Housing Uptick May Not be Sustainable
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Many signs indicate that housing has entered a seller’s market. Most pundits point to record-low home prices and mortgage interest rates to show that economic incentives are in place for buyers to flood the market.
That’s true, but it’s only a side point. Demand for housing hinges on one key ratio: the number of new households being formed relative to the glut of empty homes that exist. New household formation is driven by the number of young adults who are ready to move out of their parent’s home and single people moving out of shared/roommate housing arrangements.
Some people wonder if America’s Baby Boomer population will hurt the number of new home starts, but demographic trends indicate otherwise: The 18-65 age group represents 37 percent of the U.S. population. In contrast, only 13 percent are Baby Boomers, according to the U.S. Census, and a full 23 percent are under 18. Translation: Americans are younger than many people think, and they're ready to form new households.
Since 1965, an average of 1.3 million new households have been formed each year, according to the Census Bureau’s Housing Vacancy Survey. Last year, that number stood at 1.1 million, which is fairly close – though still down – from its long-term average.
But during the first decade of this century, builders created roughly 1.5 million new homes every year. That means supply outpaced demand. The building spree screeched to a halt about five years ago, when home prices plummeted and profits for builders declined. New household formation for the last half-decade has soaked up the excess inventory.
Now builders are back with a vengeance: The U.S. Census Bureau reports that new-construction permits and new housing starts have risen 19 percent and 23 percent, respectively.
No wonder homebuilders are among the biggest winners of the 2012 stock market. Stock prices for PulteGroup (NYSE: PHM), Ryland Homes (NYSE: RYL), and Lennar Corp. (NYSE: LEN), three of the biggest homebuilders in the U.S., have more than doubled in the past year.
This jump in stock price was largely been driven by higher revenues and more ambitious appetites for growth. Pulte, for example, reported a 32 percent increase in year-over-year orders for Q2. Ryland is growing through an acquisition spree: it raised capital by issuing $225 million of notes, due 2018, purchased Westport Homes, obtaining 504 new lots for development in Indianapolis, purchased Timberstone Homes, a builder based based in Charlotte and Raleigh, and announced a groundbreaking of a new subdision in Columbia, Maryland. Lennar Corp. is taking the most ambitious risks of all: it's close to signing a $1.7 billion loan package with China Development Bank, which it will use to develop 18,500 homes in San Francisco, according to Bloomberg News.
The question is: can these companies sustain their upward trajectory for the rest of the year? Opinion is mixed, but some analysts say no. Citigroup, for example, just downgraded Pulte from a “buy” to a “neutral,” despite its strong revenue. Why?
#1: Higher Revenue Now Priced In
All the major homebuilders are trading near their 52-week highs. The increase in revenue and new-home orders is a good sign, but it’s already priced into the stock.
#2: Foreclosures Create Uncertainty About Future
The glut of foreclosures that’s currently caught in red tape poses a massive threat to the homebuilders. Once those foreclosures are listed for sale, they’ll further saturate the market and depress prices.
According to RealtyTrac, there are currently 1.5 million foreclosed homes on the open market. That’s more than double the number of foreclosures that saturated the market in 2007, when housing prices sat near record lows.
As of last year, an additional 872,000 foreclosures were sitting in red tape, waiting to come onto the market. Their slow trickle will keep prices down for a long time to come.
#3: Jobs Data Still Bleak
People won’t buy homes if they don’t have jobs – in part because they don’t have the down payment, and in part because most banks are reluctant to issue personal residence mortgages unless the borrower has at least two years of uninterrupted work history.
But the U.S. jobs report is still weak. The nation holds 8.2 percent unemployment, according to the Wall St. Journal, and in areas of the country that have the most foreclosures, like California, the jobs report is even worse. (One California county, San Bernadino Valley, has 11.9 percent unemployment, according to the NY Times). And since banks demand two years of employment history, bleak jobs data can result in depressed housing demand for years into the future.
Until the jobs data improves, it’s risky to bet that the uptick in housing demand will remain strong.
Housing is showing some good signs for recovery, but demand will be slow and volatile. I’m keeping an eye on homebuilder stocks, but I’m not ready to hit the “buy” button quite yet.
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