The February National Association of Home Builders/Wells Fargo (NAHB) Housing Market Index was released yesterday, and it gave the industry and Wall Street quite a shock. The builder confidence index dropped sharply from a 56 reading in January to a 46 reading in February. Any number below 50 is considered a negative for the housing industry.
Click to Enlarge As you can see from the accompanying chart, the one-month drop-off in the housing market index is quite drastic.
Some of the decline in builder confidence was blamed on recent bad weather, and today’s follow-up report that housing starts were off 16% last month — their biggest drop in three years — also cited snow as a likely culprit, helping to legitimize the thought.
But weather is a short-term effect … it’s doubtful that it would’ve accounted for the whole of the 10-point drop in the housing market index. So, feel free to still consider that reading alarming.
After all, 2013 was a banner year for the housing market. Rising yet still affordable prices and low interest rates combined to give consumers the confidence and wherewithal they needed to purchase new homes in large numbers. Subdivisions were sprouting up again in lands that were acquired in the mid-2000s but never developed. Things were looking up and builders were optimistic for the first time in many years.
2014 looks like it’ll be a different story … for several reasons.
The Millennial Effect on the Housing Market
According to Bankrate.com, fewer 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 ZERO in savings. This is especially true of the millennial-generation consumers (born 1980-92), who are battling against a weak job market and rising debts.
Millennials comprise the largest demographic of first-time homebuyers, but right now they are struggling financially, and many are in no position to buy homes. They do not have sufficient down payment money, nor money for closing costs and moving expenses. A recent Gallup poll found that 14% of people ages 24 to 34 are still living in their parents’ home, and many of these, despite having college degrees, are unable to make ends meet. Almost half of those aged 18 to 23 are still living with parents.
Furthermore, many millennials are more deeply in debt than previous generations, and have little in savings. This diminishes their chances to qualify under debt-to-income requirements for most types of mortgages. Student loans are the biggest culprit. The New York Federal Reserve reports that student loan debt increased by $114 billion in 2013 to total $1.1 trillion, or double the student loan debt held in 2006. What’s more, 11.5% of all student loans are at least 90 days past due or in default, and this is historically very high. (In 2009, the rate was only 8.8%.)
Older millennials are now dealing with increases in health insurance as a result of the Affordable Health Care Act. Some are bearing the brunt of doubled monthly premiums, while others with low premiums thanks to government subsidies still must shoulder huge deductibles. One trip to a hospital ER can mean thousands of dollars out of pocket. Paying it, even over time, could prevent this age group from saving the funds necessary to buy a home. Those who decline to pay will find their credit scores suffer, rendering them unable to qualify for a mortgage.
The national real estate market simply cannot thrive without the involvement of this age group.
However, this is not the only problem which threatens the housing numbers in 2014.
The ACA Itself
Another issue is the Affordable Health Care Act itself, which has already triggered employers to cut costs by slashing workers’ full-time hours down to part-time or just eliminating jobs altogether.
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.
Another obstacle is the “qualified mortgage,” enacted this year by the Consumer Finance Protection Bureau, which makes it more difficult for lenders to approve loans for certain borrowers who fall outside of mainstream underwriting guidelines.
In addition, a new policy established by the Federal Housing Finance Agency (FHFA) raises fees on all government-backed loans … though new FHFA head Mel Watt has ordered Fannie Mae and Freddie Mac to delay those fees, and an elimination of an older fee could be in play, too.
Housing Stocks Outlook
Given these problems, it’s quite possible that the recent rebound in real estate sales and prices will soon be coming to an end.
Therefore, investors should avoid most of the traditional housing stocks right now — such as D.R. Horton (DRI), PulteHomes (PHM) and Toll Brothers (TOL) — and also tread cautiously when buying high-dividend mortgage-related real estate investment trusts (mREITs), such as Annaly Capital Management (NLY) or Invesco Mortgage Capital (IVR), both of which have soared of late.
Builders are aware of the housing market problems I’ve detailed here and are peering ahead with a less-than-favorable outlook.
I believe this pullback in builders’ sentiment could signal the start of a new downward trend, and investors should stay away until and unless conditions begin to improve again.
As of this writing, Ethan Roberts did not hold a position in any of the companies mentioned in this article.