Since mid-2013, the housing industry has been seeing a continued downtrend with declining demand noticed in most of the U.S. states for both new and existing homes. For instance, year-over-year sales volume of existing homes which represent nearly 90% of the market has been consecutively down for 10 months in a row. Despite the fact that 30-year mortgage rates are at the 52-week low, new regional data available through various sources are showing further detoriation in the housing market. This fact is also reinforced by the extreme negative divergence in the homebuilder stocks versus the S&P 500.
This situation in the U.S. is also impeding the growth of construction companies as the investment climate remains at the all-time low. Thus, companies like Caterpillar (CAT, Financial) have started to feel the heat. Let’s dive in and find out how the fundamentals of the housing industry are at this juncture and whether investors’ should hold on to the homebuilder stocks trading on the NYSE or NASDAQ.
The weakness prevails
Several states from different regions around the country have begun to report declining sales either on amonth-to-month or year-over-year basis. Recently, home information collected from Corelogic show that in the states of California, Seattle, Las Vegas and Miami there have been prominent home sales decline in the month of August.
In Vegas, sales were the lowest for the month of August after around 16 years of demand appreciation. Similarly, sales in Miami were 12.6% below the average sales for the month of August since 1997.
Prices on diminishing trend
Home price growth has been declining constantly and is a concern for home builders. Analysts have opined that this price deprecation directly reflects rising housing inventory and declining demand for new and existing homes. The declining demand is reflected in the almost weekly decline in mortgage purchase applications, which has led to the sales volume dropping significantly for the sector.
This is especially true given that the decline in the number of all-cash buyers hit the six-year low in the month of June this year. In September Corelogic commented that cash sales represented 33% of all home sales in June compared to 34.4% in May this year. This was the lowest reported monthly cash sales, after it hit a peak of 46.2% of overall sales in January 2011.
Real estate owned (REO) sales comprised around 55% of the cash transactions in June 2014. However such sales made up only 7.2% of the home sales, and were contrary to what had been noticed in January 2011 when REO sales accounted for nearly 24% of the total home sales. The second highest share of cash transactions at 32.5% went to re-sales, followed by short sales and new homes trailing at 31.8% and 16.2%, respectively.
Short-selling builder stocks
Since the housing industry fundamentals are at a dwindling phase, the investors’ are worried and are eagerly awaiting the recovery in the sector. Meanwhile, many stockholders are short selling their homebuilder stocks such as DR Horton (DHI, Financial), KB Home (KBH, Financial) and Ryland (RYL, Financial). Also new home builders are resorting to price discounts and are offering freebies in several markets to improve the housing demand. It looks like almost all the massive homebuilders have built their inventory to levels that are close to or may have exceeded their inventory levels in 2005 and 2006, at the peak of the housing bubble. As demand is on a declining trend, homebuilders would need to go for aggressive price discounting to move their inventory in order to repay the debt used to build up such inventory levels. This likely explains why the Dow Jones Home Construction index is down 6% YTD, while the S&P 500 is up 5% in the similar comparable period.
Final word
As the trend of declining sales and prices is likely to continue, investors should be short-selling any homebuilder stocks at this point of time. As home builders struggle to sell new properties to clients and with prices entering into new all-time lows, there is little hope of the industry revival this year. Let’s stay tuned and keep a close watch on the upcoming news in the U.S. housing sector which might portray some positive signs for the industry that is currently showing softness in demand and sales.
