Buffett Bets Big On US Housing Recovery

Published in Investing on 19 June 2012

The Oracle of Omaha stands to make billions when the US housing market revives.

Investment genius Warren Buffett -- the world's third-richest man, with a personal fortune of $44 billion -- is renowned for making big, bold bets on the future direction of the US economy.

For example, the giant conglomerate Buffett runs, Berkshire Hathaway (NYSE: BRK-A.US) (NYSE: BRK-B.US), bought Burlington Northern Santa Fe -- one of American's biggest railroad firms --for $44 billion in February 2010. In September 2011, Buffett followed this by spending $9 billion buying lubricant maker Lubrizol.

Unsafe as houses

However, one of Buffett's biggest bets is steadily increasing Berkshire's exposure to any future turnaround in the weakened US property market.

Until they peaked in mid-2006, ever-rising home prices were a mighty engine driving the US economy. Rising home equity fuelled ever-increasing borrowing and spending, propelling US economic growth well above its long-run average.

Then came the subprime-mortgage crisis, followed soon after by a global credit crunch and deep recession. After the housing bubble burst, US home prices dived by 28% between June 2006 and March 2012, according to US mortgage behemoth Freddie Mac.

What's more, following massive losses and taxpayer-funded bank bailouts, risk-averse investors have come to regard US housing and mortgage securities as 'toxic waste' to be avoided. Not so, Buffett. Where others see danger, he sees opportunities; where they see past losses, Warren looks ahead to future profits.

A huge bet on housing

"Housing will come back -- you can be sure of that." (Warren Buffett, February 2012)

For almost a year, Buffett has suggested that US home prices have returned to reasonable levels and that the US housing market is poised on the brink of a (modest) recovery.

As a result, Buffett is ramping up Berkshire's ownership of firms with heavy exposure to a sustained recovery in home prices and sales. Last week, the Oracle of Omaha bid nearly $4 billion to buy a portfolio of distressed loans.

Yesterday, Bloomberg reported that Berkshire Hathaway has offered $3.85 billion (almost £2.5 billion) to buy a mortgage business (for $2.4 billion) and loan portfolio (for $1.45 billion) from Residential Capital. This lender was owned by GMAC, the finance arm of General Motors (NYSE: GM.US), until it was placed into bankruptcy so as to protect its parent company, Ally Financial.

In addition, Berkshire Hathaway is the largest shareholder in Wells Fargo (NYSE: WFC.US), currently America's number-one mortgage lender with a market share exceeding 30%. What's more, recent regulatory filings reveal that Berkshire is increasing its stake in Wells Fargo by buying more shares.

Also, Berkshire's real-estate unit, HomeServices of America, is snapping up rival real-estate brokers, ready for any rebound in home sales.

In January 2011, Berkshire added to its 'bricks and mortar' portfolio by agreeing to buy Jenkins Brick to add to Acme Brick, its existing brick-maker. Clearly, with the number of US households rising faster than the number of housing starts, Buffett expects demand to increase, with squeezed supply spurring new property developments.

Is Warren right?

It's far too early to say whether the 81-year-old investor's brave bet on US housing will pay off.

Then again, a few housing indicators have picked up recently. For instance, foreclosure filings (repossession actions) have fallen for 20 months in a row. Also, US house prices leapt by 1.8% in March, their biggest monthly rise for 20 years, driven by ultra-low mortgage rates.

Nevertheless, the Nebraska-based investment wizard seems to be doing something that he's done successfully many times in the past. He's buying assets on the cheap at a time of market distress and then waiting patiently for their prices to recover.

For this reason, I certainly wouldn't bet against Buffett's prediction of a turnaround in the US housing market!

By the way, do you know which British business Warren Buffett has been gleefully buying into in 2012? To find out which FTSE 100 firm the 'Sage of Omaha' is backing, simply download your free copy of our latest report, The British Business That Warren Buffett Loves.

Further investing opportunities from Cliff D'Arcy:

> Cliff does not own any of the shares mentioned in this article.

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ANuvver 20 Jun 2012 , 1:43am

BRK is a proven cash-generative juggernaut, and I'm looking for a home for some dollars.

Unfortunately, it's currently well above the criteria under which he himself would buy it.

Guy5pd 20 Jun 2012 , 9:03am

Hey ANuvver, lazy of me to ask (sorry) but are BRK currently buying back their own shares? If they are it might indicate that they think the current valuation is too low.

A quick search shows that there are some funds with big (20%+) holdings in BRK, which would offer a way in, but their charges are a prohibitive 2%+.



ANuvver 20 Jun 2012 , 7:15pm

As far as I understand it, Buffet indicated he had obtained a board mandate to buy back BRK at anything up to book value +10%. When I last checked, that meant he'd in the market if the B shares were somewhere in the low $70s. My feeling is that they haven't actually bought any yet - the announcement put a floor of sorts under the price and became a sort of self-negating prophesy...

Further, the buyback mandate is just that - permission, not obligation. I reckon it's likely that during the kind of market drop required to send BRK down into the mandated territory, Buffet would have far more interesting uses for his capital.

Bear in mind that we're talking about a stock with a beta of 0.5 currently trading at $82 and change. So, ceteris paribus, the wider market would have to fall some 24% to put BRK in the range where it would consider supporting its own SP.

With all that in mind, I reckon the shares have solid support around $77. Also, the US election-year voodoo so far seems to be on track.
Still, I'm a patient man...

As for 2% fees, I'm afraid I'm just not that philanthropic!

Guy5pd 20 Jun 2012 , 10:53pm

Ah, the mandate must be what I was thinking of, apologies. In any case, thanks for your response, it was an interesting and informative read - much appreciated!


ANuvver 21 Jun 2012 , 6:42pm

Glad to hear you found it helpful.

I see the much-vaunted buyback announcement as a backstop on their own stock, which they calculate they'll never have to implement. And WB is quite cute with such calculations - we are talking about the man that Goldmaned Goldmans...

Always interesting to watch what this man does. He spent most of the past decade sitting on his hands and stockpiling T-bills. Well, okay, he also handicapped junk bonds for a bit of fun (he compared it to shooting fish in a barrel).

He has recently become a prominent cheerleader for the US economy in general, but is very aware of his reputation as probably his most valuable asset, and not to be squandered on cheap manouevres.

A fascinating blend of value, income and contrarian investor is our Uncle Warrant.

He may be perfectly right on TSCO (sorry MF, "You'll be amazed - Buffet has bought a pie shop! Click here to find out which one.") Letting other people feel good about getting in under him is part of the complex dynamic that I'm sure he understands. Another backstop of sorts, really.

Meanwhile dumptrucks of cash keep on heading to Omaha. Great business. I still want it cheaper though - and so would he!

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