Housing Prices Rise in Response to Reduced Supply, Higher Employment

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 |  Includes: RKH, XHB, XLF
by: Lee Adler

No, this is not an April Fool's joke. In a surprising turn of events, listing prices rose sharply in March.

Listing Prices Rose in March- Click to enlarge

It could be a case of hope springs eternal, but may also be a result of less foreclosure inventory on the market and a strong gain in total employment in March.

The reduction in supply is largely due to the legal foreclosure problems the banks are having now for screwing the mortgage pooch in the first place, but the shadow inventory is still out there. The clock is ticking. The question is whether the lenders will be able to clear up the legal issues faster than the properties become functionally obsolete due to neglect or vandalism. Total obsolescence occurs when the repair costs and legal costs are greater than what can be recovered in a sale. Bad for the lender and the financial system in the short run, but good for the market in the long run.

Housing demand correlates directly with employment, and the economy gained around 900,000 jobs in March. March is a seasonally strong month, but this month’s gains were a little better than the typical March gain over the past dozen years. That may have contributed to the bump up in pricing. The question is whether the employment trend has really reversed, or we are seeing the rigor mortis rally of a bunch of dying government and Fed stimulus programs.

Meanwhile, all the other price indexes are declining. That’s because they are all impacted, by varying degrees, by reporting and methodological lag. Case Shiller is the Alpo of housing market indicators; it just has that horribly stale smell all the time. Its current reading effectively represents pricing conditions as of mid- to late-October. Other measures like the NAR’s median sales price and the FHFA index, as well as the Commerce Department’s new home sales survey; all show prices hitting new lows.

This isn’t the first month that sales price measures have hit new lows, either. FHFA’s index began making new lows last September. Pundits worrying about a double dip have been looking at the wrong data, and missed the boat. The market is in the same downtrend it has been in all along. Measures of listing prices trended down throughout 2009-2011, with a pause of a just a few months in 2010. If there had been a bounce from which to double dip, I think that sellers would have noticed.

Only because of the weird methodology used in the Case Shiller index did it show any recovery trend in prices. That’s because it excluded the distress sales that have been so much of the market, and because of its policy of using three months of data at a time instead of just the most recent available month.

It also fails, and so do all the others, partly because it did not take into account the false price reports resulting from the two homebuyers’ tax credits. Aside from the fact that the credits distorted the market by pulling demand from the future, and induced people to buy who may never have otherwise been in the market, the buyers did not pay what the sales prices reflected. That so-called recovery from which the market is “double dipping” was all smoke, mirrors, and Alpo.

Measures of sales volume remain extraordinarily weak. The most recent available data is the weekly data on mortgage applications. That’s real time. It just keeps bumping along the lows. Another recent measure is for new home sales in early March. It and the most credible existing home sales data, in other words anything not published by the National Association of Rattlers, shows sales at new lows in February and early March. That means that even though inventory is coming down, entirely attributable to a decline in the eastern 2/3 of the U.S., supply is still a problem because inventory to sales ratios remain too high. Furthermore, supply is on the upswing again in the West.

A significant percentage of new sales are cash deals. The NAR reported that a record 33% of sales in February were all cash. Thus the mortgage applications index is likely understating the actual level of sales. But if cash buyers, particularly bulk buyers, are mostly investors and speculators as the NAR reports, then this is “activity without absorption.” Not only does it not solve the problem, it perpetuates it because it does little to remove inventory and it puts some inventory back on the market at a lower basis. Can you say “flipper"?

In the case of bulk condo sales, they are either being converted to rentals or are being put back on the market at enormous discounts to their former asking prices. That is bad news for all the rental apartment market bulls out there. I am also seeing new condos here in South Florida being advertised for sale at prices 65-75% below their initial asking prices of a couple of years ago. Stuff that was selling for $500,000 is being offered now for $150k. Whaddya say we go out and catch some falling knives? Meanwhile, homebuilders can't compete with these discounts.

This is less of an issue with single family sales, where a relatively small percentage would be converted to rentals. To the extent that happens, it could help to begin to put a floor under sale prices by removing sale inventory. Ultimately, however, an increase in prices will depend on an increase in owner occupant demand. That will only happen when more people have good stable jobs, and when prices stabilize for a significant period. As long as millions of homeowners are under water on their mortgages, there will be motivation to walk away. As long as prices are falling, many would be buyers will remain out of the market.

Overall, the data is a mixed bag, not quite as bad as the now overwhelming consensus that housing will remain in the toilet indefinitely, but not really much to get excited about. 26 pages of supporting charts, data, and extended analysis are available for those who wish to dig deeper.

Homebuilders like Standard Pacific (SPF), DR Horton (NYSE:DHI) and Toll Brothers (NYSE:TOL) may be getting a break in the short run, as the flow of foreclosure supply is reduced. But they will continue to have their hands full trying to compete with the massive supply of foreclosed properties likely to continue coming to the market at deeply discounted prices.

The size and durability of the seasonal uptick in employment in the first half will have a lot to say about whether any uptick in demand can be sustained. Once Federal stimulus spending and the Fed's QE2 money pumping comes to an end over the next couple of months, the market will have renewed problems. The homebuilder stocks are at best dead money, and more likely, dead companies soon enough. They should continue to be avoided. Forget about XHB. It has few home building components and is mostly a retail, appliance, and home furnishings ETF.

Shadow inventory will play a big role. But because of the difficulty banks are having getting control of delinquent mortgages and the properties, this may be less of a problem for the market and much more of a problem for the banks than the pundits currently grasp. The inability to bring a significant portion of that shadow inventory to market ultimately may be good news for the housing market in the long run but very bad news for the big banks. Citibank (NYSE:C), Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), and Wells Fargo (NYSE:WFC) face enormous losses. The financial ETFs like RKH and XLF may be a way to play this, but the timing will be tricky. The current rally in the market seems a good opportunity to build short positions in the banks as they continue to face pressure from the foreclosure problem and fail to take adequate loss reserves, or even any loss reserves, in recognition of the problem.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.