Stuck in Neutral: Real Estate’s Mixed Q2 Results

Homebuilders and homebuilding stocks stagnate as the real estate industry tries to right itself after a tough winter

After a surprisingly difficult first quarter of 2014, the U.S. real estate market showed a few signs of life during the second quarter. However, when you look below the surface numbers, doubts about the sustainability of improvement continue to linger, especially for homebuilders and homebuilding stocks.

quarterly review and outlookAfter NAHB/Wells Fargo Builder Confidence Index suffered its worst monthly decline in history, with a monthly reading drop from 56 to 46 in Q1, the second quarter saw a small bounce back to 49. However, this reading is still below 50, so it’s historically negative for how the homebuilders themselves feel about the state of the market.

Another negative for real estate this quarter was the May building starts report, which showed a 6.5% decline from April, with starts down for both single-family homes and apartments. Construction jobs are still 20% lower than they were at the end of 2007, a sign of the ongoing difficulties that homebuilders continue to have.

As for home sales, it’s not easy to make sense of all the up-and-down numbers. The National Association of Realtors (NAR) reported this week that closed existing home sales were up 4.9% to 4.89 million in May, after being revised in April to 4.66 million. This was the highest monthly rise since August, 2011. Median existing home prices were 5.1% higher than they were in May, 2013. Another positive was that foreclosures and short sales as a percentage of all sales were down to 11% from 18% a year ago.

The Real Story for Real Estate

Sounds great, right? However, behind the main numbers lurk some negative ones. May closed sales were 5.0% below the 5.15 million numbers from May, 2013. Also, first-time homebuyers accounted for only 27% of all May purchases, a drop from 29% in April of both 2014 and 2013. All cash sales, which include both investors and owner occupants, comprised 33% of all sales. Mortgage applications were basically flat this week, after falling two weeks ago.

It is important to look deeper behind the numbers to realize what is happening. A large percentage of total sales is from investors and “step-up” homeowners, rather than from first-time buyers. As prices rise, it becomes more difficult for first time buyers to afford the homes that are available, and investors begin to back off from making purchases.

As I have noted before, Millennials are still struggling financially with student and car loans, credit card debt, and job insecurity at their low-paying jobs. Many are still living at home or with roommates in cheap apartments. Many still lack the credit scores, low debt-to-income ratios, or down payments necessary to qualify for a mortgage. Eventually, both the first-time homebuyers and investors may both withdraw even further from the real estate market.

NAR’s Pending home sales index ( index of homes under contract that have yet to close) increased 0.4 % to 97.8 in April from 97.4 in March. However, in April, 2013, the index was as high as 107.7. Regions were also mixed, as the Midwest and Northeast showed gains, while the West and the South had declines. The next report is due out on June 30.

In addition, the Standard & Poors/Case-Shiller 20-city home price index released this week showed an annual gain of 10.8%. However, the rate of gain has been slowing throughout the quarter. The West Coast had returns that dropped by 3%, and only Boston produced an annual rate improvement.

Bottom Line

So in summation, we have a total mixed bag of results for the real estate industry, and homebuilding stocks very much reflect this. The SPDR S&P Homebuilders ETF (XHB) was $32.55 on March 30, and hasn’t moved much since. The leading individual homebuilding stocks right now are D.R. Horton (DHI) and Lennar Corp. (LEN), while Hovanian (HOV) and Ryland Homes (RYL) continue to lag while trading below their 200-day moving averages.

dr horton dhi chart
Source: Stockcharts

As the accompanying chart shows, DHI, up 13% this quarter, is one of the very few homebuilding stocks that has done well. KB Home (KBH) has recently climbed above its 200 day moving average, which bodes well for the homebuilding stock.

My forward outlook for the homebuilders, as it is for the XHB, is that they remain stuck in neutral. Occasional positive reports will boost these stocks over the short term, but we still lack a compelling number of first-time buyers or higher paying jobs to propel homebuilding stocks higher over the coming quarter. The ongoing Homebuilder Confidence Index number that remains below 50 confirms that the homebuilders don’t see a big change coming soon either.

If you really like the real estate sector, buy DHI or KBH, but leave the rest alone for the time being.

Ethan Roberts doesn’t own any of the companies mentioned in this article.

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