Here’s a questionable investment idea. If you invest with me, I can guarantee you a 2% low-beta return. I know fees are on everyone’s mind, with an extra .1% in fees in a mutual fund enough to make you want to reconsider the whole investment. In my idea, if you want to get your money out in the 5th year, I can normalize my fees to be something like a “2-and-66″ – I get 2 percent baseline, and an additional 66% of your profits. Technically I get 6% baseline if you want your money out, though maybe higher, regardless of performance.
What am I going to call this new fund? It’s called “The Housing Market.”
“Say you live in a neighborhood that you believe is going to clean up, crime will go down, housing stock will improve, and rent is going to go from $500 a month now to $1,000 in three years and then grow at 8% a year perpetually.”
The market return during boom times is 8-10%. The best evidence I’ve seen for long-term housing appreciation from Shiller is something like 2% from 1940-2000. Does Adam really think housing is a better return than the S&P 500 on an arbitrarily long time period?
The problem in the speculation story is that land is illiquid, has incredibly high transaction fees and is a “lumpy” good, which means it is terrible for speculative purposes. Hedge funds and speculators should be people picking up nickles in front a steamroller. This model of speculation is like using a steamroller to catch a rabbit with a nickle on its collar.
Felix notes: “DanHess and Matt Turner make the point that buying a house is a great way of forcing people to save over the long term.” There are no free lunches of course, and the reason it is a great way of forcing people to save over the long term is that it is incredibly expensive and difficult to get any money out of it. A 6% fee for selling is a baseline, and with 2% appreciation you need to be in the house five years to not lose money (and even then it nets to a “2-66″ hedge fund fee). If your house has appreciated, there’s no way to sell off half your investment in it, in the same way if you speculate with stocks you can sell off half your stocks in order to hedge. Shorting REIT stocks and praying aside, there’s little in the way of actually hedging the housing itself.
For a marginal dollar of investment, it’s hard for me to think of a good reason to put it into housing rather than a diversified mix of risk-free bonds and a market aggregate portfolio. If you want housing for a hedge because of its (supposed, is this true?) low beta, why not just go T-bills or commodities? If you like leveraging up in the low beta zone is Adam suggesting people take out negative amortization loans? Interest-only loans? That would be the way to juice up the leverage the most. However it’s important to remember how incredibly volatile local housing markets can be.
These are my quick thoughts. This is an incredibly important issue for consumer financial literacy, so I like that there is a critical discussion ongoing.
UPDATE: Check out Richard Serlin’s comment below.