Homebuilders are Strong but Housing is Weak
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The recent rise in the share prices of homebuilder stocks should not lead investors away from the fundamental weaknesses of the housing market in the United States. While the housing market and homebuilder stocks are two different and distinct entities, there is an underlying relationship that results in weakness for both sectors as existing inventory has an impact on both. Without strong economic growth in the United States, there will be no enduring recovery for homebuilder stocks or the housing market as the inventory of properties available will depress prices and sales.
So far, there has been a robust recovery this year for homebuilder stocks. Year to date, SPDR S&P Homebuilders (NYSEMKT: XHB), the exchange traded fund for the sector, is up by more than 27%. Share prices for individual companies have fared just as well, if not better. PulteGroup (NYSE: PHM) has risen by 74.48% for 2012. Over the same period, DR Horton (NYSE: DHI) has increased by 51.95%. KB Homes (NYSE: KBH) is up 51.55% for 2012. Lennar Group (NYSE: LEN) has soared 57.67% since January 1 of this year.
While the homebuilding sector is doing well as newly constructed properties are selling, the housing market is weak as existing ones are not. June sales were off 4.5% from May. There are, literally, millions of homes in various stages of foreclosure yet to hit the market. As noted by Anand Nallathambi, president and CEO of CoreLogic, a housing research group, "The shadow inventory remains persistent even though many other metrics of the housing market show signs of improvement."
As for the actual number of these properties still waiting to hit the market, Roger Staiger, a faculty member of The Johns Hopkins Carey School of Business, stated that, "I'm predicting another 2 million homes to be foreclosed. I would say there are about 3 million homes close to foreclosure or in distress, meaning owners are 90 days delinquent on payments."
So, while the homebuilding sector has been robust for 2012, there is a very unhealthy shadow inventory lurking that could undercut both the prices and actual sales of new homes. This is reflected in the financial indicators of homebuilder stocks.
Perhaps the most telling indicator is the high level of short floats. A short float of 5% is considered to be troubling. KB Homes has a short float that is staggeringly high at 48.35%. For Lennar Corp., the short float is 21.05%. DR Horton has a short float of 13.02%. The short float for PulteGroup is 11.17%. And, in a sign of the perceived weakness of the overall homebuilding sector and not just the individual companies, the short float for SPDR S&P Homebuilders is 17.96%.
There are reasons for that.
The capital structures and income foundations for homebuilding stocks are very shaky. Earnings-per-share growth for KB Homes this year is down 157.20%, with a debt-to-equity ratio of 4.28 and a negative profit margin of 4.28%. Lennar Corp. has a debt-to-equity ratio of 1.28 with earnings-per-share growth declining by 4.97% this year. Pulte Group is losing money with a negative profit margin of 4.62%, which makes its debt-to-equity ratio of 1.62 even more burdensome. For DR Horton, earnings-per-share growth is off this year by 70.70% and the debt-to-equity ratio is 0.65.
Earlier this year at an interview conducted at the economic conference in Davos, Switzerland, Yale Professor Robert Shiller, one of the creators of the Case-Shiller Index to measure real estate prices, stated that housing prices are not recovering anytime soon in the United States. When asked if housing prices had finally bottomed, Professor Shiller replied, "But I don't see that. I don't see any reason to think that prices are going to start heading up dramatically now."
Writing in Forbes magazine, Gary Shilling warned that, "I expect single family housing prices will fall another 20% due to excess inventories. Homeownership rates will slide from foreclosures. Many people suffering from chronic unemployment and the inability to meet mortgage standards will simply give up on the idea of owning a home. So expect more underwater mortgages, more defaults and even less consumer spending."
The major reason for this, according to Professor Staiger from Johns Hopkins, is the the weak economy of the United States. This will greatly increase the shadow inventory, he claims: "If you look at wage growth over the last five or six years, it's almost nonexistent. We are on the way to $5 gas. Things are not getting better. Unemployment is getting better because more people quit looking for jobs."
Until the economy improves in the United States, the housing market will not. The unemployed and those concerned about their jobs do not take on the responsibility of a 30-year mortgage. Renting is far more preferable than the possibility of a foreclosure.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
