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US Housing Market Starting to Turn?

Gordon Pape

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Contributing editor Glenn Rogers joins us this week from his home in Laguna Beach which, for those unfamiliar with the geography of southern California, is on the Pacific Coast between San Diego and Los Angeles. Like many people there, and across the country, he has been keeping a close watch on the shattered U.S. housing market ever since the 2008 collapse. Now, for the first time, he sees signs of hope and an investment opportunity. Here is his report.

Glenn Rogers writes:

Living here in the U.S., one of the big questions people have been asking for a few years is: "Has the housing market bottomed or not?" I started thinking about this recently because a friend of mine from British Columbia has been looking for a home in Laguna Beach. He plans to live here during the winter months, spending the summers back up in Whistler.

After a three-month search he finally bought a house last week for just under $700,000. That's unheard of for this area. Not long ago the going price around here was at least $1 million for that kind of home. Interestingly, as his search progressed he found that the bank-owned repossessions and short sales that he had been focusing on began to dry up. Not only that, he was beginning to be outbid with multiple offers at asking prices.

Laguna Beach is an unusually affluent area and, like Canada, we never experienced the absolute depths of the housing depression that cratered areas like Phoenix, Las Vegas and Miami. Nonetheless, real estate around here still took a noticeable hit over the last few years. But now local realtors are reporting that activity is picking up dramatically and prices are beginning to creep up a little. Admittedly, an increase in activity from the very low base that has become the norm for the past two or three years doesn't say much, but it is an indicator that the market is slowly improving.

Another early indicator is that homebuilding stocks and issues like Home Depot (HD) and Whirlpool (WHR) have all been on fire over the last three months, clearly outperforming the broader market. Homebuilder stocks are up about 38% year to date and 85% since Oct, 1 compared to a 7% and 18% rise, respectively, in the S&P 500.

But the market is far from stable. Recent data shows that we are still seeing some decline in pricing on a national level. True, the rate of decline has slowed dramatically from a couple of years ago. As we gradually work through the foreclosure bulge related to the Robo signing settlement, the housing market should begin to stabilize and head up. Home sales have been rising, but mortgage applications to purchase the homes have not. They are down nearly 8% from a year ago - largely because lending standards still remain tight and investors are using full cash offers to give them an advantage in acquiring distressed properties.

Consumer sentiment is also improving. A monthly survey from Fannie Mae shows that people who think that now is a good time to sell rose by 3% to 13%, the highest level in over a year. However, respondents who think this is a good time to buy actually fell by 1%, though still high at 70%. Truth is, affordability is dramatically better than it was back during the peak and mortgage rates are at an historically low point.

Affordability against median income is at one of its lowest points in history. Although national home values fell nearly 25% from their peak in May 2007, current values have inched back to their late 2003 levels.

All this has begun to move the markets, but the still high unemployment rate and the large amount of housing inventory that overhangs the market means it will still be some time before we can look at a truly robust housing sector. In the meantime, the rental market continues to show strength. Many investors have benefited from investing in property stocks that focus on apartment rentals like Associated Estates Realty (AEC) which manages over 13,000 units, or the iShares Residential ETF (RES) which tracks a basket of 36 different REITs in apartments and senior living centres.

In light of all this, some cautionary thoughts come to mind before I get to my recommendations. First, I believe the overall market is due for a fairly significant pullback. Second, the homebuilder stocks may pull back even more given the recent run they've had.

Once this happens, then I think you can begin to build positions in the issues I'm about to recommend. If you just can't wait or if I'm wrong you can take small positions now but no more than about 25% of your final target position. This is a short-term market timing strategy. Over the longer term, 24 months or so, stocks in this area will continue to improve.

I am recommending this ETF:

SPDR Homebuilders ETF (XHB). This is an interesting basket of not only the major home builders like Lennar (LEN), D.R. Horton (DHI), and PulteGroup (PHM) but also a selection of related companies such as Home Depot, Whirlpool Corp, TempurPedic International (TPX), and Pier 1 Imports (NYSE: PIR). The units are up just over 14% over the past year compared to 5.5% for the S&P 500. Total holdings include 27 firms with roughly 30% of its assets in homebuilders and the rest in manufacturers and providers of home furnishings.

Action now: Buy XHB at $21 or less with a target of $25. The shares closed on Friday at $21.51.

Another one that is worth a look is the iShares Dow Jones Home Construction ETF (NYSE: ITB). Two-thirds of the total holdings of this fund are homebuilders. Firms in the building materials segment occupy nearly 20% of the portfolio and home improvement related companies pick up another 9% of the total assets. Names like Sherwin-Williams (NYSE: SHW), Masco (NYSE: MAS), and Ryland Group (NYSE: RYL) are included in this basket. D.R. Horton and NVR Inc. (NYSE: NVR) are the two largest holdings. However, this issue has not done as well as XHB, gaining 7.9% this past year compared to 5.5% for the S&P 500. Historically the two issues trade similarly, but overall performance has been better with XHB.

Of course you can research individual stocks in these groups and look for higher Beta (more risk, higher return potential) than you will get from the ETFs. Toll Brothers (NYSE: TOL) and PulteGroup are my favorites but, as usual, you will trade some peace of mind for the possibility of improved performance.

For a lower-risk way to play PulteGroup, check out PHA on the New York Stock Exchange. This is an unusual stock in that it is based on a 40-year debt instrument and pays a hefty dividend, unlike the common shares which had their dividends suspended after the housing market collapsed. The current payment is $1.84 per share annually for an attractive yield of 7.4%. However, there is very little upside potential here.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.6/5 (19 votes)

Comments

kfh227
Kfh227 premium member - 2 years ago
Just look at rail traffic for lumber. It has bottomed.

USGs drywall shipments finally went up in the recent quarter granted it's hard to say by how much due to how they report the numbers.

I sold off USG on Friday. I understand $18/share. Not more than that though. I will happily buy back on a dip.

shaved_head_and_balls
Shaved_head_and_balls - 2 years ago
This article makes no mention of the valuation of the stocks that make up the ETFs the author is promoting. Suffice it to say, their valuations are currently high because of the huge recent runups. This article is not likely to be popular on this website, as you're basically suggesting that the value-oriented investors on this website buy high and sell higher. In other words, momentum investing.

Laguna Beach home prices might be 30% or 40% below the bubble peak, but you neglected to mention that the bubble era pushed up home prices there 200% to as much as 400% in less than a decade. This doesn't mean the homes are a good value relative to local affordability. It just means the prices aren't as ludicrous (relative to the median income of residents) as they were five years ago.

The California market is currently undergoing a price compression of the most excessively overpriced coastal market (mid- to high-priced houses). The low end housing regions in So Cal is the only stable market, as landlords are buying houses for rental income.

In many coastal So Cal cities, less than 20% of the households can afford a house in their city even after the recent price drops. (Besides the fact that too few qualifying incomes can afford the still high prices, don't forget that in many cities over 50% of the homeowners are underwater on their mortgages. Such owners generally cannot sell their homes, which means they can't get a loan to buy new ones either.

On a final note, you might want to tell your Canadian friend to sell his Canadian house and become a renter before the epic housing bubble there crashes and takes back all his (illusionary) paper gains.

kfh227
Kfh227 premium member - 2 years ago


There is no reason to expect the california would be the first or last housing market to recover. If I were to bet though, I'd expect California, Las Vegas and Florida to be the last to recover since the boom there was the biggest.

Simpl fact is that for the first time in a long time I am seeing renovations and new construction occuring in Connecticut. This is congruent with rail numbers and USG's public data.

If other countries pop, that is good for the US since hte US dolalr will strengthen. Sad but true side effect.
superguru
Superguru - 2 years ago
shaved_head - thanks for your explanation. You said - "The low end housing regions in So Cal is the only stable market, as landlords are buying houses for rental income".

Do you see price compression still going on in middle and expensive, like 500K and above, housing?

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