There has been a recent 10% -15% pullback in U.S. housing-related plays such as Dr Horton (DHI), Lennar (LEN) and Pulte Homes (PHM) as well as other housing-related stocks as mortgage rates have increased. The fact is the fundamentals of U.S. housing are still very strong even with mortgage rates moving from 3.4% to current 4%.
The demand side is not going to be curtailed by the rise in rates especially against still such extreme affordability ratios, pent up demand and also considering that Lennar estimates rates would need to rise to 10.5% to arbitrage out the rent versus buy equation in the U.S. housing market. As long as the cost to borrow is below 10.5% it is better to buy than rent. Please see here for the Lennar report.
The point is demand will remain robust. In terms of new build, demand will also certainly remain robust enough to sustain the approximately 500,000 of new house sales forecasts for 2013. Remember the constraint is the rate at which builders can produce (such as labor shortages) rather than demand. Total U.S. housing starts is forecast to be up 27% in 2013 to reach a level of 1 million with single family starts forecast at about 650,000 for 2013. I don't see a big move on these forecasts either way.
Recognizing the above analysis, investors have two possible scenarios and courses of action as below:
Buy U.S. housing-related plays on this pullback now and buy back into the strong fundamentals and the long run cycle briefly outlined above.
Investors should wait for a further pullback and an even better entry point over the next few months. Please consider the following potential sequence of events.
U.S. house price inflation will slow through the summer. The high recent rate of house price inflation should slow due to the supply side responding. Inventory is growing as sellers are waking up to the fact there are buyers active in the U.S. housing market after a 6 year hiatus. This is consistent with what I am seeing on the ground. Inventory YTD in the U.S. is up a greater than seasonal 25%, Please see here for an analysis of this latest Realtor.com data.
The sharp rate of house price appreciation especially that was seen in certain cities over the last 12 months (for example Phoenix and Las Vegas saw over 20% price inflation YoY as reported in the latest Case-Shiller) will moderate. This will be driven by the supply side and pent up sellers listing their homes and not demand being quashed by rates.
Inventory in the U.S. as measured in terms of Inventory Months / Sales has rebounded from a low of 4.4 months in Q1 to 5.3 months in April. I expect it to go higher in May to 5.5 months. Six months is considered a balanced market with a ratio below 6 months being considered a sellers' market, and a ratio above 6 months being considered a buyers' market.
There will then be huge mis-identification by speculators that the slowing rate of house price appreciation is being caused by higher mortgage rates crimping the U.S. housing market recovery. This will lead to further selling of housing-related stocks.
This will then provide a significant opportunity to buy into U.S. housing plays on this further pullback given the strong fundamentals of the U.S. housing market. The cycle still has a long way to run in terms of housing construction and house price appreciation potential.
Credit is still very tight for buyers of U.S. housing. However I believe we are on the cusp of a credit creation cycle in the U.S. as we move into 2014. Rising collateral values will spur credit creation.
Volume plays on U.S. housing will benefit from growing inventory as since demand has leaped in the last 12 months, it is the supply side's lack of inventory that has kept total single family homes sales in the 5 million range forecast. More inventory will enable more transactions to occur increasing the volume of transactions in the U.S. housing market.
There are obviously risks with this of trying to over finesse a long-run cyclical fundamental trade. For example mortgage rates might pull back near term. However I think investors will get an even better opportunity in coming months to buy into their favorite housing-related stocks.
Additional disclosure: I am deeply involved in the U.S. housing space running a partnership that invests in single family houses in the South East of the U.S. Having spent 13 years in finance working in Equities, am seeing opportunities to relate what I am seeing on the ground with the wider macro data points I read about.