Inspecting Housing's Foundation for Flaws
Aaron Pressman
09/16/04 - 07:13 AM EDT
Reports of the real estate bubble's demise have persistently proven to be premature. Some folks, notably
Federal Reserve Chairman Alan Greenspan, even dispute the notion a real estate bubble exists.
But recent weakness in housing stats suggests the winning combination of cheap borrowing and rapid price increases finally may be coming to an end.
Such a change in sentiment, should it persist, has widespread implications for the economy and some of the market's best-performing sectors, including the still-hot homebuilders.
"Regrettably, we are witnessing a replay of the late-1990s telecommunications and technology boom-and-bust experience, where a surfeit of speculative finance fosters destabilizing overspending in the 'hot' sectors," writes Doug Noland, market strategist at David Tice & Associates, managers of the
(BEARX Quote)Prudent Bear fund.
Admittedly, Noland is among those skeptics who've been fruitlessly searching for the end of the housing boom for some time. But early warning signs may be emerging: While the
S&P 500 gained 0.6% in the week prior to Wednesday's setback, real estate companies such as
WCI Communities (WCI Quote) and
St. Joe (JOE Quote) lost over 4% each, and the industry group fell about 1%, according to Morningstar. Meanwhile, real estate investment trusts (REITs) lost 3.5%.
The recent weakness could be a harbinger for the housing sector, but still left real estate up 16% year to date and REITs up by 12.1%; enviable gains compared with the S&P's less-than 1% advance.
Huffing and Puffing
The entire residential real estate sector has been fueled for the past few years by rising prices and falling interest rates. High home prices have encouraged quick sales and prompted lenders to open the spigots. Lower interest rates increase demand by making homes more affordable, attracting first-time buyers and converting renters to owners. Mortgage debt stands at a record $6.8 trillion.
Celia Chen, director of housing economics at Economy.com, says housing sales may remain strong for another month or two, but should slow substantially by year-end as mortgage rates tick up and the furious pace of the past few years leaves fewer and fewer buyers. Indeed, evidence is starting to emerge that robust trends in housing are starting to falter.
Sales of new homes fell 6% in July from June to an annual rate of 1.13 million, the slowest pace since December. That was almost 2% below July 2003, as well. The number of unsold homes on the market has been building as inventory stood at 393,000 at the end of July, a 15% jump from a year earlier.
Existing-home sales hit a record annual rate of 6.9 million in June and then fell off almost 3% in July to 6.7 million. Economists are forecasting a further slowing of sales to 6.6 million for August.
The Mortgage Bankers Association index of applications for purchases dropped 4.3% for the week ended Sept. 10. It's still 11% higher than a year ago. The rate on 30-year mortgages of 5.68% for the week was 0.3 percentage points lower than a year ago.
Of course, not everyone is ready to write off the housing boom just yet. (Notably, several
RealMoney.com contributors have expressed optimism about homebuilders of late, including Jim Cramer, Dan Fitzpatrick and Steve Smith.)
"Following record levels of new single-family home sales in May-June and the sustained low mortgage rates, we expect housing activity and new housing starts to remain firm in coming months," Bank of America economist Mickey Levy recently opined.
In an interview on
CNBC Wednesday evening,
Pulte Home (PHM Quote) president and CEO Richard Dugas said: "People look at [moderating] overall housing stats, but we're in a position where we're taking share. The large builders are in great shape."
Homebuilding stocks have certainly been in great shape, up more than 11% since Dec. 31 and over 40% in the past year. Still, a couple of the bigger players cooled in the past week, including Pulte and
Lennar (LEN Quote).
Supply/Demand Imbalance
Housing's many skeptics say the rapid pace of sales has obscured the magnitude of inventory overhanging the market. Another 2.4 million houses were on the market at the end of July, according to the National
Association of Realtors. That represented only 4.3 months supply at July's rate of sales -- but if sales slowed even to 2001 levels of about 441,000 a month, the inventory ratio would jump to 5.4 months.
A Morgan Stanley research report last week pointed out that the inventory situation is even worse than it appears in the months-of-sales ratios. In absolute terms, inventories have risen for almost five years and, as a proportion of total homes, are reaching the 1990s recession level of 2.5%.
Rapid turnover -- the quick flipping of homes to cash out huge price increases -- is masking the inventory buildup. Turnover is at an all-time high of tover 9%, Morgan Stanley's analysts wrote.
The firm also noted that so many renters have now bought homes that the number of households still renting is nearing a 20-year low, and the financial stability of those remaining is sinking. According to the firm's calculations, the combination of rising interest rates increasing mortgage payments and the shrinking pool of renters will reduce the number of potential homebuyers by 2.1 million, or about 20 percent, over the next three years.
Already, home-price appreciation has far outstripped growth in incomes, reducing affordability. Nationwide, the median home price of $183,800 in the second quarter was about 4.3 times median income at the end of 2003, which was $43,318. That's up from about 3.5 times three years ago. The average price of a single-family home rose nearly 9.4% for the 12 months ended June 30, the largest 12-month increase since 1979, according to the Office of Federal Housing Enterprise Oversight.
Regionally, Las Vegas had the greatest median home appreciation last year, putting prices at six times income. In Los Angeles, prices are 10 times income and in Orange County, Calif., 14 times higher. Miami and San Francisco also have ratios above 10 and Boston's is almost 9.
As
Fortune magazine pointed out over the weekend, 80% of the households in California can't afford to buy a house at the median price in the state.
The Los Angeles Times reported on Wednesday that home prices around the city declined 1.6% between July and August.
On
CNBC, Pulte's Dugas suggested the price hikes in certain metropolitan areas were the result of "local government's continuing to prevent us from getting lots on line to meet demand."
But despite alleged restrictions on building, new construction has continued at a furious pace. Single-family home construction totaled $371 billion in July, 21% higher than a year earlier, while spending on apartment units rose 12% to $39 billion, the Census Department reported. Single-family home construction is outpacing 2003's 17% expansion, which already was the fastest in at least 10 years.
At some point, the combination of rapid building, record-setting debt levels and rising interest rates will put a major crimp in housing and related stocks, especially if the employment growth remains punk.
"Of course these stocks will blow up," Jeff Macke, founder and president of Macke Asset Management in San Francisco, said of the homebuilders. "Eventually, you'll get down to a few juggernauts in each housing space and it's an economic certainty they run out of space" to develop at favorable economics.
But Macke, a contributor to
TheStreet.com's professional site,
StreetInsight.com, has no positions in the sector, explaining that the homebuilders' relatively low valuations -- a reflection of the Street's skepticism about long-term prospects -- insulates them from big declines.
"[Their] hitting the wall could be forestalled longer than anyone thinks," he said, effectively summing up the recent history of this battleground sector.
