Saturday, February 27, 2010

Buffett on Housing

by Bill McBride on 2/27/2010 08:33:00 AM

Here is Warren Buffett's annual letter to shareholders. The following is an excerpt on housing (Buffett focuses on manufactured housing because Berkshire owns Clayton Homes):

The [manufactured homes] industry is in shambles for two reasons, the first of which must be lived with if the U.S. economy is to recover. This reason concerns U.S. housing starts (including apartment units). In 2009, starts were 554,000, by far the lowest number in the 50 years for which we have data. Paradoxically, this is good news.

People thought it was good news a few years back when housing starts – the supply side of the picture – were running about two million annually. But household formations – the demand side – only amounted to about 1.2 million. After a few years of such imbalances, the country unsurprisingly ended up with far too many houses.

There were three ways to cure this overhang: (1) blow up a lot of houses, a tactic similar to the destruction of autos that occurred with the “cash-for-clunkers” program; (2) speed up household formations by, say, encouraging teenagers to cohabitate, a program not likely to suffer from a lack of volunteers or; (3) reduce new housing starts to a number far below the rate of household formations.

Our country has wisely selected the third option, which means that within a year or so residential housing problems should largely be behind us, the exceptions being only high-value houses and those in certain localities where overbuilding was particularly egregious. Prices will remain far below “bubble” levels, of course, but for every seller (or lender) hurt by this there will be a buyer who benefits. Indeed, many families that couldn’t afford to buy an appropriate home a few years ago now find it well within their means because the bubble burst.
Note: Buffett also mentions an industry specific reason reason that manufactured housing is in trouble - the differential in mortgage rates between factory-built homes and site-built homes.

I agree with Buffett's general comments on housing, except I think it might take a little longer to work down the excess housing inventory than Buffett's "a year or so" - I guess it depends on the definition of "so"!

In Housing Stock and Flow, I argued that substantial progress will be made this year in working down the inventory:
[T]he number of excess units should finally start declining in 2010 - perhaps by more than 600 thousand units, perhaps even cut in half.
As Buffett notes, this low level of starts is good news for the housing market, but it is also bad news for the economy and jobs in the short term. The good news is the excess housing inventory is being absorbed - a necessary step for housing (and the economy) to recover. The bad news is economic growth will probably be sluggish - and unemployment elevated - until residential investment picks up.