Americans Turn To Real Estate
At first glance, the infatuation of U.S. households with the booming financial markets looks as strong as ever. Beneath the surface, however, economist Joseph Carson of Deutsche Bank Securities spies a sea change that has substantial implications for the investment community.
Specifically, Federal Reserve flow-of-funds data indicate that it has been investors from abroad rather than Americans who have been the big net buyers of U.S. financial assets over the past year or so. Last year, foreigners snapped up some $350 billion worth, and they have apparently stepped up the pace in 1998--providing vital liquidity that has helped keep the good times rolling on Wall Street.
In contrast, the Fed data reveal that U.S. households have actually become large net sellers of financial assets (chart). In fact, although they poured some $220 billion into mutual funds and even more into 401(k) plans last year, they sold such massive amounts of directly held stocks and bonds that total net sales of financial assets by households in 1997 ran close to $200 billion--a trend that shows no sign of slackening.
At the same time, observes Carson, the household sector has been directing more and more of its cash toward purchases of real assets, primarily housing. In 1997, new financial flows into residential real estate totaled $260 billion, and net flows into housing this year appear to be running some 25% to 30% faster.
As Carson sees it, people aren't redirecting their cash flows toward home purchases simply because incomes are up and mortgage rates are low. They're being drawn by relative valuation and potential aftertax returns. Back in 1982, the cost of buying 100 shares of each of the stocks in the Dow Jones industrial average was about 1.75 times the price of an average home. By the end of last year, the ratio was up to about 8 to 1--making home purchases seem dirt cheap in comparison to equities.
Similarly, Carson notes that existing home prices have recently been rising at a 6% annual clip--more than the yield on a five-year Treasury. And new tax laws, which allow homeowners to realize $500,000 worth of tax-free capital gains on home sales every two years, are a powerful investment incentive.
While these considerations suggest that households will be shifting capital toward hard assets for some time, Carson thinks that the direction of foreign investment is less predictable. Just as troubles in Asia and elsewhere have inspired flows into dollar assets, he says, recoveries in those areas could spark outflows, as could concern about America's widening trade deficit.
If such a reversal were sudden and large, the impact on U.S. financial markets could be traumatic. And that downside risk, compared to the lower risks in a housing market that has just begun to experience healthy appreciation, says Carson, may be one more reason that households are putting more of their new capital into real estate.