One of the most often talked about parts of the economy is the real estate market sector. Because real estate is such a large and important part of the economy, naturally, many eyes are focused on whether or not this market sector can and will rebound from its deep decline.
While we have certainly seen a strong bounce off the bottom, there are still many concerns for the future of both the real estate market sector and housing stocks, specifically. Investors in housing stocks are definitely ahead of the curve, as many housing stocks have increased substantially. With gains in excess of 100%, the question on many people’s minds is: will the real estate market sector continue its upward trajectory, or are housing stocks teetering on the edge of a massive decline?
The Department of Commerce just released the number of housing starts for October. As I expected, housing starts exceeded estimates, coming in at an annual rate of 894,000, up 3.6%. This is the fastest annual rate since July 2008. Many estimates taken by Bloomberg in a survey are still far too low, coming in at 780,000–873,000. (Source: “Housing Starts in U.S. Increase to Four-Year High,” Bloomberg, November 20, 2012.)
The reason why publicly traded housing stocks are doing so well and driving housing starts is that they are able to take advantage of extremely cheap financing. Essentially, private homebuilders are not able to borrow funds as cheaply as publicly traded housing stocks. Because investors are looking for places to park their money due to the low-interest-rate environment, this is giving housing stocks so much excess funding that they’re running out of land to build on.
Anytime a market sector has excess financing capacity (lots of money, but no place to put it), the costs for the borrower drop precipitously. So, now we’re in a situation where homebuyers have historically low mortgage rates and housing stocks can buy cheap land and make large profits on new homes by borrowing for essentially nothing. Naturally, home starts are going to exceed expectations. If you had a business where demand was strong and you had free money to expand, wouldn’t you do so?
But why is demand strong in a weak economy? This is another interesting point that I believe is driven by the publicly traded housing stocks. Many people who have been involved in a foreclosure or just have bad credit history are having difficulty obtaining a mortgage from traditional lenders, such as the large banks. The banking market sector, in general, does not want to load up in the housing industry so soon after the crash. However, I believe it’s much easier to obtain financing if one were to buy a new home from the publicly traded housing stocks. They would be able to help arrange financing, even if it was at slightly higher rates. After all, if one was to pay $1,400 a month for rent or $1,000 per month for a mortgage, it would make sense to buy. This is yet another positive factor for publicly traded housing stocks that have access to cheap investment capital.
However, because of the large move up in housing stocks this past year, I think most of the easy money has been made. In fact, many of the CEOs for the top housing stocks are cautious regarding their market sector.
Recent comments by the CEO of D.R. Horton, Inc. (NYSE/DHI), Donald Tomnitz, can illuminate a lot. Tomnitz stated in a conference call that he was quite concerned that the lack of jobs might lead to lower home sales next year. D.R. Horton is, by volume, the largest homebuilder in America. One of the most sobering moments was when Tomnitz stated, “I also see the fact that there are potential layoffs in a number of industries, especially the defense industry.” (Source: “D.R. Horton Falls as CEO Cautions on Job Growth Next Year,” Bloomberg, November 12, 2012.)
While housing stocks have done well, the overall real estate market sector is still susceptible to a downturn. Even if we don’t get a decline in home prices, for the current housing stocks to remain at their elevated levels, they would need to see the real estate market sector continue its extremely strong trajectory. I think too many of these housing stocks are priced to perfection.
I also think people need to realize that the real estate market sector won’t exceed the recent peaks in price. The boom in the real estate market sector was created by artificially cheap money. Unfortunately, the recent moves by the Federal Reserve might actually be beginning to stimulate yet another boom fueled by cheap money. I believe that people entering the real estate market sector should look at the cost of renting versus buying and expect limited price appreciation. I believe we’re getting back to a more traditional structure for the housing market sector, in which one buys for security and not speculation.
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