Buffett always talks about a moat around a business. There is nothing with a bigger moat than shelter for yourself and your family. The key of course is the price you pay when considering it as an investment. Just like Coca-Cola at 50 times earnings in the late nineties, real estate at a ridiculous multiple of rental income isn’t a good investment.
Here are notes from Ackman’s presentation:
What Ackman and Pershing Square Look for In Investments:
1) Forced Sellers
2) Attractive capital structure
3) Favorable long-term supply dynamics
4) Favorable long-term demand dynamics
Ackman Believes He Has Found an Investment With the Following Characteristics:
1) A low valuation
- Lowest valuation in at least a generation
2) Forced sellers
- A large number of distressed transactions
3) Extremely attractive financing available
- High LTV, low-rate, fixed-rate, long-dated, non-recourse debt,
pre-payable without penalty
4) Favorable long-term supply dynamics
- Short-term oversupplied market, but long-term supply is controlled
5) Favorable long-term demand dynamics
- Demographically driven demand growth
- Currently, this is a somewhat shunned asset class
And What is this Investment Opportunity that Ackman has identified ? Housing of course !
Ackman Provides a Background on the Causes of the Creation of the Housing Bubble:
1) The second lien market allowed for a huge additional layer of leverage and demand for housing products. The second lien market went from $10 billion per quarter in 2001 to over $100 billion per quarter in the bubble formation years of 2004 through 2006
2) The financial innovation of interest only and negative amortization mortgages. These alternative products went from 2% of the mortgage market in 2000 to over 25% in 2004 through 2006.
3) The Asset Backed Security Market provided a huge amount of liquidity for originators. Issuance of ABS went from $70 billion in 2000 to over $500 billion per year in 2004 through 2006
The result of all of this additional money chasing houses was a 13% CAGR from 2001 through 2006.
Ackman Comments on Current Housing Valuation
1) Home prices are down 28% nationwide
2) Falling home prices and lower interest rates dramatically improve affordability. Median family income is now 78% higher than what is required to qualify to purchase a median price single family home using an 80% LTV.
3) The breakeven appreciation rate for rental equivalent value is the best since the 1970s
Ackman Comments on Why Housing is Cheap
1) Over 30% of sales nationwide are distressed sales (seller in foreclosure). Those numbers are more like 50% for Las Vegas and Phoenix.
2) Number of short sale transactions are increasing (steady trend up). Note that a short sale in real estate is when the lender accepts a transaction where proceeds are less than the balance owing, but decides that is better than the hefty fees involved in foreclosure.
Ackman On Why the Home Mortgage is Exceptionally Attractive Today
1) Low Fixed Rate – 4.43% APR
2) Long Term – 30-Year Amortization
3) High LTV – 80% (97% for FHA loans)
4) Non-Recourse – Loans are explicitly or effectively non-recourse
5) Adequate Financing Available – $417k to $730k, depending on location
6) No Prepayment Penalties – Creates refinancing optionality
7) Tax Deductible Interest – More valuable with coming tax increases
Typical Conforming Mortgage Term Sheet
Concludes that no other business or investor can get a loan at such favorable terms.o
Ackman On Favorable Long Term Demand Dynamics
1) Household formation will accelerate as recovery takes hold
2) Home ownership rates have declined to pre-bubble levels
3) Immigration drives new home ownership over the next decade
Ackman On Temporarily Elevated Supply Levels
1) In the short-term, for-sale homes and shadow inventory will weigh on home
prices. This provides an opportunity to buy a long-term investment at an
attractive valuation in a market facing short-term distress
2) Builders have sharply reduced their construction capacity, increasing lead times when the market does recover
3) It can take 3 to 7 years to get land permitted in more desirable areas
4) Housing starts have fallen sharply and are now lower than at any time in at least
the past 50 years. Starts today are less than half of average long-term demand.
Examples Ackman’s Best Investments Being When Everybody Else Is Afraid
1) The best investments we have made are the ones no one else would touch.
2) BusinessWeek 2009 – “Even at 89 cents it still looks pretty bleak out there for General Growth Shareholders”
3) Business Insider 2010 – “The US housing market is headed for a complete and total nightmare”
4) Yahoo Finance 2010 – “Now they tell us – Experts say housing is a lousy investment and it always will be”
Ackman Conclusion – Why Housing Now ?
- Interest rates won’t stay this low forever
- New monetary easing increases the risk of inflation
- Even with the current inventory levels, at today’s valuations, it is unlikely we will see another substantial decline in prices
- Forced selling may abate as lenders’ balance sheets improve
- Generally, there is more liquidity on the way down than on the way up
- An economic recovery could cause housing to recover faster than many people think
Ackman On Housing Being An Institutionally Under Owned Asset Class
- Institutional investors have almost no exposure to single family home rental properties (“SFHRPs”) as an asset class
- Low valuation, high current yield and long-term appreciation potential make SFHRPs an intelligent investment for institutional investors
- Despite these investment characteristics, we are unaware of any large pools of capital that have been raised to pursue this opportunity. This will change.