Poor Start for US Real Estate

With the poor housing market performance so far in 2010, the next few months will be critical in defining whether 2010 ultimately marks the beginning of recovery in the real estate market. With the Federal Reserve ending its mortgage backed securities purchase program, and interest rates expected to increase later this year, the real estate market could be in for a rough ride for the remainder of 2010. See the following article from The Street for more on this.

Two months ago I concluded in an article on how the housing market has a way to go that there were some signs of hope for 2010.

This article will look at the data so far in 2010 which, for January and February, have seen major disappointments for housing markets. If this does not change in the next two months, 2010 may be worse than 2009. That is not what many have been expecting.

Collapse of the Housing Bubble of 2009

Sales volumes have collapsed from highs reached in 2009. While existing home sales remain above the lowest points of early 2009, new home sales have reached new lows. The recent data can been seen in the chart on the next page. This is not like the housing bubble that peaked in 2006, but it certainly looks like a micro bubble.

The chart includes these negative features: Quadratic trend lines are cupped downward; new home sales have been below the three-month moving average since July; and existing home sales have been below the three-month moving average since December.

home  sales  graph

The box drawn for March and April indicates the time frame that will set the tenor for the rest of 2010. The reasons for this assertion are:

  • These two months are the final two months for purchase contracts to be signed for purchase of homes with eligibility for extended federal tax credits.
  • These are the months where recovery will occur from any effects of severe winter weather.
  • This comes as the Fed ends purchase of MBS (mortgage backed securities) in support of the housing market.
  • The expectation of higher future interest rates should move demand forward into these months from later in the year.

If there is not a turn of sales volume to the upside in March and April, I see a disappointing year for home sales, perhaps well below 2009.

housin   graph

Two months ago we speculated that home price trends might be turning up. The chart that gave us that thought was the previous version of the chart above. The latest data is more consistent with the long-term trend in pricing flattening, rather than turning up. Two months ago the quadratic trend line for new home prices was slightly upwardly cupped.

The latest two months have turned the cupping downward, consistent with continuing the downward trend. We may see this type of trend indicator continue to fluctuate. A more pronounced curve down in the next couple of months would be a very discouraging indicator for new home sales in 2010.

As mentioned in the last section, March and April are the two months when the stars should be aligned for improvement in housing. If both prices and sales volumes remain weak over the next two months, the outlook for housing sales and for homebuilders will be bleak for the balance of the year.

home  graph  2

Not much is looking promising for builders, yet analysts’ estimates for the near future are very optimistic. (Analysts’ estimates will be discussed later.) The new home market has been significantly weaker than existing home sales. As long as the supply of foreclosures keeps coming to market, it will be hard for new home sales to make any headway.

I have estimated that there will be between two and three million additional foreclosed and short sale homes on the market this year. Others have estimated a higher number. Two to three million represents 40% to 60% of the current annual sales rate for homes.

Homebuilding stocks have had quite a run in recent months. Over the past nine months, the SPDR S&P Homebuilders(XHB) has risen 55% and just hit a new 52-week high.

If you are looking at individual stocks, such as Toll Brothers(TOL), D.R. Horton(DHI), Hovnavian(HOV), Pulte Homes(PHM), KB Home(KBH)and Lennar(LEN), I would recommend comparing debt loads and cash positions. The tables above list two parameters that reveal some cash and balance sheet metrics of these six builders.

The first column in the first table gives the inventory value divided by the debt for each company. A healthy balance sheet for a builder should have inventory significantly larger than debt. The second data column can be considered to be the net cash position of the company. Values close to zero are problematic and less than zero indicate money problems may be imminent. Low cash to debt ratio is also a red flag. Areas of concern are highlighted in red.

The second table shows the consensus estimates by analysts for sales growth are very ambitious compared to poor sales growth, on average, for the past year. A dramatic change in sales is anticipated.

If things do not improve in the next few months, this may not only be crunch time for the housing market, but also for some homebuilders. Even if sales improve in March and April, the projections by analysts for the first half of 2010 seem much too optimistic. If March and April disappoint, some homebuilders may be in deep trouble in 2010.

If I were to gamble at this time on any of the six home builders mentioned here, I would pick D.R. Horton, based on balance sheet and cash flow considerations. However, I am not going to gamble. If you do, I wish you good luck.

John B. Lounsbury is a financial planner and investment adviser, providing comprehensive financial planning and investment advisory services to a select group of families on a fee-only basis. He worked for 34 years with IBM, and spent 25 years in R&D management and corporate staff positions. He also was a Series 6, 7, 63 licensed representative with a major insurance company brokerage for nine years.

This article has been republished from The Street. You can also view this article at The Street, an investment news and analysis site.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: