The U.S. real estate market has seen a strong rebound in both new home sales and resales for the past two years, with prices up more than 12% nationwide in 2013. This rebound in housing has been fueled by lower prices, miniscule interest rates, hedge fund investors and foreigner buyers with cash, small improvements in the labor force, and buyers with previous foreclosures or short sales qualifying to purchase homes once again.
It was a perfect storm of bullishness for a sector that had been all been left for dead in the wake of the 2007-11 meltdown.
But as I hinted at previously, signs that a new slowdown in the real estate sector might be upon us have already begun to emerge.
Last week, the Commerce Department reported a 13.4% decline in its July new home sales report — a much-greater-than-expected drop, and the lowest reading since October 2012. A spike in interest rates to two-year highs from May through July was blamed for the bad report.
Then yesterday’s S&P Case-Shiller report showed that although June prices were up 0.9% from a year ago, there was a slight slowing of price increases from the May report. Although the report cited continued strength in the housing markets, Robert Shiller had this to say:
“In the single family realm, I think that there is a chance that there is weakening. The housing market has gotten very speculative and it goes through big cycles … It’s a rollercoaster, that’s what these markets have become.”
Shiller added that when the large hedge funds begin to sell the homes they purchased cheaply a year or two ago, the added inventory will also depress market values. While that is true, national inventory levels are at a five-month supply, which by historical standards is still below average.
But now comes word from the National Association of Realtors (NAR) that even though July pending sales were up 6.7% from a year ago, they were 1.3% lower than in June. That will translate to fewer closed sales this month and next.
And worse, there are more signs of weakening down the road for the housing market. A number of fees and other increases are going to make it more difficult for borderline borrowers to qualify for loans. These include:
- Higher interest rates from expectations of a Fed tapering are already here, and they’ll continue creeping up. Higher rates equate to higher payments on a mortgage, which discourages consumers from paying higher prices for homes.
- The Biggert-Waters Flood Insurance Reform and Modernization Act of 2012, in an effort to raise reserves for FEMA, will increase the annual limitation on flood insurance premium increases from 10% to 20% starting this October. This will raise prices for homeowners who are mandated to purchase flood insurance in certain flood-prone areas. In addition, redrawn flood maps could increase the number of homes that are determined to be at risk.
- Homeowners insurance rates have also risen in recent years. Between 2003 and 2010, the average homeowner insurance was up 36%, and areas on the east and southeastern coasts of the U.S. — where hurricane potential is the greatest — continue to rise every year.
- FHA increases in Mortgage Insurance Premium costs were initiated in 2012, increasing the upfront fees from 1% to 1.75%. They also raised the monthly PMI by almost $10 per month for a $100,000 home. This could set the stage for increases in other non-FHA loans as well.
- Local tax rates are climbing as homes are reassessed, following the 12% price home price increases seen in the last year.
- Debt-to-income ratios, currently permitted by law to go as high as 57% for owner occupants, are the subject of much debate, as regulators have hinted at plans to cap DTI at 43%. The feeling is that lower DTI ratios will reduce default rates. However, when DTI ratios are reduced, consumers are forced to either buy cheaper homes, or to wait until they pay down debt to buy more expensive ones.
All of these measures will impact the prices of homes that consumers can purchase, and soften the bids made on listed properties as well.
Of course, employment is the most important determinant of housing. Unfortunately, the implementation of Obamacare in a few months already has many businesses announcing cuts in the hours of previously full-time employees. Other companies are waiting to see how the new health care laws will impact their bottom lines before hiring new workers. This does not bode well for the real estate market.
Given these headwinds, investors should be cautious in selecting any real estate-related stocks, especially homebuilders. While investors might continue to buy foreclosures and short sales, it is typically the first-time owner occupants who are buying brand new homes.
The good news is homebuilder stocks have already been crushed during the past few months. Toll Brothers (TOL) is off roughly 20% from its May heights, while D.R. Horton (DHI) and KB Home (KBH) are each off about 30%.
The bad news is that while these stocks could produce an oversold bounce, the conditions mentioned above are likely to keep this sector a market laggard over the next four to six months.
So for now, stay away from homebuilder stocks until you see improvements in employment numbers, coupled with a loosening of fees and restrictions upon the mortgage industry.
Of course, given recent history, it’s doubtful either will occur anytime soon.
As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.