Housing stocks, housing conversation, housing this and that is attracting a crowd – in part due to today’s announcement of “soaring” home builder confidence – more on that later. As with most crowds, the majority of the people in that crowd are going through what experts and academics call “cognitive dissonance.” This is a state of mind when we are faced with two conflicting opinions or truths – what Wikipedia calls cognitions – and being unable to deal with the tension created by that conflict the person suffering from cognitive dissonance opts for one choice over another.
In the case of the home builders and the housing market, the dissonance comes from wanting things to be better and seeing one neighbor unable to sell their house. Seeing another neighbor under water on their mortgage and unwilling to sell their house. Driving by the abandoned development where you go to the beach, noticing the weeds are taller. In this case, people who should know better are saying the home builders are turning round.
To quote the football analysts on ESPN, “c’mon man!” There is no housing rebound in site – ask Ben Bernanke, who has admitted he has been surprised by the sustained downturn. His predecessor, Alan Greenspan, was surprised by the ferocity of the downturn. That ferocity is the reason for Bernanke’s surprise – and why we will not see a real rebound until 2017 at the earliest.
A deluge of excess supply in housing market
Seriously, 2017? Here is why.
There is a huge, excess supply of houses on the market and that is going to hit the market for the next five years. Where are they coming from? First, foreclosures – at least another 7 million or so before we return to historical rates for foreclosures. Second, this supply is coming from people up to date on their mortgages but doing short sales or selling their homes for just the balance on their mortgage.
- More than two years ago, 35% or more of the people owning homes said they would sell if they could. I can only assume that number is greater now but even at one-third, that will put a lot pressure on the market – and prices.
- The foreclosure number is the big one — roughly 4% of mortgages — and calculating the future is a matter of simple math. You look at the default rate, the percentage of defaults that go into foreclosure and the time it takes a foreclosed home to hit the market. Roughly 90% of first-time delinquencies become serious and roughly 80%-90% end up being foreclosed. In February of 2007, I told my subscribers this mess was coming using the same kind of math. Right now, the number of houses in some form of foreclosures is eight times the historical average.
- Delinquencies and defaults are rising again – in December, the rate for first mortgages rose to 2.19% and for second mortgages to 1.33%. If that does not sound like a lot, but the total number of mortgages in default is roughly 8% and that is more than double historical norms.
- Do the math and you see the foreclosure pipeline – and that includes the more than half a million units that have been foreclosed but not yet listed by banks.
- Foreclosures hit pricing – many are relatively more homes or are sold at a fraction of their original price. Today data was released showing the impact of this pipeline – median prices for homes sold declined an average of 3% in 118 out of 149 markets in the U.S.
- Demand for houses is still slack for obvious reasons – concerns about or lack of household income; tightened credit requirements; the availability of rental units; a broken appraisal system; and concern about whether a newly purchased house’s value will fall.
- A critical issue is that change in sentiment among first-time buyers in particular – many first-time buyers know their purchase is a starter home that they will trade up from when the kids arrive or they will need to sell if they get a job somewhere else. With transaction costs of 12% — 6% on the purchase and the sale of that starter home – they need to see 3% or more appreciation per year for five years to make even a little profit on their investment. Rentals, with the exception of a couple of localities, are available at bargain-basement prices.
Home-building stocks: trading on hype and hope
People on Wall Street can read – at least some of them. And yet they deny this reality, bidding up home-building companies that have no meaningful earnings power for another five years, if they survive. I hear pundits talking about home-building stocks as cheap because of their book value – well, book value is in the eye of the beholder. The builders enjoy fuzzy and generous accounting rules as to how to measure their book value and I wonder how much impaired property – land and half-finished developments and the like – is being carried above real market value. I know, sounds like what the banks do – more on that in another column.
Forget home builders; focus on rental REITs
Today the home-builder confidence survey “soared” to its highest levels in four years and the stocks moved up. Soared to 29 – the historical average before 2007 was 54, and below 50 means business is not really good. But it soared, don’t you know (forgive the idiom; one of my sons goes to college in Minnesota).
Bottom line: Home prices will continue to fall, demand for new homes will continue to be at radically depressed levels, the home-building stocks are trading on hype and hope. Think rentals – yes, there are rental REITs. They are expensive by historical standards but at least they are in the right place in the housing market at the right time. Three that come to mind are Equity Residential (EQR) with a 3.9% yield, Essex Property (ESS) with a 2.9% yield and AvalonBay Communities (ABV) with a 2.6% yield.