Don’t Get Too Giddy Over Home Prices

by Ethan Roberts | January 30, 2013 10:49 am

Yesterday’s glowing S&P/Case-Shiller report on November home prices added more coal to the fire burning in the real estate market.

Various factors have contributed to its now extended turnaround, such as lower prices, miniscule interest rates, improvements in the short sale system, depleted inventory and a re-emergence of qualified buyers who had foreclosed on homes between 2007 and 2009. The latest homes data sent homebuilder stocks like D.R. Horton (NYSE:DHI[1]) and Hovnanian (NYSE:HOV[2]) climbing roughly 12% and 4%, respectively — with the former also buoyed by better-than-expected earnings.

The report showed November prices rising more than 5% annually among the composite index of 20 American cities. This was the largest increase since August 2006 — the peak of the housing bubble. The monthly increase was 0.6% on a seasonally adjusted basis, and marked the 10th consecutive month of gains. The largest area increases were seen in Phoenix, Ariz., up 22.8% from 2011, and San Francisco, up 12.7%.

But the Case-Shiller report was tempered somewhat by a weaker consumer confidence report, with a drop in the confidence index from 66.7 in December to 58.6 in January. This was the lowest reading since November 2011.

Even with the fiscal cliff issues resolved, Americans are feeling gloomy about the economic outlook and their own financial futures, with higher payroll taxes being seen as the main culprit. Consumers also cite the weak job market as an ongoing challenge.

So the question now is, will reduced consumer expectations negatively affect the real estate market and bring the recent gains to a halt?

I believe they could. Not only that, but there are four other factors that could derail the real estate train over the remainder of 2013. They are:

  1. A rise in the number of listed properties: Abnormally low inventory levels have boosted recent prices. But if home values continue to rise, homeowners who have delayed selling because they were upside down on their mortgages are no longer underwater. As they begin to list their homes, it might return depleted inventory levels to previous numbers.
  2. Shadow inventory: Banks still are holding onto excessive numbers of foreclosures, perhaps in an effort to stabilize prices. Eventually they will begin to release more of it, however, and that will contribute to inventory increases as well.
  3. Weak job creation: Unemployment still is high at 7.8%, and many of the 150,000 average monthly jobs being created recently are just part-time, with low wages not conducive to growing home ownership. In fact, home ownership rates have continued to decline in recent months.
  4. Appraisal problems: Investor cash deals and multiple offers on cheap homes have also boosted recent prices. But homes that are purchased with mortgages require appraisals, and there might not be enough comparative sales to support the loftier price tags going forward.

Given these obstacles, it is entirely possible that we could see a slowing of the recent price appreciation and number of sales for the remainder of 2013. If that occurs, the homebuilder stocks will have a much more difficult time matching their superb performances of 2012.

However, of the homebuilders, the three I believe will do the best this year are the two mentioned previously, HOV and DHI, along with Toll Brothers (NYSE:TOL[3]), which I recently discussed[4].

HOV has recently pulled back from $7.35 to $6.20, with declining downside volume, and probably is the best current trade of the three. The other two seem well extended from their most recent base, and are best left alone until they pull back from current levels.

So tread cautiously in 2013 with the homebuilder stocks, and pick your spots, rather than chasing extended values that might be unsustainable.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.

  1. DHI:
  2. HOV:
  3. TOL:
  4. recently discussed:

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