Global Market Comments
April 18, 2018
Fiat Lux
Special Residential Real Estate Issue
Featured Trade:
(WHY THE HOMEBUILDERS ARE NOT DEAD YET),
(DHI), (TOL), (LEN), (ITB), (KBH)
Posts
Two years ago, there was an open house listed in the San Francisco Chronicle in my neighborhood for $1.8 million. It offered a cavernous 6,000 square feet, five bedrooms, a generous den I could use as a home office, a gourmet kitchen, and a spectacular view of the entire bay area. It was a slow Sunday, so I went to check it out.
The home offered every imaginable upgrade, including a four-car garage, elevator, and beveled glass windows in the 1,000-bottle temperature and humidity controlled wine cellar. Nobody cared. The building was deserted except for a lonely and depressed listing agent. The only visitors had been a handful of other real estate agents.
The seller gave up, pulled the listing, and rented it to a visiting Oracle executive for two years. I heard the agent got so fed up dealing with people in bad moods that she left the industry.
Last weekend, another open house was advertised for the same exact house. I thought I would drop by and see how the market had changed. There was not a parking spot to be found on the street. After quite a hike, I made it to the house, only to be told to wait in line to gain entry. The rooms were as crowded as a Tokyo subway car at rush hour. I briefly lost the kids in the shuffle. And this was at the new listing price of $3.5 million. Yikes!
I asked a younger, slimmer, better looking listing agent if there had been any interest. She answered abruptly that there had been three all-cash offers since the morning. Unless I wanted to pay over the asking price, I shouldn?t waist my time. Double yikes!
The bottom line of this little interchange is that the recovery in the residential real estate market is real, has legs, and will have a major positive impact on the US economy. The implications for the rest of us are huge.
The turnaround came much earlier than many analysts expected, and has proceeded with an amazing ferocity. Demographic data suggest this wasn?t supposed to happen until 2022, when most of the Baby Boomers have retired and a new generation of homebuyers appears. Home mortgages, especially jumbos, are still hard to get. The banks are still laboring under a stock of 5 million foreclosed homes. Some 20% of homeowners are still underwater on their mortgages and are unable to trade up or out.
It appears that the prospect of the end of the ultra low interest regime offsets all of this. The Fed is certainly putting the pedal to the metal, with 3.5% interest rates charged for 30-year mortgages. Everyone knows these are a once a century occurrence, hence the bubble 2.0. Buyers are ducking credit issues by paying all cash for 50% of recent closing. Hedge funds, private equity funds, and other long-term investors are still generating 30% of purchases, as they see this a one great big yield play.
We learned as much yesterday when the January S&P-Case Shiller data was released. It was a blowout report, with the 20-city index showing an eye popping 8.1% YOY gain in prices. This is three-month-old data, and February and March are expected to be stronger still.
The basket cases of yesterday are delivering the headiest gains, with Phoenix up +23.2%, San Francisco, +17.5%, and Las Vegas, +15.3%. The foreclosure capital of the United States only a year ago, Atlanta, showed a robust +13.4% improvement.
The residential real estate market is not without its shortcomings. First time homebuyers have been conspicuously absent, accounting for only 30% of new deals, instead of 60% during the last cycle. They are, no doubt, being shut out by credit issues. What will happen to the millions of homes that institutions bought, once their have substantial capital gains? My bet is that they sell to realize profits, capping further appreciation.
The snapback in new construction has been even more dramatic. Monthly new housing starts have soared from the low 300,000?s to 800,000 in the last three years, a jump of 167%. That?s still a fraction of the 2.2 million peak we saw in 2006. Surviving homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) so dramatically shrank their cost basis during the dark days that they are unable to meet current demand.
The obvious benefit for the rest of us is the addition of 50-75 basis points to the US GDP growth rate this year. We?ll get a better read with a future GDP announcement, which could bring in a preliminary Q1 number as high as 3%. That will most likely take us to the Fed?s target of a headline unemployment rate of 6.5% sooner than later.
There is a greater advantage for we stock investors. Some two thirds of the home equity lost since the 2008 crash has been recovered. The total value of the US housing stock has bounced back from $10 trillion to $17 trillion. That creates a huge ?wealth effect? that steers more individual investors back into risk assets generally, and shares specifically. Should anyone be surprised that the Dow average is grinding to new all time highs every other day?
Not a day goes by when you don?t hear of shortages of workers in the building trades, such carpenters and plumbers. As a result, the shares of this sector have been the best market performers over the past 18 months, with some issues rising sevenfold. Whatever you do, don?t rush out and buy these stocks. They have run too far, too fast, and the risk/reward is terrible here. You missed it. I missed it.
Better just to bask in the glow of a home that it rising in value daily, and a retirement portfolio that is doing the same.
What Am I Bid?
Before you place a down payment on that next home, consider that you are voluntarily becoming dependent on government welfare, reliant on massive subsidies, and may become the next ward of the state.
Don?t kid yourself that the housing market has become anything but another bubble driven by artificially low interest rates and lax lending standards. Without the wholesale privatization of profits and socialization of losses, the current ebullient real estate market would instantly cease to exist. That cruel ending may be a lot closer than you think, as well.
Some 95% of all home mortgages are now bought by the US home mortgage agencies, Fannie Mae and Freddie Mac. That is up from only 35% in 2006. Never mind that both of these institutions are in conservatorship, which is a polite way of saying they are bankrupt, having burned through all of their capital during the housing bust.
Without this source of government funds, there is absolutely no way banks would be lending anywhere near the amount they are, as the spreads have become too minuscule to make it worthwhile. But by selling loans to the government they can offload their risk and skim off handsome fees along the way.
This is why the balance sheet of the Federal Reserve has grown to a mind boggling $3.8 trillion, on its way to $5 trillion, but we are measuring no real growth in the money supply. The money is simply moving from one government account to another, untouched by human hands.
The current pattern of modest appreciation in the most oversold markets, like Miami, Phoenix, and Las Vegas, will continue, as long as the Fed is giving us money for free and the government is bearing all the credit risk. When that ends, things could turn very ugly, very fast.
Most of my hedge fund friends expect ten-year Treasury yields to be back above 4% in two years. That would take the rates for the conventional 30-year fixed rate home loans from 3.50% to 6%, or more. Double the cost of carry on a house, and you halve the affordability. The effects on the secondary market would be devastating.
While many have nice paper profits on houses they bought over the last two years, that all becomes very academic if you can?t sell. The number of homeowners currently delinquent or in foreclosure would soar from the current 6 million to 16 million. That would be piled on top of the 30 million hapless homeowners, who, despite the bounce, are still underwater on their mortgages.
This is not some wild conspiracy theory that I picked up on the Internet. Since congress is in a cost cutting mood, the chances of Fannie Mae and Freddie Mac getting sufficient recapitalization are small. The home mortgage tax deduction is also on the chopping block. At the very least, we can expect it to get pared back to mortgages of $500,000 or less. That would seriously boost the real after tax cost of homeownership, especially on the high priced left and right coasts.
Of course, the good times will continue as long as the Fed is spiking the punchbowl. Buyers are strongly motivated by existing home prices that are half of the new cost of construction, as well as a fraction of 2006 peak prices. As my friends say in New Orleans, where great deals are still to be had, ?Laissez les bons temps rouler? (let the good times roll).
Current guidance says they will maintain ultra low interest rates until the unemployment rate falls below 6.5%, down from the present 7.8%, which we could see in two years. Those driven more by demographic data, like me, don?t see such a turnaround for five more years.
I am not seeing another crash here. A more likely scenario is that we continue to bounce along a bottom for several more years. Tell me how bullish prospective homebuyers will be after we see a 2,000-point plunge in the Dow, which could come as early as this summer.
What this does illustrate is how grotesquely expensive the homebuilding stocks have become, like Lennar (LEN), Pulte Home (PHM), and KB Homes (KB). These stocks are up as much as 700% in 18 months. This entire piece is in response to a question I got yesterday, Should I be buying the homebuilders here. My answer is a full throated ?NO!?
The only bull market you can really count on is the one for rents, which will accelerate, once the long term decline in homeownership resumes.
As we continue flirting with a final top in equities for the year, I am stepping up my search for the best ways to participate on the downside. At the very top of the list are the homebuilders, one of the top performing sectors since the October, 2011 bottom. The performance of individual names has been absolutely blistering, with Pulte Homes (PHM) clocking a 245% move to the upside, beating the (SPX) by 210%.
You do not need to engage in any sophisticated financial analysis to see how expensive this group is. Spend a day visiting open houses put on by the big companies, like Pulte Homes (PHM), KB Homes (KBH), Ryland Group (RYL), Toll Brothers (TOL), and Lennar (LEN), as I did yesterday. Then scan the real estate pages of your hometown newspaper with a calculator in hand. You will quickly find that new homes are selling for double the cost of existing homes on a dollar per square foot basis.
This is a lot to pay for that black granite kitchen counter, built in vacuum system, flashy gas barbeque in the back yard, and solar panels on the roof. You may also notice that the homes are shoehorned so tightly on to their plots that you will become too familiar with the intimate details of the lives of your prospective neighbors. In fact, new homes are trading at the biggest premium over used in history.
I am loathe to bet against those lucky ones selling to the 1%, or anyone who earns close to them, whose wealth and spending power are expanding exponentially as I write this. That knocks out Lennar (LEN) and Toll Brothers (TOL). I am very happy to short stocks of companies saddled with selling on an increasingly impoverished 99%.
That trains my sites over to Pulte Homes (PHM) and KB Homes (KBH), the old Kaufman & Broad. (KBH) has already fallen 38% off of a poor earnings report. At least Eli Broad had the decency to give away most of his money after selling out at the market top. The Los Angeles art world is all the richer for it. That leaves Pulte (PHM) as the next overripe piece of fruit to fall.
I know that many of you have been getting calls from real estate brokers insisting that the bottom is in and prices are on their way up. I get the same calls from stock brokers too. Here are the reasons for you to let those calls go straight to voicemail.
There is still a huge demographic headwind, as 80 million baby boomers
try to sell houses to 65 million Gen Xer?s, who earn half as much money. Don?t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%.
Fannie Mae and Freddie Mac, which supply 95% of all the home mortgages in the US, are still in receivership, and are in desperate need of $100 billion in new capital each. Good luck getting that out of Washington, which is likely to be gridlocked for at least another five years, and maybe more.
The home mortgage deduction is a big target in any revamp of the tax system, which would immediately yield $250 billion in new revenues for the government. How do you think that will impact home process?
There are undeniable signs of life in best prime markets, where the pent up demand can be substantial. Here in the San Francisco Bay area you are seeing bidding wars for anything that is commuting distance from Apple, Google, and Facebook, or the rest of the booming tech world. Real estate is more local now than it ever has been.
The best case scenario for home prices is that we continue bumping along a bottom for as long as ten more years, when the demographic picture shifts from a huge headwind to a major tailwind. The worst case is that this is just another bear market rally and that we have another 20% on the downside.
Show me the Rally
Yes, But Does It Have Solar?