With existing homes, it is not the volume of turnover that is important, it is prices. The level of existing home sales is only significant relative to the level of inventories, since that provides a clue as to the future direction of home prices. If there is an excess inventory of existing homes, then it makes very little sense to build a lot of new homes.
It is the building of new houses that generates economic activity. It is not just about the profits of D.R. Horton (DHI). A used house being sold does not generate more sales of any of the building products produced by Berkshire Hathaway (BRK.B) or Masco (MAS). Turnover of used homes does not put carpenters and roofers to work. New homes do.
When new home construction picks up, it could do so in a very big way (at least percentage wise, from the current extremely depressed levels), and the national homebuilders will probably pick up market share as hundreds of small mom and pop shops have gone out of business in this downturn. A doubling in new home construction would still put the level of construction at historically very low levels, and many of the national builders could see their revenues triple or more.
Sales of existing houses simply collapsed in July 2010, after the home buyer tax credit expired, and have remained depressed ever since. The extremely high ratio of homes for sale to the current selling pace is likely to downward pressure on prices. Existing home sales in September fell by 3.0% from August, and the months supply edged up to 8.5 months. That is still high enough to indicate downward pressure on prices.
Inventory Progress
That absolute level of listed existing homes for sale has been coming down, falling 2.0% in September, and off 13.0% from a year ago, but the level has to be judged relative to the sales rate. There is also still quite a bit of “shadow inventory” out there as well. That is, homes where the owner is extremely delinquent in his mortgage payments and unlikely ever to make up the difference, but that the bank has not yet foreclosed on or a foreclosed house not yet listed for sale.
It also includes all those people who think that the decline in housing prices is just temporary, and are waiting for a better time to sell. The “new and improved” plan for refinancing underwater homes held or backed by Fannie and Freddie may indeed but a significant dent in the shadow inventory problem, but will not by itself solve it.
Mortgage Assistance
The original HARP program was far less effective than everyone had hoped, reaching less than 25% of its stated objectives. Those who tried to take advantage of it were mired in endless paperwork and foot-dragging on the part of the banks.
The new program significantly streamlines the process, but only applies if your mortgage is held or backed by one of the GSE’s. Still, that is a lot of houses, and should (provided it is executed well) make significant progress on keeping people who have stayed current on their mortgages in their homes.
I had been thinking that the decline would last through the end of the year, but that the size of the declines from this point would be limited. After that, I expect a prolonged period of essentially flat prices for existing homes, not a sharp rebound. The flat period may well be coming sooner than I expected, but it is still to early to be sure.
Prices have been edging up in recent months, but that is entirely due to seasonal factors; they have been flat at best on a seasonally adjusted basis. Given that there is significant seasonality to home prices, the adjusted numbers are the ones you should be focused on, even if the vast majority of the reporting will be based on the somewhat deceptive non-seasonally adjusted numbers.
Second Down-Leg Much Shorter
We are unlikely to have a decline anything like the first downdraft in housing prices. The reason is in the graph below (from this source). People need a place to live, but they do not have to own a house. They have the option of renting. A house is a capital asset, and the cash flow from owning that asset is in the form of rent you do not have to pay.
One of the clearest signs that we were in a housing bubble was that the prices of houses got way out for line with rental prices. While on this basis, houses are not yet “cheap” on a national basis, neither are they absurdly expensive the way they were a few years ago. If prices fall too far from here, it will become cheaper to own than rent, and lots of people who are now in apartments will start to buy.
Housing Prices Now at Historical Norms
Fortunately, relative to the level of incomes and to the level of rents, housing prices are now in line with their long-term historical averages, not way above them as they were last year. In other words, houses are fairly priced, not exactly cheap by historical standards, but not way overvalued either. That will probably limit how much price fall and I don’t think they will go down more than about 3% from current levels. That, however, is more than enough of a decline to do some serious damage.
Housing is, of course, highly location-dependent, and in many areas of the country it has already become cheaper to own than to buy. This graph also includes the CoreLogic housing price data which is similar to the C-20. Rental vacancy rates have started to fall significantly and in many areas of the country rents are rising, not falling. The price-to-rent ratio is already at the high end of normal based on the Case-Schiller index, and in the middle of the normal range based on the CoreLogic index.
Rising rents will move the ratio toward the middle or even low end of the range without more weakness in housing prices. The apartment-oriented REITs such as Equity Residential (EQR) should benefit from this.
BERKSHIRE HTH-B (BRK.B): Free Stock Analysis Report
D R HORTON INC (DHI): Free Stock Analysis Report
EQUITY RESIDENT (EQR): Free Stock Analysis Report
MASCO (MAS): Free Stock Analysis Report
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