Homebuilding on an Uptrend?

by: Wall Strategies April 03, 2008 | about stocks: KBH / LEN / XHB    

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In the past few months, homebuilding stocks have made some very optimistic moves upward, and a look at the Dow Jones Index of U.S. Home Builders [$DJUSHB] shows that ever since the beginning of 2008, this industry has been on an uptrend. The most recent data to reach the public eye actually has some mixed signals but in the end we can clearly see a capacity for improvement.

First there was the National Association of Realtors’ [NAR] existing home sales report, which was perhaps the most optimistic of all of the data we have seen. The report actually showed a sequential increase in existing home sales from January to February; something we haven’t seen since July 2007. Annualized sales increased to 5.03 million from 4.89 million.

Though the sales of existing homes (basically used homes) does not directly affect homebuilders’ financial situation, it has a very significant impact on the housing market as a whole. Excess supply in the market is one of the main factors causing home prices to fall, and it is good to know that some progress was made in working through that excess inventory. The inability of customers to sell their old homes has also been a major deterrent to new home sales, so if homeowners are able to get their old properties out the door, this bodes well for the homebuilders. The potential downside to this report is sales are still lingering at a very low level, but one cannot expect sales to all of a sudden jump back to a “normal” rate.

Secondly there was the Census Bureau’s new home sales report. The data certainly took some sting out of the existing sales report’s ensuing rally. Sales fell to an annual rate of 590,000 in February from 601,000 in January, marking a continuation of the fast deterioration we have been witnessing for over a year.

Earnings reports from Lennar (LEN) and KB Home (KBH) were the final pieces of data, and they did not impress. Both performances were typified by very slow sales, as demand was very stubborn. While they lagged in sales, however, they did a good job of shoring up their balance sheets, as both companies continued to streamline operations in an effort to shield themselves from continued losses. As a result, they have both lost some capacity to make sales, while giving themselves more maneuverability in the future.

Lennar made aggressive efforts to sell off excess inventory holdings and proactively write down inventory value in prior months, and this showed through in its most recently completed quarter, as losses were mitigated and the outlook appears optimistic. All in all, the homebuilders intentionally took considerable damage at the end of 2007 in an effort to soften the effect of any future losses.

The good news for us is that the market has not yet seen the full benefit from recent actions taken by the Federal Reserve and Federal Government which should help to improve trends throughout 2008 and into 2009.

Here is a list of significant developments:

1. Peak cycle Federal funds rate of 5.25% in September 2007 has been cut to 3.00%. Theoretically, this should make borrowing between banks easier, and as such it translates into lower mortgage rates. Unfortunately, this has failed to materialize to a large degree thus far given the frozen state of the credit market. Many would-be buyers continue to be on the sideline waiting for more attractive rates, while those looking to transition into fixed rates from adjustable rates mortgage (ARMs) remain frustrated by the lack of movement in rates.

2. White House “Teaser Freezer” plan which was put into action on January 1, 2008, temporarily freezes adjustable mortgage rates for a select group of borrowers who have been deemed at risk of foreclosure, but can be helped with aid. The plan also gives the Federal Housing Administration [FHA] more mobility in allowing consumers to refinance into fixed rate federal loans. These actions should help to stall the upcoming expected wave of foreclosures in 2008. January foreclosures increased to 233,001 from 215,749 in December, which emphasizes the need for help in the mortgage market.

3. Economic stimulus package signed on February 13 raised the maximum loan cap on government sponsored lenders Fannie Mae (FNM) and Freddie Mac (FRE). The companies can now finance loans of up to $729,750, above the previous limit of $417,000. This will provide lower rate mortgages to more homebuyers and provide liquidity to the mortgage market in general as higher priced homes are sold through.

4. Office of Federal Housing Enterprise Oversight [OFHEO] announced that it will lift the caps on Fannie Mae and Freddie Mac’s mortgage investment portfolios. The companies had been limited to $735.0 billion portfolios in the aggregate, but starting March 1, it will be unlimited. This action will further expand Fannie Mae and Freddie Mac’s abilities to provide more affordable loans and give the mortgage market more liquidity. The OFHEO also reduced its 30% capital requirement on the companies to 20%, which will allow them more freedom to expand portfolios.

5. The Federal Reserve said on March 13 that it will make $200 billion worth of treasury bonds available for financial institutions to swap with FHA mortgage backed securities. This will help to add liquidity into the lending market and make mortgages cheaper and more available to homeowners and home buyers.

All in all, as mortgage rates decrease, assisted by interest rate cuts and intervention from Fannie Mae and Freddie Mac, purchasing a home should become a more attractive and feasible proposition for consumers. Furthermore, as home prices continue to fall, consumers will certainly be alerted, and the psychological barrier of fear surrounding poor economic conditions should eventually be offset by perceived lucrative buying opportunities.

What is important to realize about the current housing market situation is that no one particular factor, such as specific government action or sales price discounts, will act as a catalyst to turn around the market. The ultimate goal is for consumers to become comfortable enough to spark a wave of buying due to a convergence of external stimuli. This occurrence is slowly being facilitated by rapidly falling home prices and government aid.

Written by David Urani a Research Analyst for Wall Street Strategies (www.wstreet.com) specializing in the homebuilding, staffing, medical devices, and logistical services industries.

Disclosure: none

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This article has 7 comments:

  •  
    Apr 03 02:04 AM
    there is no fix for housing especially in the states that matter (make up most of nations gdp) such as CA. Remember, 1 year ago and for five years before that, we had hundreds of loan programs where a household income of $85k a year could buy a $1 million home worth zero to 5% down. Actually, no household income was ok on stated, no ratio or no doc programs, which were abundant to 100% interest only with teaser rates.

    Now, with only 30-yr fixed, 15-yr fixed and selective 5/1 product, the same $1 million home requires 20 cash down and a household income of $150 - $175k. Inventories are up 500+%.

    Essentially, we have 95% fewer buyers to buy 5x the number of homes for sale. And that does not include REO inventory. Remember, only 3-5% of homes sell to a 3rd party in foreclosure. The banks buy the rest back and add them to REO.
    Reply | Link to Comment
  •  
    Apr 03 02:14 AM
    1- NAR Existing Home Sales Report...30%+ were bank owned REO which sold. Not a strong report at all.
    2- New Home Sales reported at the time of contract signing and with rates up sharply over the past month or so, and jumbo money over 8%, you will have a much higher fall out rate.
    3- Fannie/Freddie jumbos will not help people to refi out of bad loans. It ill only help someone with a large downpayment who makes alot of money buy a home. That person did not need help in the first place. Plus, AGency jumbo loans will be priced much higher than standard conforming.
    4- OFHEO news will not do much. They won't spend it all at once and they will look to buy distressed AAA closed loan assets to dilute the bad stuff happening with their portfolios.
    5- Mortgage rates should not decrease...we have an inflation problem. Every move the Fed has made since last year when they began has spiked weakened the dollar and spiked mortgage rates. Why would that change. In a perfect world, as rate cuts stimulate economy, Bond yields/mortgage rate rise.

    Go back to the drawing board on your thesis. You are dead wrong.
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  •  
    Apr 03 06:15 AM
    At the end of March 2008 a couple of articles written by Marek Fuchs of TheStree.com pointed out "the dangers of trusting trade association data" the source of which is the National Association of Realtors (NAR) report of existing home sales from January to February. The fact Marek uncovered, was "the past four years February sales were greater than January sales" and the latest increase of just 2.8% certainly is much weaker and doesn't suggest anything close to an uptrend.

    March 18, 2008 marked the sixth consecutive rate reduction by the Fed; the action slashed its fed funds target rate by 3 percentage points to 2.25% since September. In your list of significant developments, item #1, you make reference to the Fed Fund Rate of 3% and that is almost 3 weeks earlier than the current rate, which makes you late to the party.

    I have been looking at homes currently on the market and whether the home is a resale, short sale or bank owned, the firm asking price is no bargain. The money necessary to clean, make repairs and replace items, made those homes I viewed more costly than a new home of the same model.....so much for your item #5 description "perceived lucrative buying opportunities."

    It seems apparent to me that it's business as usual: dupe consumers by distorting, eliminating and lying about the facts to fabricate the existence of an improved and attractive market.

    I agree with Mr Mortgage; "You are dead wrong" and you need to paint another picture.
    Reply | Link to Comment
  •  
    Apr 03 11:22 AM
    And, just to add to what the other commentators have stated, you forgot about credit scores. The banks, in addition, to requiring more money down (e.g., 20%) will not be handing out money to anyone who asks for it (e.g., no doc loans). The banks will require folks to have FICO scores (e.g., 700+). This cuts down the number of buyers -- esp. in a recessionary environment.
    Reply | Link to Comment
  •  
    Apr 03 01:58 PM
    Who the hell believe any numbers coming out of the real estate, bank or insurer industry. How many times can I say this. Sales were up in Feb? So what? Sales were up because they have started foreclosure auctions selling at 70-90% of the current value, not the loan value. And these auctions will not be able to keep up with the new foreclosures coming on line.

    When these guys open their mouths only one of two things comes out: bad news or lies.
    Reply | Link to Comment
  •  
    Apr 03 05:12 PM
    Wow, all this pessimism is music to my ears. I bought into the XHB yesterday, simply because of technical indicators. All this negativity makes me even happier as it means that it has been unpopular investment idea.
    Reply | Link to Comment
  •  
    Apr 03 08:48 PM
    I'm with Tringo! I love all this bad news! When the crowd is talking about all these buyers who can't buy, because of the lending guidelines, down payment requirements, etc., I just love it! First of alll, we're talking about real assets here, houses, places for people to live! Right now, in many markets, a house can be purchased at a deep discount, minimally fixed up, and rented out for an attractive Net cap rate, with the added benefit of knowing without a doubt, that prices will ultimately recover and continue their climb. Add a little bit of leverage (conservative debt), and ROI's for Real Estate Investment will be phenomenal over the next 5 plus years. I can just hear someone thinking, "Gee, doesn't this guy get it, nobody can buy right now! We're in a financing crisis!" Actually, if investors can purchase mortgage backed securities with their "low risk" and low yield returns, then rest assured, investment dollars will find...are finding their way into the real estate market. Nature abhors a vacuum, and the astute will take advantage of the clamor of the down in the mouth herd, and five years from now, new mortgage products will have flowed back into the market, and even the Retail Real Estate market (ie, the families still wanting to buy the homes) will be in full swing. Those who get in now will be winners! Now cynical pessimists, rip me up! Then sell me your properties at a deep discount!!!!
    Reply | Link to Comment
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