US housing: a long-term attractive opportunity

Momentum in US housing has turned in 2011, with US residential real estate investment contributing positively to GDP growth for a fifth consecutive quarter in Q2 2012, whilst it has been a negative drag on growth for 18 out of the 21 quarters between Ql 2006 and Ql 2011. The average quarterly contribution of US residential investmentto GDP growth over the past 3 quarters stands at 0.3%, versus 0.6% between Ql 2006 and Q3 2011.

In our view, getting exposed to US real estate today is an excellent long-term investment opportunity:

1. 1. Although slightly below its peak in January, the US National Housing Affordability Index stands at 179 at the end of June 2012. This is 48% above its historical average since 1971. At the same time, the US housing price to income ratio is largely back to pre bubble levels, around fair va I ue/ cheap territory.

2. The US housing market risk premium, defined as the net rental yield (net expected income from rentinga property divided by the value of the property) less real mortgage rate stands at 2.7% at the end of Q2 2012, only 0.2% below its late 1993 historica I high (2.9%), and 2.1% above its historical median (0.6%).

3. Although sti II above its long run average, excess supply has started to come down significantly. The ratio of vacant year round housing units (available for sale, rent and other) to total units was down to 7.0% at the end of June 2012, from its 7.7% peak two years ago.

4. Over the past 30 years, banks have never had such a low exposure to real estate, reflecting the significant downsizing of their mortgage operations. Although this does mean that it is difficult to get a mortgage, and that credit conditions are still tight for potential home buyers, such under-exposure makes for a good environmentto invest in the sector, as prices should be boosted when banks re-enter the market.

5. We like real estate as one of the best hedges against potential inflation risks over the long run. However, given the muted improvement in employment and the continued tight credit conditions, we would expect end-demand for homes to remain subdued.In the shortterm, uncertainty around US elections and fiscal issues could lead to weaker investment, as well as consumers cutting back on big ticket items like houses, leading to somewhat softer prices.

All told, we believe US real estate to be an excellent longterm opportunity, with a currently very attractive entry point in terms of valuation, even though sub-par economic growth is likely to make the rise in prices much more gradual than during previous recoveries.

An interesting way to gain exposure are companies sensitive to a stronger US housing market (e.g. building materials or equipment).