The first two quarters of 2013 produced one of the strongest real estate markets since its peak in late 2006, but there’s reason to believe things could cool off in the final half of the year.
Of course, let’s start with the good news — of which there’s been a laundry list. Take a look:
- This week’s S&P/Case Shiller index showed that prices nationwide were up 12% annually — the strongest gain in seven years — while some cities — including Atlanta, Las Vegas, Phoenix and San Francisco — had gains over 20%.
- Also this week, the commerce department reported that May sales of new single family homes rose to their highest level since 2008. The 2.1% monthly increase was the third straight month of sales gains and sales were up 29% year-over-year.
- Re-sale numbers have been quite strong. The National Association of Realtors reported over 5 million homes were sold in May — a 13% annual increase more than a three year high.
- Ask any Realtor about listings in their local market and you will likely hear two magical words: “Multiple offers.” Almost every deal has several competing buyers, with a large percentage of homes closing above the original listed price.
- Inventory is still light, with only a four-month supply of available homes on the market as foreclosures are still being released for sale at a snail’s pace.
- Many of these sales also continue to be cash transactions, with both investors and owner occupants taking cash from stock market gains and diversifying it into low priced real estate.
- Even mortgage sales have been strong, as anemic interest rates propelled renters and even consumers with previous foreclosures to finally take the plunge. The 30-year fixed mortgage meandered through the 3% range for the first five-and-a-half months of the year, while the 15-year rate could be had for as little as 2.75%!
To sum it up, real estate’s had a confluence of positive factors in the first half, including attractive prices, low interest rates, stock market gains and limited inventory to trigger an avalanche of sales in both the new and pre-existing homes market.
So what could go wrong?
In the middle of all this real estate bliss, enter Ben Bernanke and the Fed. Last week, the announcement came that they may start to taper off on the asset purchase program near the end of 2013, perhaps ending it completely in 2014 (although tapering is contingent upon the economy continuing to improve).
Since then, mortgage interest rates have zoomed up, as you can see in the table below:
Table courtesy of MortgageNewsDaily.com
Despite the fact that, by historic standards, these interest rates are still extremely low, it is the public’s perception of rates that often determines the strength of real estate sales. When people become accustomed to 3% rates, they feel let down when interest rates spike up near 5%.
While there could be an initial rush to buybefore rates climb even higher, eventually the combination of higher rates and prices will make it difficult for first time homebuyers to purchase something that would have been much more affordable a year ago.
Of course, there are other headwinds as well. Just consider these numbers from Bankrate.com, for example: Less than 25% of Americans have enough money in savings for more than six months of expenses, while 50% have only three months and 27% have no savings.
A lack of savings is especially a problem for younger consumers battling against a weak job market and student or car loans — the usual demographic of first-time home buyers. The question going forward is whether or not the real estate market can thrive without their involvement.
On top of that, some new laws coming in 2014 could drag down real estate sales in the second half of 2013. The first is Obamacare, which is likely to have employers decreasing many workers’ full-time hours in an effort to save costs. A recent Gallup poll found that 41% of employers had frozen hiring and 19% had already reduced their staff as a result of the new healthcare law.
The second is the “Qualified Mortgage.” This set of mortgage restrictions proposed by the Consumer Finance Protection Bureau could have lenders making the required modifications to their loan qualifiers even before the law takes effect in January.
The Bottom Line
Of course, even in the face rising interest rates and other challenges, there are still a few standout housing stocks that investors should consider for their portfolio. Homebuilders are a prime example, as names like DR Horton (DHI) and Lennar Corp. (LEN) are poised for the best performances in a tougher second half.
In contrast to a stock like Pulte Group (PHM), which is currently trading at 23 times xx earnings, the P/E is only 7 for DHI and 10 for LEN. And unlike KB Home (KBH), Beazer Homes USA (BZH) and Hovanian Enterprises (HOV) — all of whom have negative earnings per share — DHI and LEN each have positive earnings … plus small dividend payouts.
Plus, Case-Shilling’s outlook for the homebuilders is fairly strong over the next 12 to 18 months, although better job and income growth are needed to sustain the housing recovery beyond then.
All in all, not all housing stocks will perform equally during a tougher second half, so investors should gravitate toward those with the strongest fundamentals.
As of this writing, Ethan Roberts doesn’t hold a position in any of the aforementioned securities.