt get you much house. A $400k home in So California is a dump needing lots of work. Needless to say add in the mortgage insurance because most will not have the 20% on $400-$450k home. Forget about hiding income to lower your taxes here in California everything costs money (one of the worst states for taxes). There is a much larger shadow inventory than the banks are willing to divulge. CoreLogic data doesn’t represent the entire market because the banks books are cooked. I’d take gold over a house ANY day ANY DAY…gold doesn’t tarnish, it doesnt wear, a house? 15 years its the roof, the water heater, dishwasher, etc. Oh wait…an eathquake…remember the Northridge quake did quite a bit o damage! I also think with the market bubbles being created we are likely to see multiple dips in housing.