Cash Buyers, Inflation, and Real Estate

Do you accept... CASH for this 5BR/4BA Colonial?

The recent news out of California, that cash buyers have set a record in home purchases, is the kind of news that makes me go Hmmmm. I wrote about it on AOL briefly, but wanted to dive into a bit more detail here.

First, the news from the LA Times (h/t: Calculated Risk):

All-cash buyers grabbed a record 30.9% share of the Golden State’s houses and condos in January as low prices lured investors and others, according to San Diego research firm DataQuick Information Systems.

Cash activity has been brisk for months in foreclosure-ridden areas such as Riverside and San Bernardino. But now, the cash buyer has become a major player in Southern California’s most expensive communities, where cash deals account for as much as two-thirds of home sales.

The trend is being driven by several factors, analysts say, including the difficulty of getting a “jumbo” loan from lenders still stinging from the mortgage meltdown. It also reflects speculation by wealthy investors who believe home prices are at or near a bottom.

“A lot of people think housing will outperform other financial investments,” said Andrew LePage, a DataQuick analyst. “This is just a place to park their money.” (Emphasis mine)

There are some tantalizing hints in the full article, but the above is somewhere we can start.

I think this is the tip of the iceberg in which the real estate market — like every other market — is about to feel the effects of real inflation, not yet reported in the official CPI figures.

Why Is The Smart Money Suddenly Buying Houses?

What puzzled me with this article was, why are these wealthy people suddenly snapping up real estate? And for cash?

We’re not talking about $50,000 condos in Phoenix and Las Vegas that can be rented out at $1,000 a month here. We’re talking about $5 million trophy properties that are unlikely to be rental properties. The LA Times article suggests that it’s because of the difficulty of finding jumbo loans. That might make sense for the $1m house in Laguna Beach, but it doesn’t make a whole lot of sense for the $5m mansion. The people who can afford to buy a $5m mansion aren’t exactly credit risks. They can get financing, from someone, even if it’s a private bank in Switzerland. So why are they paying all cash?

The LA Times:

There’s just more of them now. Cash buying has reached fever pitch in parts of Orange County, where the Balboa community of Newport Beach saw the highest percentage of sales going to cash buyers last year of any $1-million-plus Southland community — 66.7%.

Chris Crocker, a Coldwell Banker broker in Corona del Mar, said well-heeled buyers are using cash to acquire investment properties and second homes or to better their portfolios.

“Buyers are looking out 10 years, and buying a trophy property for 40% off its price” before the housing downturn, Crocker said.

Within a five-mile radius, his office closed 24 all-cash deals in the $5-million-and-up price range in the last six months.

The trouble is that the idea that buyers are looking out 10 years and buying trophy properties for 40% off just doesn’t jive. It isn’t as if folks don’t know by now that real estate was in a bubble. 40% off of bubble prices is hardly a bargain. Furthermore, there are quite a few opinions out there that suggest that housing prices are still too high, and have perhaps another 20% or so to fall. This is especially the case when we’re talking about the smart money. Rich people don’t tend to get that way because they’re stupid, make bad decisions, or throw their money away. Except for professional athletes or Hollywood people, rich people get to be rich because they’re smart as hell, well-informed, and save their pennies.

Plus, the wealthy have access to advice and information that the rest of us don’t. Private bankers, high-end consultants, data analysts, professional investment advisors — all of whom can provide the best-available information and advice on whether to buy a particular asset or not. Portfolio diversification is an art and a science at the highest levels when we’re talking about the very wealthy.

So why are these very wealthy people paying all cash for real estate?

One Possible Answer: Inflation

The most convincing answer I’ve come up with is that the smart money, with access to the best financial advice, are betting on inflation.

The official government stats for inflation, the Consumer Price Index, as published by the Bureau of Labor Statistics, suggests that inflation throughout 2010 was a measly 1.6%. The core CPI, however, which excludes food and energy, was only 1.0%. That’s hardly indicative of inflationary pressure.

However, there are quite a few otherwise serious people who think that inflation is not only on its way, but that it is for all intents and purposes, already here:

Commodity prices, as measured through the Standard & Poor’s GSCI, are up about 7 percent this year alone..

Still, the see-no-inflation hear-no-inflation speak-no-inflation deflation monkeys insist that these rising commodity prices will have no pass-through effects onto grocery store shelves.

Of course, we all know they’re wrong.

Consumers have been getting hammered for the past year, even if it doesn’t show up in the heavily massaged consumer price and producer price indexes.

Strong words from CNBC. Then there are those who think that what the Fed is doing is intentionally devaluing the dollar in order to stave off deflation:

The bald fact, though, is that by turning on the printing presses the Fed will drive down the value of the dollar absent a similar move in another currency. Much of the new investment created by QE will be made not in the U.S. but will be money borrowed in the U.S., exchanged into a foreign currency, probably an emerging markets one, and invested overseas. That will drive the dollar down, which will help to make U.S. industry more competitive.

There you have it; competitive devaluation, a beggar-thy-neighbor policy. It is not much of a lever, but it is one of the few which the Fed has left to pull.

Don’t expect anyone from the Fed or the Treasury to tell you this in simple declarative sentences, but it’s true nonetheless.

“Devaluation is the intention, and devaluation is what is going to happen,” Avinash Persaud, Chairman of Elara Capital told the Forex Forum conference in New York on Tuesday.

We can surely expect the U.S. to deny this, as Treasury Secretary Timothy Geithner did in October, but the truth will be seen in the foreign exchange markets, where the dollar has been falling and will fall further as the year winds down.

And what has been the dollar doing? Well, it’s trading near a 13-month low, according to the San Francisco Chronicle.

If you’d like to get really worried, you can also do Google searches and run across sites like Shadow Government Statistics and articles like this one:

Even with the government’s spending, debt and obligations running far beyond the ability of the government to cover with taxes or the political willingness of the government to cut entitlement spending, the inevitable inflationary collapse, based solely on these funding needs, possibly could have been pushed well into the next decade. Yet, the printing presses already are running, and the Fed is working actively to debase the U.S. dollar. Actions already taken to contain the systemic solvency crisis and to stimulate the economy, plus the ongoing devastating impact of a severe economic contraction on tax revenues, have set the stage for a much earlier crisis. Risks are high for the hyperinflation beginning to break in the year ahead; it likely cannot be avoided beyond 2014.

Even if we discount the worst of the doom-sayers, there is reason enough to believe that inflation is headed our way. If you’re a very rich guy with very expensive accountants and financial experts advising you, you might know something that the rest of us do not.

Real Estate As Inflation Hedge

Of course, if we get into a true hyperinflation scenario, a la Zimbabwe, then the only assets that matter will be food, medicine, and ammunition. But let’s say we assume things won’t get that bad, but may be looking at say 9% annual inflation in the near future. (Again, there are some who believe we’re already at that point today.)

With 10-year Treasury bonds yielding 3.42% (as of today), any rich guy with $5m in those bonds is looking to lose a bunch of money to inflation over time. Equities will be affected in unpredictable ways with currency devaluation and inflation, so that’s a whole lot of risky. Mr. Richie Rich already has a couple of hundred thousand dollars in gold bullion in the Cayman Islands. So what’s left?

Real estate would indeed be a very attractive option, particularly over the long-term, especially if you can upgrade your personal lifestyle in the meantime. Even if house prices are “overvalued” by 20% or so, if you’re expecting significant inflation, there’s little reason not to buy a $5m house that will be worth $4m, with $5m in cash that will be worth $3.5m in about five years’ time.

Could this be what is driving the smart money to be snapping up properties all over the place?

If it is, then what consequences for the rest of us?

For one thing, I’d imagine we can’t talk about a recovery in the housing market without taking inflation into account. GCI income in 2011 or 2012 is not the same GCI income as in 2008, even if in nominal terms, it’s the same. House prices “recovering” ain’t the same if there is significant inflation.

For another, until and unless we see income growth to keep pace with price inflation, I’d imagine that buyer demand would be even lower than anticipated. A first time homebuyer family that is suddenly spending 20-30% more on gas and groceries isn’t going to be saving up the 20% downpayment necessary to get a mortgage as quickly, if at all, without getting raises. And the last I checked, unemployment remains a serious issue, which means wage growth is probably a pipe dream for most Americans.

Nonetheless, if inflation is real (and that is a big IF), then the truth is that now is a great time to buy a house, assuming the sellers haven’t caught on….

Now… what to advise your seller clients… that’s a whole different ball of wax, no?

As always, your thoughts are welcome.


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Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

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