Honing in on Homebuilding Situation

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Includes: ITB, XHB
by: Ilan Babaji

According to a new Standard & Poor´s report, the homebuilding prices at a national scale dropped 1.1% during the last quarter of 2009, with respect to the previous three-month period.

The states that were the most affected by this price fall, which has not found recovery yet, are California, Florida, Nevada, Arizona, Michigan and Georgia.

Subsequently, the Commerce Department reported that new home sales in January fell a record 11.2%, a number not seen since 1963. This drop was a huge surprise, as analysts had predicted a 5% increase.

Moreover, the National Association of Realtors reported that existing housing sales fell 7.2% seasonally annualized in January, as compared to the consensus estimate of a 1.1% increase.

The consequences of these reports are devastating for the real estate market. If an individual has an underwater mortgage, and the price of his building continues to drop, it becomes more and more difficult to sell the property or refinance his loan.

There are many ARMs (option-adjustable rate mortgages) that will be reset during the next months, and many of their holders will be compelled to default on their obligations. Even though the income in American homes is increasing again, over 25% of the owners find themselves in stressful situations (i.e., their home equity is negative), which could generate an evil encouragement to consider it more profitable for people not to pay their debts.

If this happens, the mortgage rates could rise and the result would be really hard on the real state market and the banking sector (mainly, for small banks).

The homebuilding market has not recovered yet, and it is a factor of main importance for the microeconomic analysis of the United States. It must be kept in mind that one of the elements that generated the crisis experienced between 2007 and 2009 was the bubble of home prices. Afterwards, the market was involved in a process of deleveraging much more intense than everyone expected.

There is a balancing value for every asset in every instant; such is the value resulting from the game between demand and supply in that market. Agents within the homebuilding market determined that the buildings’ values were overvalued and, therefore, they managed to redirect prices towards a new balance.

But something slipped through our fingers. The homebuilding market represents a great percentage of the domestic income of every country.

For the past 15 years, the United States, Spain, Ireland, Greece, Portugal, Italy and Iceland, among others, have experienced firsthand what happens when buildings’ prices rise very rapidly and also what happens when they fall at a quick rate.

Currently, we are facing a scene where global-level assets are consolidating their recovery. But there are other assets that still have not shown any signs of life after the collapse. As it happens, that is the case of the asset that experienced a bubble during the last years: real estate.

Nowadays we meet possible hopes and a rather promising signal: the possibility that the fall in property prices completely halt (and there is no resurgence), and that the bottom reached is the preface of a recovery in its values.

“Towards a new balancing level?” I wonder. Will it be towards a path of lower volatility, now that the prices no longer undergo intense deflation and inflation at a global level? Or will this situation occur only for a brief period of time, and then shake again and head towards the ends of the Gaussian bell, in order to show us the meaning of volatility?

Generally, there is scepticism within the market, particularly after a crisis such as the one experienced. It is scepticism about the veracity of the recovery and about its extent.

There is scepticism, cynicism and upsets regarding the markets, the economic progress and the policies conducted by the policy-makers.

In the present, the market knows that it has been rallying for a year and the uncertainty about the future is latent. But the building market is still fragile, it shows no signs of life, and if it does, they are quite negative.

Upward markets are built on pessimism and uncertainty, whereas downward markets arise from low uncertainty and high assumed risk.

Currently, the building market is characterized by uncertainty, fragility and a rather interesting invitation for the most risky investors.

Disclosure: No positions