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4 Reasons Real Estate Might Be Heading for a Slowdown

Lennar (LEN) took the street by surprise last week, reporting strong earnings of 78 cents per share. Analysts fell all over themselves on the financial shows to pump the real estate stocks going forward.

real estate stocks, lennar earningsLEN stock was up about 5.5% on the good news, KB Home (KBH) was up 4.4%, and some of the other homebuilder stocks, such as D.R. Horton (DHI) and Toll Brothers (TOL) rallied about 2% in sympathy. Year-over-year, LEN’s delivery of homes was up by 9%, and new orders were up 23%.

The same day, the National Association of Home Builders reported that their Confidence Index rose 4 points in September to 59, beating the estimates of 55.5. That increase is a solid sign of improving confidence among that group.

So with good news on two different real estate fronts, what’s not to like? Why am I so ready to splash cold water on this happy party?

The truth is that, behind the headlines and the glee, there are four specific reasons to be concerned about real estate’s future.

4 Concerns for Real Estate

Declining purchasers: Recent reports indicating that the number of cash purchasers, by both investors and owner occupants is now declining. Price appreciation has investors nervous, and the rental prices are probably about as high as they can go without driving the 20- to 35-year-olds back home to Mom and Pop. Investor return on investment is being squeezed as prices rise on single-family and multi-family properties.

Falling condo prices: Why is this important? Because condos are the last type of housing to appreciate during good times, and the first to depreciate when the market turns cold. So even while prices are still rising on homes, condos may well have reached their peak. If condos were a real estate stock, we would say they have the worst relative strength in the sector.

Jobs report: The August jobs report was dismal, with nonfarm payrolls growing a paltry 142,000 after a couple of months of growth exceeding 200,000. Expectations for August were for 230,000. That’s a huge miss, and couldn’t be blamed on bad weather or anything else of substance. New Federal Reserve Bank surveys in New York, Philadelphia, and Washington D.C. indicate that 20% of employers continue to cut jobs and job work hours because of Obamacare. The U-6 unemployment rate, which includes all of those part-time Millennial workers and Baby Boomers who are just marginally attached to the work force, remains at a stubborn 12%. In addition, average hourly wages were up only 2% from last year. The bottom line is, if you couldn’t afford to buy a house last year, you probably still won’t qualify to buy one now.

Building starts: One day after all of the hoopla for LEN’s earnings report and the Builder Confidence Index, the Census Bureau reported that August building starts plunged 14.4% to an annualized rate of 956,000. This was well below the expected number of 1.038 million. Building permits, which are less significant than starts, were at 998,000, but also came in below the expectations of 1.055 million. So the forward-looking jubilee of the day before was severely tempered.

In analyzing the LEN earnings report, we need to remember that tight inventory has allowed home builders like LEN to raise their prices and increase their profit margins over the past three years. But as prices rise, more homeowners become “right-side up” on their mortgages, and those who planned to sell but couldn’t, are finally able to do so. Eventually, that will cause more inventory to reach the market, and new home prices will either stabilize or fall.

So although LEN stock may not have reached its peak for the year, it’s likely that LEN earnings, as well as those of the other home builders, probably have. If you currently own LEN, I would hold it, but I would not add to positions. That’s even truer for the remainder of the real estate stock sector, which continues to lag badly behind the S&P 500.

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

Article printed from InvestorPlace Media,

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