Warren Buffett on Housing
Warren Buffett, in his once a year letter to shareholders, steers apparent of discussing prospects for the overall economy. But he touches on real estate and housing finance as they affect Berkshire Hathaway’s Clayton Homes, which makes modular housing units.
Mr. Buffett cites two reasons for the industry being “in shambles.” (Industry output of manufactured homes has fallen from 382,000 units in 1999 to 60,000 units in 2009.)
1) Historically low housing starts (554,000 units in 2009), which “must be lived with if the U.S. economy is to recover.”
“Paradoxically, this is excellent news,” he writes. “People thought it was excellent news a few years back when housing starts ?- the give 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 finished 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 wait far below ‘bubble’ levels, of course, but for every seller (or lender) hurt by this there will be a buyer who benefits. To be sure, many families that couldn?t meet the expense of to buy an appropriate home a few years ago now find it well within their means because the bubble burst.”
2) Manufactured housing is suffering from a “punitive differential” in mortgage rates between factory-built homes and site-built homes, Mr. Buffett writes. He acknowledges that “Berkshire has a dog in this struggle,” but he says the rate differential causes problems for many lower-returns Americans, in addition to Clayton.
“The residential mortgage market is shaped by government rules that are expressed by FHA, Freddie Mac and Fannie Mae. Their lending standards are all-powerful because the mortgages they insure can typically be securitized and turned into what, in effect, is an obligation of the U.S. government. Currently buyers of conventional site-built homes who qualify for these guarantees can obtain a 30-year loan at about 5.25%. In addition, these are mortgages that have recently been bought in massive amounts by the Federal Reserve, an action that also helped to keep rates at bargain-basement levels.”
“In contrast, very few factory-built homes qualify for agency-insured mortgages. Therefore, a meritorious buyer of a factory-built home must pay about 9% on his loan. For the all-cash buyer, Clayton?s homes offer terrific value. If the buyer needs mortgage financing, but ?- and, of course, most buyers do ?- the difference in financing costs too often negates the attractive price of a factory-built home.”
“Last year I told you why our buyers ? generally people with low incomes ? performed so well as credit risks. Their mind-set was all-vital: They signed up to live in the home, not resell or refinance it. Consequently, our buyers usually took out loans with payments geared to their verified incomes (we weren?t making ‘liar?s loans’) and looked forward to the day they could burn their mortgage. If they lost their jobs, had health problems or got divorced, we could of course expect defaults. But they seldom walked away simply because house values had fallen. Even today, though job-loss troubles have grown, Clayton?s delinquencies and defaults wait reasonable and will not cause us significant problems.”
“We have tried to qualify more of our customers? loans for behavior similar to those available on the site-built product. So far we have had only token success. Many families with modest incomes but responsible habits have therefore had to forego home ownership simply because the financing differential attached to the factory-built product makes monthly payments too expensive. If qualifications aren?t broadened, so as to open low-cost financing to all who meet down-payment and returns standards, the manufactured-home industry seems destined to struggle and dwindle.”