Real Estate Recovery Intact

Includes: ITB, PKB, REZ, XHB
by: Markos Kaminis

Many in the popular press and a good number of analysts saw this week’s housing data as either mixed or negative. That had a lot to do with the weak Existing Home Sales Report, but in my view, which is inclusive of that data, the week’s news was purely positive. In fact, I see the real estate recovery intact. Allow me to explain …

The current week offered several housing data points, including the Housing Market Index (home builder sentiment), Housing Starts (new construction), Existing Home Sales, Weekly Mortgage Activity and the FHFA House Price Index. Four of five reports showed improving trends, though each report showed the usual low level of activity on an absolute basis.

Students of securities markets will recall that it is the forward outlook which matters to markets, and so change in trend or the anticipation of it acts as catalyst to start securities higher. My articles this year have called for and reported that change in trend, oftentimes against the tide of overwhelmingly negative real estate market sentiment. That’s the same tide I faced on the way in, when I was forecasting the real estate bubble implosion and financial crisis.

Housing Market Index

Working from first to most controversial: We covered the Housing Market Index independently in an article earlier this week. We reported that homebuilder confidence, which is what is measured by the index, improved. We noted that the gains came solely on prospective hope for the next six months, and we theorized that homebuilders were simply looking forward to the improving real estate market that most economists and trade organizations are openly forecasting for the second half of this year. In the past, we have stated that even while new home activity should lag, the stocks of homebuilders might lead if real estate were to turn toward growth and price recovery, which is what we see through the second half of the year. Certainly, we view the current real estate environment as attractive for home purchase, barring new catastrophic event, which by the way is also not lacking in potential.

Housing Starts

Housing Starts, which measure the beginning of new construction, were reported next and offered what we thought was just delightful news for real estate investors. Housing Starts rose 14.6% in June, to an annual pace of 629K. The rate of Starts in this year’s period also marked an impressive 16.7% increase over the June 2010 pace. We expected some improvement here, given the comparison against the prior year period within which the First-Time Homebuyer Tax Incentive had just become ineffectual. New construction tied to the deal would have had to have begun earlier than June, which was when sales were to have been completed.

More good news arrived in Building Permitting activity, which rose 2.5% over May, to 624K, and stood 6.7% over the prior year period. This offered some evidence that Starts would remain higher than the prior year period in the months ahead as well. Finally, single family home starts (+9.4%) and permits (+0.2%) both rose over May. The single-family structure market is often viewed as the purest metric of the real estate market. Thus, Housing Starts data clearly offered a positive catalyst for real estate and housing stock investment in my view.

Weekly Mortgage Activity

Jumping over the Existing Home Sales data for now, we note that Weekly Mortgage Activity improved dramatically in the period ending July 15. However, the move was due to anomaly in my view. Last week, we theorized that the holiday period was not adequately adjusted for, as seasonal adjustments accounted for the July 4th holiday, but could not perfectly account for the soft business activity that precedes and immediately follows the holiday. That can be seen clearly in the data, as the unadjusted Market Composite Index of mortgage activity gained 43.9%, but still rose 15.5% on an adjusted basis.

We believe we were proven correct this week in our holiday impact theorizing, as both Mortgage Activity and Weekly Jobless Claims moved in counter directions to the prior week, seemingly balancing out the impact from the prior week change. Mortgage activity mysteriously gained robustly over the immediately preceding week despite mortgage rates basically holding steady. Average contracted rates on 30-year and 15-year fixed rate mortgages improved to 4.54% (from 4.55%) and 3.66% (from 3.68%). The Mortgage Bankers Association’s Refinance Index improved 23.1%, while the adjusted Purchase Index, which measures mortgage applications tied to the purchase of a home, declined fractionally. Due to the holiday, we cannot give weight to this weekly data point, but it has been proven that the prior week’s bad news was equally negligible.

FHFA House Price Index

On Thursday, the Federal Housing Finance Agency (FHFA) reported its House Price Index for May. The FHFA reported that American house prices rose 0.4% in May, marking the second consecutive month of price increase. The index benefited from a downgrading of April’s average pricing, making that month’s rise only 0.2%, versus the 0.8% increase initially reported. Thus, the bar was lowered for May, but that doesn’t change the fact that home prices have increased for two months in a row. While prices varied across the nine regions measured, only 2 of those posted price decline in May. This is clearly good news, and supports my case that the bottom in housing has just been established (barring catastrophic event, like S&P downgrading the American sovereign rating).

Existing Home Sales

The only real estate report that offered deterioration in data this week was the Existing Home Sales Report for June. Unfortunately, this was the most important report, based on the vision of the masses. Worse yet, the report was misunderstood, and drove a decline in housing stocks Thursday that countered earlier week strength. However, the drop in the SPDR S&P Homebuilders (NYSEARCA:XHB) was just $0.03 at the day’s close of trading, and the security is higher Thursday. So, clearly the market understood something differently than the popular press once it had a chance to analyze beyond the headline.

Looking at the report in more detail, and thinking about it a bit, leads one to realize the decline is not too weighty to the real estate outlook. The big reason why I say this is because the Existing Home Sales Report measures completed transactions. Thus, its 8.8% shortfall against the prior year count is due to the advantage gained a year ago; June of 2010 marked the final month for completed transactions to qualify for the First-Time Homebuyer Tax Break. Still, that doesn’t explain the month-over-month shortfall of 0.8%.

What does is the same factor that impeded April’s Pending Home Sales, the weather. April of 2011 was the rainiest month on record, and very likely kept home shoppers indoors. May’s Pending Sales showed nice improvement, but those would not likely be reflected in Existing Home Sales until July. June’s sales pace of 4.77 million was also impacted by multi-family structure sales weakness. Single-family home sales ran at about the same pace as in May, about 4.24 million. Existing condominium and co-op sales fell 7.0% from May. Finally, cancellations impacted the figure, and this may be the result of a pending (Oct. 1) unfavorable change to FHA loan limits that some banks may be already implementing. This relative legislation needs to be renewed if Congress really wants real estate recovery.

Housing inventory increased to 9.5 months from 9.1 months in May, but this is impacted by the pace of sales, which was lower in June. It acts as the denominator in the calculation, and so the monthly supply figure is ratcheted up as a result. Good news was discovered within the pricing data, and it coincides with the data seen on a lag from Standard & Poor’s and the FHFA. The median existing single family home price was up 0.6% from a year ago, to roughly $184,600.


In conclusion, when considering that the dip in Pending Home Sales seen in April should have allowed for expectations for the decline in Existing Home Sales seen in June, then the housing data reported this week is absolutely positive. We saw price improvement, new construction growth, better sentiment among homebuilders, mortgage application improvement and we have good reason to expect June’s Existing Home Sales disappointment to prove short-lived. Thus, the data continues to come in supportive of my case for the bottom being already set in real estate. However, I continue to qualify that statement with the risk notation that the environment should deteriorate dramatically if a downgrade should occur to the American sovereign debt rating.

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