Pending Home Sales Better: Is it Time to Buy Homebuilders?

The National Association of Realtors pending home sales index increased by 6.7% to 90.3 in April. This marks the largest increase in that measure in more than seven years and continues a streak of three straight months of strengthening data. Pending home sales is regarded as a leading indicator because it tracks the number of contracts signed, however this does not always translate to a completed transaction. Polling of industry analysts had yielded consensus expectations for a gain of only .5%. Housing is comparatively more affordable now than any time in recent history as housing prices have fallen, mortgage rates hit historic lows, and the $8,000 tax credit for first time home buyers contained within the stimulus plan have all made buying a home more attractive.

Even though pending home sales have improved consistently over the past few months, as of yet existing home sales (recorded when the sale closes) have been much more volatile. Existing home sales were lower in February, increased in March and only slightly increased in April by about 2.5%. The disparity between the pending home sales and existing home sales suggests that mortgages are tougher to come by as banks have tightened their lending standards. This seems to correlate with recent data suggesting that lenders have not yet resumed lending at a historically normal pace. Either potential home buyers are taking longer to approve or are not being approved at all. However, as Brian S. Wesbury and Robert Stein of First Trust Advisors suggest bank lending is a lagging indicator, but their analysis focuses on commercial and industrial loans to businesses rather than mortgage loans. It would make sense that banks would be more conservative in their mortgage lending practices as well, as capital preservation is still at a premium right now.

The important point in this data is that it shows demand is starting to be pulled back into the housing market. It is on this news that homebuilders are getting a boost; as Hovnanian (HOV) leads the pack up 10% while DR Horton (DHI), Toll Brothers (TOL), Pulte Homes (PHM) are all up as well. However, as you can see from our chart of the Residential Construction sector, we are not at all positive on the stocks in this sector. There has simply been too much of a degradation in earnings and too many balance sheet damaging write-downs that shares have not fallen enough to justify us getting more positive on them.

Furthermore, there is still a huge overhang of supply of housing in the market, and the combination of housing starts having declined very rapidly and this renewed demand is the only way to bring the market back into something of equilibrium and stop the destruction of housing prices. In April, fueled by a record month for foreclosures housing inventory increased 8.8% to almost 4 million existing homes available for sale. That represents more than 10 months of supply given current pace of sales, but the initial buyer’s interest is being drawn into the market which is at least an encouraging sign.

It will be very interesting to see how the rise in mortgage rates will affect these developments going forward. The average 30-year mortgage rate has increased to 5.32% from 4.94% just a month ago. This data is a good sign, but it is still too early to tell if housing is turning a corner. Either way, the earnings potential of homebuilders in an environment where supply is still hanging over the market, makes us want to steer clear of those stocks.

Original post

Comments

[Mad Hedge F...:]

Better check out lumber. Those fortunate few who took my advice to go long lumber futures (www.madhedgefundtrader...) can now go out and build a bonfire to celebrate. Since then, the homebuilder’s favorite commodity has rocketed by 35% to $200. The biggest producers, Weyerhaeuser (WY), Rayonier (RYN), or Louisiana Pacific (LPX) have also done well. The last gap up was prompted by more mustard seeds that the housing market may have hit bottom. The enormous subsidies offered to first time buyers is also helping eat into inventories. After seeing similar Chinese inspired moves in copper, crude, and coal, this is further proof of the beginning of a much broader, long term bull market in commodities.

Jun 03 01:19 PM

[Jimmy K:]

Mad Hedge, you gotta stop with the lumber comments... or so help me I'll find a Charybdis and hit you with it...

Jun 03 02:41 PM

[Michael Shu...:]

I find the optimism amusing -- given the low base, existing inventory and the gigantic inventory overhang that is building. There are nineteen million vacant housing units in the US - only six million are listed. Banks are sitting on more than 600,000 homes they gave foreclosed but not listed, I am assuming they do not like current prices. Mortgage re-sets of funky mortgages - options ARMs and ALT-As - do not peak until mid- 2011 and these have unreal default rates -- Goldman Sachs puts the default rate for option ARMs at more than 60%. And defaults mean more foreclosures. Inventory will not stabilize until 2012 -- maybe -- this is a statistical anomaly. A green shoot. I have twin boys, and when they were infants you could see green shoots coming through their diapers -- seems to me they are the same thing.

Jun 03 02:55 PM

[Radardoc:]

"Pending Home Sales Better: Is it Time to Buy Homebuilders?"

No

Jimmy,
I'm gonna grab a Scylla and help you out!

Jun 03 03:56 PM

[HardwoodFlo...:]

Mad Hedge Fund Spammer- I've been making typos about lumber shortages since before there were lumber shortages. So quit your blather.

Nevertheless, this info will whipp the CME into a lather (there's about 4 guys in that pit). $250 is an operational break even for Lumber, anything below is being sold below cost. So, WY and the lot won't see a real benefit until it breaks that price.

Jun 03 06:19 PM

[HardwoodFlo...:]

Back on point the idea that the homebuilders will be partcipating in anykind of improvement in the next 12 months IS optimistic. The reality is the housng market of the future has little to do with them- it's about small builders building to suit for folks that already have their financing and construction loans.

Jun 03 06:21 PM

[Charles Lie...:]

Your figures are accurate, but certainly misinterpreted, perhaps intentionally so. There are 19 million vacant housing units. However, this is a total figure that includes vacation homes, housing units for rent, housing units for sale, and a few other categories and much of this total is normal. For example, I own a condo in Florida. It should be in these figures, because it is vacant. When I'm there, my primary home is vacant. But neither my home nor my condo is for sale and to suggest they are part of the housing overhang is totally misleading.


On Jun 03 02:55 PM Michael Shulman wrote:

> I find the optimism amusing -- given the low base, existing inventory
> and the gigantic inventory overhang that is building. There are nineteen
> million vacant housing units in the US - only six million are listed.
> Banks are sitting on more than 600,000 homes they gave foreclosed
> but not listed, I am assuming they do not like current prices. Mortgage
> re-sets of funky mortgages - options ARMs and ALT-As - do not peak
> until mid- 2011 and these have unreal default rates -- Goldman Sachs
> puts the default rate for option ARMs at more than 60%. And defaults
> mean more foreclosures. Inventory will not stabilize until 2012 --
> maybe -- this is a statistical anomaly. A green shoot. I have twin
> boys, and when they were infants you could see green shoots coming
> through their diapers -- seems to me they are the same thing.

Jun 04 01:46 PM

[dw57:]

no. lots of pending sales for foreclosed homes do not mean much for home builders. some time next decade maybe

Jun 04 01:59 PM

[FL TAXMAN:]

I am a tax preparer in South Florida. About 40 to 60 clients of mine have not been paying their mortgages these last few months,some a year.
They face losing their homes this year.
On the other hand,I have seen the frantic buying of good properties at and above list prices from mid April to mid May.
The question is: Which wave is larger, the buying frenzy or the comoing foreclosures

Jun 04 02:31 PM

[optionsgirl:]

This is just a gut reaction to your anecdote: I'd bet plenty of investors are waiting in the wings for more inventory and lower prices- more people waiting than buying. For existing housing, it will take some time for those foreclosures that were postponed due to the moratorium to hit the market.
If more jumbo mortgage foreclosures occur thru 2012- especially those on ARM's, ( I have read that is expected to happen), I would think that would drag down the inexpensive properties faster and harder, as the investor's dollar will go further.


On Jun 04 02:31 PM FL TAXMAN wrote:

> I am a tax preparer in South Florida. About 40 to 60 clients of mine
> have not been paying their mortgages these last few months,some a
> year.
> They face losing their homes this year.
> On the other hand,I have seen the frantic buying of good properties
> at and above list prices from mid April to mid May.
> The question is: Which wave is larger, the buying frenzy or the comoing
> foreclosures

Jun 04 02:48 PM

[Whippet:]

Makes sense, actually- record low, once in a lifetime interest rates and pending inflation make it the ultimate time to "short the dollar" by moving up or buying for the first time (after all, there are still a lot of people employed, in good industries). This is a temporary phenomenon- 30year fixed rates have already "popped" a bit, and will most likely continue a long, slow march higher for years as sellers outnumber the Buyer of Tnotes (punctuated occasionally by QE "money drops" and short covers). This will strip enthusiasm and affordability away. We'll "hate our homes and love our mortgages," once again. The upcoming Option ARM/Alt-A apocalypse in 2010/2011/2012 will deep-six the homebuilding sector. Unless they start building yurts or high-end refrigerator boxes, of course. Who knows- you may have an innovator go into the Rio de Janeiro-style favela REIT business in Kalifornia.


On Jun 04 02:31 PM FL TAXMAN wrote:

> I am a tax preparer in South Florida. About 40 to 60 clients of mine
> have not been paying their mortgages these last few months,some a
> year.
> They face losing their homes this year.
> On the other hand,I have seen the frantic buying of good properties
> at and above list prices from mid April to mid May.
> The question is: Which wave is larger, the buying frenzy or the comoing
> foreclosures

Jun 04 03:09 PM

[Jeff Nielson:]

Charles, there is a HUGE assumption in your criticism: that those Americans who HOLD multiple properties can afford to CONTINUE to do so.

TENS of millions of baby-boomers are poised to start retirement - grossly underfunded. 75% of their net assets are real estate. When these people all want to DUMP their second homes - SIMULTANEOUSLY, then we will see how relevant all those empty homes are.


On Jun 04 01:46 PM Charles Lieberman wrote:

> Your figures are accurate, but certainly misinterpreted, perhaps
> intentionally so. There are 19 million vacant housing units. However,
> this is a total figure that includes vacation homes, housing units
> for rent, housing units for sale, and a few other categories and
> much of this total is normal. For example, I own a condo in Florida.
> It should be in these figures, because it is vacant. When I'm there,
> my primary home is vacant. But neither my home nor my condo is for
> sale and to suggest they are part of the housing overhang is totally
> misleading.

Jun 04 06:05 PM

[victoralpha:]

There is a big problem out there that skews these numbers. A lot of homeowners that are upside down which is about 90% who bought during the housing boom are actually buying another home and walking away from there's. Why not and it is even being suggested to them by financial consultants. The effect of this will not really hit the markets for at least 3 to 6 months, but it will. Factor that with a huge inventory and continued inventory when the new foreclosure's hit the market and rising interest rates dictates that these homebuilders will be struggeling for a very long time. At this point in time $1.00 is overpriced for these builders.

Jun 05 12:04 AM

[victoralpha:]

About the lumber futures the price increase has nothing to do with supply and demand, only that the canadian dollar strengthened. We are in a very overvalued market which was pumped up by the free money, the feds are in a very tight spot and need to get interest rates back down in order to keep the housing market on the shoe string that it is on, in order to do that the market has to pull back which will help to strenthen the dollar and lower rates at the same time this will bring down the canadian which will bring down the lumber prices, the actual lumber break even is $175 which it will be back to shortly. The factor to watch for is Hurricane season.

Jun 05 12:15 AM