Daily Report: Existing Home Sales, Prices And Rates

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Includes: CLAW, HOML, ITB, NAIL, PKB, XHB
by: Andri Capital

Summary

Growing demand for homes signifies continuing upswing in the economy.

Limited supply and higher production costs put upward pressure on prices and may limit homebuilders' earnings potential as demand from would-be first-time buyers stays subdued.

Interest rates are likely to continue rising with higher housing prices - gradually affecting demand and stock returns, while holding back supply growth for existing homes.

Investors should consider REITs, homebuilders and other real-estate companies that can pass on increased costs through higher prices and benefit from growing demand (incl. for rental housing).

Situation Today

Recently we discussed housing prices, the potential impact on inflation and interest rates due to increased homebuilder costs from the recently sharp rise in lumber costs. On Monday April 23, 2018 the National Association of Realtors released new numbers for existing home sales. Those numbers give a good insight into the housing market, general price levels and aggregate growth in the economy.

Existing Home Sales, Prices & Interest Rates

According to the release, existing home sales grew by 1.1% in March - representing 5.6 million homes sold (seasonally adjusted rate). Although this is generally good news and a sign of continuing demand in an otherwise healthy economy there were still noticeable signs that might be indicative of some concerns.

"The unwelcoming news is that while the healthy economy is generating sustained interest in buying a home this spring, sales are lagging year ago levels because supply is woefully low and home prices keep climbing above what some would-be buyers can afford." (Source)

There seems to be a general trend going on in the housing market. The economy is healthy and that drives up demand. However, supply is constrained - it interesting to see how the economy has now clearly grown far out of the oversupply that followed the great recession. This puts upward pressure on prices (in line with our previous discussion on housing prices). In fact, existing-home prices have risen by 5.8% year over year since March 2017, which significantly exceeds overall inflation.

"Although the strong job market and recent tax cuts are boosting the incomes of many households, speedy price growth is squeezing overall affordability in several markets." (Source)

The demand for housing coupled with hampered supply growth (due to high production costs) causes excess demand and higher prices. Supply is not only limited due to lack of new-home supply (stemming from higher production costs) but owners of existing homes may be hesitant to seek new homes as mortgage rates are rising (limited supply of new housing also limits the availabilities and potential growth in supply of existing homes).

The rising production costs for new homes makes it more attractive for homebuilders to focus on higher-priced homes, also leaving less supply available for first-time buyers in the lower-priced bracket. Without increased supply of more affordable housing we are more likely to see would-be first-time buyers resort to renting (thereby allowing the continued growth of the "Airbnb economy").

Lastly, as interest rates are edging higher so are mortgage rates. This dampens demand. But while there is still a growing demand that is not fully met by increased supply, prices are likely to continue rising with corresponding impact on interest rates.

Conclusion

Overall, the growth in existing home sales is a sign of the economy's continued upswing. Although this is a good thing it is worth for investors to also consider the following:

  • Inflation: Excess demand and increased production costs in the housing market drive up prices. Although strong demand benefits real estate companies the high production costs may be detrimental to homebuilder earnings (especially for those that are not able to fully pass on the increase in costs through higher prices). Less demand from would-be first-time buyers also limits the earnings potential.
  • Interest rates: Higher interest rates cause mortgage rates to rise, which may dampen demand and limit any growth in supply of existing homes. As a result, earnings growth may gradually temper while higher interest rates work as a general drag on stock returns. Still, higher interest rates are not a particular concern while demand continues to grow (but rather indicative of economic growth).

Generally, what we are seeing here is descriptive of a growing economy. Growth in aggregate demand, as witnessed through increased sales of existing homes, puts upward pressure on prices and thereby interest rates. Supply is catching up, but not fully due to higher production costs (and mortgage-rate hesitation of existing-home owners). This may pose some inflation risk and limit earnings potential, but also present an opportunity for companies that can take advantage of the situation.

As a result, investors might want to focus on homebuilder stocks that are capable of responding to growing demand by passing on costs through higher prices and serve markets for higher-priced homes, as well as considering certain relevant REIT's and real-estate companies (both ones benefiting from growing demand and rising prices, and/or increased demand for rental housing).

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.