Are Homebuilders a Buy? 16 comments
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Based on the recent jumps in homebuilder stocks, investors have again become bullish on the sector. After hitting a low of 117.41 during the week of January 11, 2008 the Philadelphia Housing Index ($HGX) has been rallying. It ended the week of April 25 at 144.16 for an impressive 23% gain. This has had the very predictable consequence of prompting pundits to again call a bottom for builders and the housing market in general.
Before deciding whether this conclusion is justified or just another example of brokers and money managers ‘talking their books,’ let’s take a quick look at the data. John Mauldin made an interesting point is his recent newsletter about the difference between sales and starts. A picture is worth a thousand-word explanation so here are the charts which provide a quick situational snapshot.
click to enlarge images
Figure 1 – Chart showing year-over-year change in new home sales. Data – US Census Bureau
Figure 1 shows year-over-year changes in new home sales that could be perceived as suggesting a bottom given that the declines have leveled off. As of March, new homes sales were selling at a rate of 526,000 per year and sales declining at 37% per year.
Figure 2 shows housing permits and housing starts. As of March, permits were being issued at an annual rate of 927,000 and starts at 947,000 per year. As you can see from the chart, permits lead starts by anywhere from one to three months and there is no indication of any sort of bottom in either based on the slope.
Figure 2 – Housing permits (green) and housing starts annualized.
Building like there’s no tomorrow…
What is interesting is that even with the rapid declines in both housing permits and starts, builders still appear to be bullish on the future of their industry. As we see from Figure 3, starts exceed new home sales by more than 400,000 units per year and while the excess has been declining, it has been a slow process that has moved in waves. In October 2006, the excess of supply being created was 518,000 units. It peaked in August 2007 at 646,000 then dropped to 390,000 in December before beginning to surge again hitting 500,000 in February. In March, the excess stood at 421,000. Between October 2006 and March 2008 (the period in Figure 3), the inventory of unsold new homes on the market grew from 249,000 (a 7.1 months supply) to 468,000 units (11 months) in March.
We also learned on Monday that vacancies have surged in the last few months from 1.8 to 2.8% which means that as homes on the market sit, they are not being rented for whatever reason. It has prompted housing analysts with years experience (and no book to sell) to conclude that we are not anywhere near a housing bottom.
Figure 3 – Putting it all together, here is a chart of housing permits (green), housing starts (blue), new home sales (orange) and the difference between housing starts and new home sales (red) which is excess production.
Sales + Inventories + Starts = Bulging Supply = Lower Profits
So is this latest rally justified? This isn’t the first time investors jumped the gun. Look at the last big rally in $HGX (Philadelphia Housing Index) when the index jumped from 187 in July 06 to 257 in February 2007 only to plummet to 117 by the following January.
In a nutshell, as of March 526,000 homes are selling per year, there are 468,000 new homes for sale but in spite of this fact builders continue to add another 947,00 homes per year to that inventory! Adding excess inventory is not a bad idea in a growing market since it provides a buffer between growing supply and current demand. But continuing to provide overproduce is financial suicide in a falling market.
Given the fact that stock price leads fundamentals and that supply will continue to exceed demand for the foreseeable future, I expect this homebuilders rally to be short and have an unpleasant ending as these undeniable realities of the market continue to negatively impact builder’s profits.
Disclosure: None currently
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This article has 16 comments:
The real issue, similar to the Investment banks, is where are the earnings going to be generated. The other issue is the quality of earnings combined with creative accounting that makes finding the real evidence a challenge. And the game goes on...court will be in session and if the defendant is found guilty the court will postpone the punishment phase (could be probation without verdict) until some future date. Of course the defendant can be declared not guilty and the court of public opinion will declare the evidence as tainted. God Bless America.
My wife wants to move to Arizona and we started looking a few months ago. We even took a 4 day weekend and went down there to do 'leg' work research.
My conclusion is that any home you may find is still about 20% overpriced. This includes the recent price drops by the builders in the last 2 weeks.
Right now I could buy a $530k home (early 2007) for $360k and the fundamentals still don't support it for the area.
People are losing their construction jobs, the economy is leveraged on those jobs, the prices doubled and tripled in 5 years time, the average Joe still can't afford a 'family' home, they overbuilt and taxes are increasing to support new planned infrastructure, etc.
Don't get me wrong, you can still find a few areas around Phoenix that are new construction and cheap. Just make sure to walk to your car with your .38 loaded so you don't get mugged. Oh, let's not even mention the rabies outbreak in Florence that they have been battling.
Lastly, even the good areas are being invaded by folks who are financing with 5 people on the mortgage. They think they are taking advantage of good prices but in reality they are helping depreciate the areas.
I'm sure the same is true of Nevada and California.
Buyer beware... Housing will take at least 3 years to stabilize even if the credit crisis is fixed tomorrow.
I bought right before the bubble because I saw the fundamentals shifting. I was renting at the time and it started to be a no-brainer to buy. That was at the end of 2000.
I sold that place in 2005 at the peak. Everyone told me I should rent it out when I move but I did the fundamentals again and said 'no way, it can only go down from here'. I peaked the market in my old neighborhood in MD and it has gone down from there after a brief stagnating of price.
Before that happened, I bought my upgrade house 40 miles away where there was a booming economy but the housing prices had not caught up yet. That was in 2003.
That's just the short history, I won't bore you with the 1990's. I did pretty well in that market also.
So, here is where I'm sitting today.
Doubled my money on the home bought in 2000.
Still up 10% on my current home even with the drop in prices (my neighbors aren't so lucky).
Looking for a home in AZ and you can read my analysis in my previous comment.
When you see home prices stagnate for a good 6 months, that is when the bottom has hit.
Check the local tax office for sales prices and do some leg work. Then relax and don't jump at the first deal. Monitor the area. You will see that the pundits calling for more housing price drops are correct.
Again, wait til you see prices stagnate for at least 6 months before calling a bottom.
Also, don't buy just because of a 'bottom'. Sit around and do the math. Does it make sense to buy a home vs rent.
If it doesn't, then the builders will have a longer flat price on their homes and their stock.
Only when it makes sense to buy a home again will the builders be ready to rally for another 5 years and you'll make money.
'nuf said.
Bottom line, this will take a long time to work itself out.
The housing crisis isn't over until I see the average home price increase nationwide for at least 3 months.
When home start back up, then it's time to get in.
I'll never forget a quote that was attributed to George Soros that could describe successful traders. He said,
“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.”
Traders do not question the reason for a trend, their goal is to catch it as early as possible then beat a hasty retreat before the crowd figures it out...
Matt Blackman
TradeSystemGuru.com
By building twice the supply needed, and adding that on top of the already large supply of new homes sitting vacant, the homebuilders are going to have all the new homes available. Plus, since none of these homes are selling it will actually appear as if the homebuilders are holding out for higher prices based on demand. Before you know it if anyone in this country wants a new house they will have to go to these homebuilders to get a house.
This will give the homebuilders tremendous pricing power. Within several months they will be charging twice what they are charging for new homes now. That is what happens when you corner the market.
Moreover, sales are going to skyrocket. Since there are absolutely no sales now, when ten people buy these new homes at twice the price the homebuilders will announce tremendous profit margins on each sale. This will lead the banks to not only call a bottom but to call a new housing boom starting no later than September.
Now as long as Eddie Murphy and Dan Ackroyd don't show up and start giving us false information we are off to the races.
I beg to differ with your analysis. If there's currently an oversupply of homes for sale, how will building more increase the prices?
I think what's more likely is that median prices will continue to fall, the inventory overhang will persist until 2009 (at least), and builders will be stuck with unsold inventory for the next 18 months, if not longer.
Demand dictates sales volume, supply dictates price. With high supply and slack demand, prices will fall until supply and demand are in balance. And the only thing that will stimulate demand apart from high supply, is lower prices.
So look for lower prices, not higher ones, as supply gets augmented.
drmalaka agrees with you; it's called sarcasm.
He's pointing out what a person needs to believe in order to think the bottom has been set.
His points are ridiculous and fly in the face of reality; just like those that think the worst is over for housing...
Construction work is slow and contractors are bidding lower to get jobs and are taking smaller side jobs.
The price of raw materials is going up and if inflation hits hard, the builders may end up holding on to properties short term but may clean up big if long.
Throughout history, the first number has always been higher than the second.