It has been my view that the last 18 months has been nothing but a proverbial "dead cat" bounce in the housing market in the context of a long-term bear market in housing that started technically when the homebuilder stocks (Dow Jones U.S. Home Construction Index) peaked in July 2005. You can review my thesis and all the data supporting my assertions in my three-part series: Part 1, Part 2 and Part 3.
One of the primary drivers of sales volume and price appreciation has been the big private equity and hedge funds that have assembled multi-billion dollar portfolios of distressed homes that are being converted into rental properties all over the country. This is an investment trend that has only been in place for roughly the last 18 months but, incredibly, many of these "smart money" investment funds are already trying to cash out by selling equity in their rental portfolios. One can only conclude that this investment trend is coming to an abrupt halt as the "smart money" is trying to unload its investments on the greater investing public. In fact, it really reminds me of this same dynamic that occurred at the peak of the Internet bubble in 2000. In other words, the "smart money" is telling us that the housing market is going lower.
American Homes 4 Rent (AMH), the second-largest homes-for-rent company went public last Thursday at $16/share, which was the low end of the $16-$18 "price-talk." It raised $706 million, which was 44% below the initial $1.25 billion amount it wanted to raise per the prospectus it filed with the SEC in June. But not only did it end up cashing out at a significant discount, the stock closed at $15.60 in its first day of trading. IPOs that close at a discount to issue on the first day are considered failures. It is likely that the underwriter group scrambled to call on favors in order to get this deal done and out of syndicate. As of today, the stock continues to languish below its offering price.
Based on the poor performance of this deal, the market is signaling that it is not optimistic about the investment prospects for the housing market. Interestingly, if you go to page 12 of the Prospectus, you'll see that AMH sold $1.2 billion in private placement stock to institutional and individual investors in November 2012, and March 2013, at $15 and $16 per share respectively. The second transaction raised $703 million - those investors are now underwater. Per the Prospectus, these shareholders sold some of their shares in the IPO, although the final Prospectus has not yet been filed so we don't know how many shares were unloaded. This raises the obvious issue of why these "inside" investors are selling shares they just bought four months ago for the same price they paid for them.
The AMH IPO was preceded by two other residential rental REITS. Silver Bay (SBY) went public in December at $18.50 and closed today at $15.84, down 14.3% from its IPO; and American Residential Properties (ARPI) went public in May at $21 and closed today at $17.48, down 16.8% from its IPO price. This poor performance is in the context of the S&P 500 hitting new records, which means investors are clearly taking their capital out of the housing sector.
I think investors in this sector like the AMH investors are bailing based on three key factors that will cause the housing market to break lower. First, as I've outlined in my three-part series linked above, not only are big investors slowing down their investments in homes to rent, but a couple early private fund investors are actually turning around and unloading their portfolios after discovering the rental business is more difficult to manage than expected.
Second, as discussed in this analysis of the for sale and for rent properties by housing market consultant Mark Hanson, there has recently been a large up-tick in MLS single family home listings and, in some of the previously hot markets, a flood of rental property listings. As you can see from this MLS report for Denver Real Estate Listings, since the beginning of June the number of MLS listings for Denver has increased by nearly 31% and the average listing price has declined by 5.5%. Given that the housing market is transitioning into its seasonal slow period, this can be seen as a very bearish development for the housing market, as inventory is starting grow in both rental homes and homes for sale at a time when sellers usually start to pause and wait until early spring, to list their homes.
Third, the fundamentals underlying the sales of new and existing homes are deteriorating quickly. Since peaking in April at $336.8k, the average sales price for a new home has plunged 12.2% in just two months (data avalable through June). It's the second-largest two-month decline on record for new home prices and it occurred during the seasonal peak selling season, when prices should be stable at the very least. In addition, through last Wednesday's Mortgage Banker's Association weekly mortgage applications report, mortgage purchase applications have dropped 13% since their peak earlier this year and the overall mortgage applications index (refi's + purchases) has collapsed to early 2011 levels.
Finally, if you spend some time going through the AMH Prospectus linked above, you'll see that the company does not make money. Given that AMH is reporting that 86% of its portfolio is rented, it's relying on "hockey stick" projections for rental rates, property growth and occupancy. Given the questionable economics underlying this business model, it is pretty easy to understand why the big buy-to-rent operators are looking to cash out. In my view, this is an unequivocal "sell at the top" signal, as these sophisticated operators are looking to monetize their investments before the business models are fully developed and mature.
If you agree with my analysis and view that the housing market has topped and is going to head a lot lower, the best way to play the theme is by shorting XHB (SPDR S&P Homebuilders ETF) or ITB (iShares Dow Jones US Home Construction ETF). I also like long-dated, out of the money puts these two ETFs. My preferred way to the play the short side of the sector is to short individual homebuilders. I'm currently short DR Horton (DHI), but Ryland (RYL), Lennar (LEN), Pulte (PHM) and KB Home (KBH) are also great short-sell prospects.