Over the last few months, housing stocks have been doing all they can to erase the bad memories of the 2007-2009 real estate collapse. While the S&P 500 has added 8% from its November low, the Homebuilders SPDR ETF (NYSE: XHB) has climbed an impressive 17%.
And despite Friday’s stock market selloff, housing stocks moved higher thanks to surprisingly good quarterly results from KB Home (NYSE: KBH). The company reported fourth-quarter earnings of 23 cents per share — 40 cents better than analysts were expecting. Although KBH sold fewer homes, the ones it did sell went for higher average prices. That helped boost profit margins, which increased to 19.7% from 19% last year.
Can the performance continue? To answer that, we need to look at what lies ahead for the housing market. And by all indications, things are looking better. And many, including value investor and hedge fund operator Bill Ackman of Pershing Square, who made billions shorting housing related bond insurer MBIA (NYSE: MBI) in the last days of the boom, are now calling for its resurrection.
In a leaked research report titled “How To Make A Fortune” Ackman doesn’t just the believe the path to wealth through homeownership has been restored. It’s on sale.
And as the economy continues to improve and jobs are created the coming rebound in the housing market will become increasingly clear. Barring some unforeseen calamity, another self perpetuating cycle of higher home prices encouraging increased homeownership and even higher prices is coming. Here’s why.
Why it’s time to buy housing stocks
Basically, the bull’s case as outlined by Ackman can be boiled down to a few simple bullet points:
- Home prices are at their lowest valuation in at least a generation
- A large number of forced sellers gives buyers negotiating power
- Attractive, low-rate financing
- Still favorable long-term supply dynamics as the U.S. has one of the best demographic outlooks in the developed world
- Housing is an out-of-consensus idea that is under owned by institutional investors
The most important factor is affordability.
With home prices down by nearly one-third from their high, housing affordability as calculated by the National Association of Realtors has moved to the highest levels since the data started back in 1971. Also, with rents on the rise again as vacancy rates fall, the required annual home price appreciation needed to “breakeven” on a comparative analysis of buying vs. renting costs has also fallen to levels not seen since the 1970s.
Don’t fear the ‘shadow inventory’
We should mention the supply side of the equation where there is a lot of concern that the “shadow” inventory of unsold, foreclosed, and delinquent loan homes will weigh on prices in the years to come.
Already the supply of existing homes totals nearly 11 months of supply. New home inventory totals around eight months of supply. Compare this to a low of less than four months of supply back in 2004 and it’s clear that the market is swamped.
But Maury Harris at UBS isn’t worried. He believes that despite as many as two million annual foreclosures hitting the market next few years, prices should stabilize by the end of 2011. It’s as simple as supply and demand.
On the demand side, Harris is looking for a big bounce back in job-driven household formation. Census data shows that as the recession bared its claws, young adults were increasingly forced to live with other relatives — pushing the household formation rate to 50 year lows. Although the jobs recovery has been tepid so far, the number of new households being formed is already bouncing back and has returned to pre-recession levels. Living with mom and dad loses its appeal pretty fast no matter how much cash you save.
On the supply side, extremely low new housing construction starts will limit the amount of excess housing units hitting the market. As a dearth of new construction and tightened credit standard force people into rentals — boosting rents and changing the buy vs. rent calculus back in favor of the homebuyer and landlords/investors looking to cash in on the rental boom.
The way to play housing stocks
The obvious way to profit from the coming housing rebound is to buy a home. But if you’re looking for an easier route, the Homebuilders Index ETF (NYSE: XHB) is a good candidate. It provides good overall exposure to the sector with holdings that include construction outfits like PulteGroup (NYSE: PHM) and KB Home (NYSE: KBH) as well HVAC manufacturer Lennox (NYSE: LII) and paint expert Sherwin-Williams (NYSE: SHW). Another option is the iShares Dow Jones Home Construction ETF (NYSE: ITB) which focuses on just home builders.
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