Housing: The Good, the Bad, and the Ugly

Marie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Institutional investors are financing the housing recovery. In Phoenix, for example, the share of institutional investors in the market increased to 26%, a 10% increase from the previous year. And in Miami, institutional investors funded 30% of all sales. Housing starts are up, home prices are rising, and construction is bustling. However, caveats like slowing furniture sales and rising mortgage rates remain.

Housing starts

The overall housing construction market is strengthening. Housing starts are up 24% year-over-year in the first half of 2013. Applications for single-family home construction increased at the fastest pace since May 2008. The uptick is beneficial for the largest residential home builder in the U.S., D.R. Horton (NYSE: DHI). Greater demand has resulted in increased sales volume, higher average sales, and higher closing prices. The number and value of orders in the second quarter increased 34% and 52% compared to the second quarter of 2012. Also, first and second quarter revenue from home sales in 2013 increased 47% and 43%, respectively.

As a result of the progressing housing market, D.R. Horton is up nearly 8% this year. And since 1993, it’s returned roughly 500 times more than the S&P 500.

Furniture and home furnishing sales

According to research compiled by the Saint Louis Fed (see picture below) furniture and home furnishing stores are performing negatively. And, according to the Census Bureau’s Advance Monthly Sales for Retail and Food Services May 2013 report, furniture store and home furnishing store sales declined approximately 12% and 2% respectively from March to April.

Although not directly correlated, it is interesting that an improving housing market hasn’t bolstered furniture or home furnishing sales.

If there are more new homes in the market and existing home sales are up 9.7% year-over-year, then why aren’t furniture and home furnishing sales rising?

Last, it’s curious that despite the declining sales trends, the stocks of furniture and home-furnishing companies, like Ethan Allen (NYSE: ETH), are doing well. Fiscal 2013 saw a 33% increase in operating profit, a 55% improvement in gross margin, and a 3% rise in sales. And thus far into 2013, Ethan Allen is up about 13%. However, if furniture and home furnishing sales continue declining, I expect sales revenue at companies like Ethan Allen to suffer.

Mortgage rate hikes

In just two months, the 10 year T-Bill has increased 83.8 basis points to about 2.5%. Similarly, the 30-year fixed mortgage rate jumped 92 basis points to nearly 4.5%. That’s the highest it’s been since 2011.

How do increasing mortgage rates affect homebuyers? Well, in one of two ways. Some would-be homebuyers walk way and postpone purchasing a home because increasing rates equal higher, unaffordable, monthly payments. Others aren’t so easily detoured. Instead of scurrying away, most homebuyers rush to secure the current rate before rates rise further.

When faced with rising mortgage rates, homebuyers hurry to sign contracts. According to The National Association of Realtors’ Pending Home Sales Index, a forward-looking indicator based on contract signings, in May the index reached its highest level in over six years. After declining in June, pending home sales rose in July to the highest level in over two years.

If mortgage rates continue rising, there will be a short-lived bull market in home sales and probably home constructions as well. But in the long-term, rising rates ultimately hamper growth in the residential real estate market.

Last, how do rising mortgage rates affect institutional investors? Believe it or not, it’s actually helping drive revenue. As some homebuyers postpone purchasing a home because of rising mortgage rates, renting becomes the most convenient solution. And no other institutional giant is better poised to gain from this than Blackstone (NYSE: BX).

In 2012 Blackstone began purchasing single-family homes. According to Jonathan Gray, head of Blackstone's real estate group, “right now, the scale of the opportunity is very big.” Fast forward a year and Blackstone has spent about $5 billion acquiring more than 30,000 single-family homes in areas where home prices have risen higher than the national average of 8%. According to S&P/Case-Shiller Home Price Index, Phoenix home prices rose 17.4% in the period between April 2012 and February 2013.

Not only are the values of the single-family homes Blackstone owns rising, but the higher prices allow Blackstone to rent its homes out more expensively, thus generating more revenue.

Conclusion

The housing market is a highly complex structure. Construction of new homes and sales of existing homes are up, but furniture and home furnishing sales are down.

Also, the business of purchasing distressed homes and renting them out has been an integral element of this recovery. However, it may be coming to an end. According to hedge fund manager Bruce Ross, “there’s a lot of stupid money that jumped into the trade.” And, as I’ve said before, when smart money jumps ship and retail investors board, RUN!

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Article by Santiago Rodriguez, edited by Chris Marasco.  Neither has a position in any stocks mentionedThe Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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