Why Invest In U.S. Housing?

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 |  Includes: AGNC, ITB, MBB, NRF, TREX
by: Real Estater

Summary

Housing continues to improve so far in 2014.

Rate increases are unlikely until 2015.

Mild rate increase should not impede housing growth.

The housing environment in the U.S. continues to improve. U.S. Housing starts for May 2014 stood at 1,001,000, comprising single-family starts of 625,000 and multi-family starts of 376,000. These figures demonstrate a decline of 7% compared to data from April 2014 and an increase of 9% compared to data from May 2013. Annual U.S. housing starts were 925,000 in 2013, an 18.4% increase over 781,000 in 2012. Although severe weather conditions in Q1 have caused housing data to appear weaker than expected, the housing market has improved. In fact, May was among the top five months in housing starts since 2008. Thus, I believe that a growth rate of 18-20% over 2014 figures will hold for 2014, so I would forecast housing starts for 2014 to be around 1,100,000.

I believe that the U.S. housing market is building new homes at a lower rate than the long-term run rate. Further rate rise are unlikely until 2015, with treasuries and bunds rallying, and current mortgage rates are very low compared to historical mortgage rates during peak housing starts, as shown in the following table.

Peak Housing Starts vs. Mortgage Rates

Peak Housing Year

Housing Starts ('000s)

Mortgage Rates

Affordability Index

1972

2,357

7.38

N/A

1973

2,045

8.04

N/A

1977

1,987

8.84

N/A

1978

2,020

9.63

N/A

1979

1,745

11.19

N/A

1985

1,742

12.42

93.2

1986

1,805

10.18

103.8

1987

1,621

10.2

109.5

2004

1,956

5.84

125.8

2005

2,068

5.86

113.7

2006

1,801

6.41

107.7

2012

781

3.66

196.5

2013

925

3.98

175.8

Source: NAHB

Click to enlarge

Although mortgage rates rose strongly from May to September last year, the rate of increase has subsided significantly. Currently 30-year fixed mortgage rates sit at 4.12%, and I do not expect these rates to rise above 5% this year. With China export growth disappointing and the European banking system experiencing stress, US treasuries and German Bunds have rallied, sending rates lower.

Even if the rates do increase, I believe that income growth should offset the effect of increased monthly payments from a potential rise in mortgage. Currently, the mortgage affordability index sits well above the long-term average. According to the NAHB, the median price for an existing home stands at around $200,000. Assuming a 30-year fixed rate mortgage with 20% down payment, the monthly mortgage payment sensitivity vs. interest rates can be seen in the table below. Thus, an increase in mortgage rates from 4.5% to 6.0%, would result in an annual increase of $1692 in payments. This increase in payment required could be offset by a 2.64% increase in median household income, which stands at around $64,000, according to census data.

Mortgage Payment Sensitivity Table

Interest Rates

Monthly Mortgage Payment

3.5%

$714

4.0%

$757

4.5%

$802

5.0%

$848

5.5%

$895

6.0%

$943

Source: NAHB

Click to enlarge

Overall, I believe U.S. housing should continue to improve despite concerns surrounding rate increases. There are multiple ways to play the rise in housing, including MBS, Mortgage REITS, Equity REITS, and home construction companies.

iShares Barclays MBS Bond ETF (NYSEARCA:MBB) sits on the low risk end of the spectrum. MBS payments are guaranteed by Fannie, Freddie, and Ginnie, so prepayment risk is the main concern.

iShares FTSE NAREIT Mortgage Plus Capped Fund (NYSEARCA:REM) tracks an index that is composed of REITs, which lend directly to real estate owners or purchase MBS. Risk is higher, but yield is also higher. Holdings include American Capital Agency Corp. (NASDAQ:AGNC) and Northstar Realty Finance Corp. (NYSE:NRF).

iShares FTSE NAREIT Residential Plus Capped Fund (NYSEARCA:REZ) tracks an index that consists of Equity REITs. The underlying REITs own and operate real estate.

Home construction companies would see the greatest benefit from an increase in housing starts. iShares Dow Jones U.S. Home Construction Index Fund (NYSEARCA:ITB) tracks an index consisting of common stock of real estate development companies. At the high risk end of the spectrum, single stocks within the group include Trex Company (NYSE:TREX), which manufactures building materials for decking and railing, and Masonite International (NYSE:DOOR), which manufactures interior and exterior doors.

Some risks to my thesis include a steep increase in rates leading to higher mortgage payments that outstrip income growth. An increase in rates could also lead to stagnant housing price growth and deter housing starts.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.