Is Now The Time To Short Housing?

Oct.26.11 | About: SPDR Homebuilders (XHB)

Case Shiller Home price data came out Tuesday morning and showed a 3.8% year-on-year drop for the 20 city home price index. Housing has been one of the critical parts of the economy which has lagged in the recovery and several attempts to support this sector have met with limited success (HARP, first time home buyers credit, Operation Twist – with an aim to lower long term mortgage rates etc.). Several analysts claim that housing is already in a double dip mode, which doesn’t augur too well for the economy. In the graph below we see that Case Shiller composite index is still bouncing around the lows from early 2009 and is down more than 30% from its peak reached in 2006.

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The latest attempt to revive the housing sector comes from Senator Charles Schumer who is preparing to introduce a controversial bill which will give residence visas to foreigners who spend at least $500,000 to buy houses in the U.S. I am sure we will see a lot of heated debates around this topic.

A recent WSJ article has some details on the bill:

The reeling housing market has come to this: To shore it up, two Senators are preparing to introduce a bipartisan bill Thursday that would give residence visas to foreigners who spend at least $500,000 to buy houses in the U.S. The provision is part of a larger package of immigration measures, co-authored by Sens. Charles Schumer (D., N.Y.) and Mike Lee (R., Utah), designed to spur more foreign investment in the U.S.

International buyers accounted for around $82 billion in U.S. residential real-estate sales for the year ending in March, up from $66 billion during the previous year period, according to data from the National Association of Realtors. Foreign buyers accounted for at least 5.5% of all home sales in Miami and 4.3% of Phoenix home sales during the month of July, according to MDA DataQuick.

International buyers accounted for around $82 billion in U.S. residential real-estate sales for the year ending in March, up from $66 billion during the previous year period, according to data from the National Association of Realtors. Foreign buyers accounted for at least 5.5% of all home sales in Miami and 4.3% of Phoenix home sales during the month of July, according to MDA DataQuick.

To understand the implications of the bill, we need to look at some important macro indicators on the housing market. As shown in the first graph in this article, looking at the Case Shiller home price index, it is fairly obvious that housing is facing a slowdown again.

Looking at the home ownership rate in the graph below we see that the rate has come down from an all time high of 69%. The rate could still have some room to the downside as the rate was mostly between 64-65% in the 1970s and 80s. A drop in this rate does not bode well for the already beaten down housing sector.

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Looking at the chart below, we see that U.S. home foreclosure filings have definitely fallen from a peak of 350K filings a month to about 215K filings a month. This is a positive sign, but as we see in the following graphs there are still some dangerous signs under the surface:

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As can be seen in the graph below, according to the U.S. Census, a significant amount of U.S. housing inventory is held off the market. This shadow inventory supposedly stands at 7.2 million houses, which is a dangerously high number and shows structural weakness in the housing market.

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The critical problem for housing is not affordability but eligibility. The following graph shows the U.S. Home Mortgage 30 Year Fixed National Average Rate, which hit a 60 year low couple of days back.

  • Recently, the National Association of Realtors said lending standards are too tight and are hurting the housing industry's recovery.
  • Through June, single-family home loans bought by government-backed Freddie Mac (OTCQB:FMCC), for example, had an average down payment of 29% and an average FICO credit score of 751, the agency said. That's up from average down payments of 23% for loans originated in 2007 and average FICO scores of 707, according to Freddie Mac.
  • FICO scores top out at 850. The national median is 711, according to FICO.

The housing sector has continued to drag despite mortgage rates being close to an all time low as shown in the graph below: (Click to enlarge)

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The U.S. Home affordability index is at an all time high. However, it hides the fact the “eligibility” is the critical link which is unable to kick start a housing recovery

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Going back to the proposed bill here are the pros and cons I see in the initiative:

Pros:

  1. If implemented with appropriate screening, this bill could definitely lend support to the flagging housing sector, which could in turn have a significant positive effect on the economy

  2. According to an article in Bloomberg, Brazilians have been buying Miami condos at bargain prices as real gains 45%. Foreign demand is already there, and this bill could galvanize investors on the sidelines to take the jump and invest in U.S. real estate.

  3. This bill would attract wealthy individuals who would look to either lead a peaceful retired life in the U.S. or try and invest their money in other U.S. ventures for which they would have to switch to the appropriate visa status.

Cons:

  1. A system of lax scrutiny could become a major security threat for the country, inviting all sorts of dangerous individuals into the country

  2. If people use this visa system as a step to get a work visa, then one could see some jobs being taken up by immigrants. This increased job competition could prove to be detrimental for the labor situation

In conclusion it is important to come up with innovative ways to revive the U.S. housing market and such policies should make for a good debate. However the housing market fundamentals still look dreary and hence one should be very careful in gaining exposure in housing related stocks.

XHB, the homebuilders ETF, has run up significantly over the last couple of weeks in anticipation of a euro bailout. However, fundamentals underlying the U.S. housing sector still do not look great. Hence, XHB looks like a good short here. One could play the short outright or against the S&P (beta adjusting the exposure).

*Charts courtesy of Bloomberg

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