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Josh Zachariah
Josh Zachariah
Articles (89) 

A Holistic View on Housing

June 26, 2013 | About:

Recently housing related stocks suffered a major selloff as investors (or more appropriately speculators) retreated amidst the rise in mortgage interest rates. Higher interest rates will certainly weigh on housing demand as it raises the cost of financing a house, but investors seem to be overreacting to the headline news. In many markets cash buyers are making up a significant share of the market. Not only that, but the problem seems not to be the cost of financing but the availability of homes and homebuilders.

It’s now widely known that there are many regions where demand for housing has grown incredibly competitive and the market is starved for new housing units. But the “invisible hand” is quickly moving the pieces around to treat the imbalance. In a builder’s conference Pulte Group (NYSE:PHA)’s CFO noted the company is ramping up acquisition and development of land:

“We've got $1.4 billion in land and development spend authorized for fiscal '13. We're not sure that we'll spend all of that, so we've given the field the latitude to go out and spend that much money.”

In the same conference, KB Home (NYSE:KBH)’s CEO noted an expected doubling in land acquisition and development:

“We feel we can evolve this year. We plan to invest more than $1 billion on land acquisition and development. We're on offense, especially compared to last year, where we only invested a little over $500 million.”

Clearly builders intend to ramp up supply of housing and demand for housing goods will grow with it. They know better than the speculators selling off their stocks that demand for housing will continue to grow in spite of rising interest rates. In the same conference some executives noted that shortages for goods and services have shown up in some markets. Land developers, which have gone dormant over the years, are needed in the market. Also some specialized tradesmen such as electricians have also been in short supply. In a recent poll by Housingwire contractors have complained of shortages in certain goods. The story noted:

The highest reported incidence of shortages was for oriented strand board, with 22% of builders reporting shortages. Following closely is wall board, with 20% of builders reporting a shortage, and framing lumber and plywood, with 18% of builders reporting shortages. “

Wall board is of course in reference to sheetrock and the largest producer USG has been heavily sold off. USG has been reluctant to bring capacity back online and in conference calls executives have said they’ve elected to add overtime to existing workers instead of adding shifts or taking online mothballed factories. Consequent of restricting new supply, prices in sheetrock have firmed up.

Sheetrock has risen from $109 per 1,000 square feet of sheetrock in 2011 to $153 this year. USG (NYSE:USG) is still operating at about 50% of its capacity and being the largest producer of sheetrock in the market they have the largest excess capacity. But because of these rather high prices for sheetrock at this point in the market where fewer than 1 million housing starts are being built, the company should have tremendous earning power going forward.

One of the more respected housing economists Robert Shiller gave an interview to Bloomberg today. Unfortunately it could’ve been more elucidating. Shiller hinted that house prices may decline after a year or two, but he didn’t say why. He also suggested buying apartments because people seem to be gravitating towards renting. It could be that Americans are losing their interest in owning single-family homes, but it could also be that those renting aren’t in a position to own a home or rather lenders won’t lend to them to begin with.

Further complicating Shiller’s argument for multifamily housing is the fact that apartment construction has already picked up dramatically and some analysts have cautioned about a bubble in multifamily construction. But for Shiller to make a broad statement about housing is difficult as real estate is largely local and every market is different. Detroit’s real estate could be impaired for years, but North Dakota may be just the opposite. Shiller may be right about one market or another, but you can’t generalize about the entire U.S. real estate market.

Shiller’s point about house prices rising in the short-run is spot-on. Housing economics couldn’t be better as the market has all the ingredients to push prices higher. Low inventory, higher building costs via labor and materials on the supply side and robust demand propelled by low interest rates, strong investor and consumer demand and employment that is improving by the month. But when housing production picks up, building costs come down, interest rates continue higher and Blackstone and company start selling houses, prices may very well start trending in the wrong direction.

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

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