Housing Could Bottom Sooner Than You Think
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If you took a snapshot of the current housing market, you would find
little reason for cheer. A flood of "for sale" signs blight many a
front yard in neighborhoods all across America, and buyers looking for
foreclosed properties seem to be the only visible signs of support.
Also, as Jim Cramer recently noted, it is not helpful that
homebuilders keep adding to supply.
Nevertheless, the total supply of unsold homes is steadily dropping.
As Tony Crescenzi points out, the rate of new household formation
handily exceeds the amount of genuinely new homes on the market. (Some
construction is the result of tear-downs or storm-damaged
properties.)
Importantly, a number of indicators suggest that the worst of the
housing slump may have passed. For starters, the steady drop in home
prices is beginning to moderate. Home prices had been slumping 2%
sequentially for a good portion of 2007, but those drops are now in
the 0.50% to 1.00% range. While home prices may fall a bit more over
the next few months, they may finally flatten later this winter.
In addition, mortgage rates are on the decline. After hitting 6.63%
last July, the average 30-year mortgage has fallen to around 6%, and
rates could head yet lower: 10-year T-bill yields have plunged to
around 3.15% (at the time of this writing), which implies that 30-year
mortgage rates could fall toward the 5% mark.
More telling is the historical relationship between owning and renting
a home. From 1975 to 2000, that ratio was fairly constant, but in
recent years, it has been far cheaper to rent than buy a home in many
markets, as home prices shot up and rental costs rose only modestly.
Now, the stunning drop in home prices has pricked a hole that bubble.
As recently as 18 months ago, the cost of owning was far above
historical trends (more than 20%) in 16 out of the 20 cities surveyed
by Case-Shiller. Now, only four out of the 20 markets surveyed show a
20%-plus gap. In the other 16 markets, the cost to own has reverted
back toward the historical mean and, in some cases, is even below the
cost of renting.
So many people insist that there are no buyers out there ready to
pounce, but that's not the problem. There are plenty of potential
homeowners waiting in the wings, most of whom simply want to see some
stabilization in housing prices. When sentiment turns among these
folks, the housing market will show real signs of life. We do not need
to wait for the glut of unsold homes to fall to zero; we just need
buyers' confidence to return.
To be sure, rising unemployment does not instill confidence, and this
thesis may not play out until unemployment appears to have peaked,
which may not happen until later in 2009. Before then, however, the
combination of low mortgage rates and a continuing increase in the
economic merit of owning vs. renting is bound to start bringing some
buyers back into the housing market.
Of course, the latest read on existing home sales wasn't exactly
encouraging, and that's likely to be the case for the next couple of
months. That being said, investors should closely scrutinize
subsequent readings for clues that this ultra-important segment of the
economy begins to show signs of getting off the mat.
Following the old saying "it's always darkest before the dawn," sector
share prices have been hitting new lows. The S&P Homebuilders Index
hit new lows last week after having fallen more than 75% in the past
three years. Many of the stocks in the index are selling not far above
tangible book value at this point. For example, Pulte Homes sports a
market value of about $2.2 billion yet has tangible book value in
excess of $3 billion.
The question for many investors is whether that book value will erode
further. That may happen if real estate carried on the books needs to
get written down even further, which, again, relies on home prices
finding a bottom. As a result, a floor in home prices may bring this
sector back into the spotlight in the context of impressive price-to-
book-value ratios.
Net-net: While many think that the housing bottom is several years
away, it could come within the next two to three quarters.
N.Sukumar
Research Analyst
www.kences1.blogspot.com
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