Homebuilding Stocks, 2015: Are They in a No-Win Position?

As we begin 2015, the real estate market and homebuilding stocks are caught between a rock and a hard place. On the one hand, we have recently seen a slowing of price appreciation and a reduction of home sales, as investors pull back from a fury of 2014 purchases, and the paucity of buyers among the Millennial generation is finally exposed.

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This does not portend well for real estate sales in 2015, nor for the overall economy.

On the other hand, we have several late year economic reports showing improvement in gross domestic product (GDP) and the job market, which should bode well for real estate sales in 2015. But here’s the catch — if the economy and employment levels heat up too much and interest rates begin to rise, that will dampen the ability of these same consumers to afford a home at current price levels.

Should the consumer then pull back, home prices could drop and those who are finally above water on their homes may find themselves again drowning in a sea of lost equity. So then the market loses the so-called step-up home purchases, which are frequently into new construction.

In short, 2015 could be setting up as a perfect “no-win” situation for most of the real estate market, and in particular homebuilders and homebuilding stocks.

Ironically, in a year that saw the overall real estate market continue to boom in both sales and price appreciation, homebuilder stocks were basically flat for most of 2014. The SPDR S&P Homebuilder (ETF) (XHB) began the year at $33.30 and finished the year at $34.12. With a paltry dividend yield of less than 0.5%, nobody got rich in 2014 by buying the homebuilder index.

Last year was instead a stockpicker’s market for individual homebuilding stocks, with D.R. Horton, Inc. (DHI) up 15% Lennar Corporation (LEN) up 12%, and PulteGroup, Inc (PHM) up 10%.

KB Home (KBH), Ryland Group Inc (RYL), Toll Brothers Inc (TOL), Beazer Homes USA, Inc. (BZH), and Hovanian Enterprises, Inc. (HOV) all produced negative returns for the year. HOV stock was the worst performer of all, losing more than 35% in 2014.

Since little has changed within the last few weeks, 2015 shapes up to be another stock picker’s year for the homebuilding stocks, as we will likely see a continuing disparity of relative strength among the various stocks within the sector. From the looks of things over the first week of the year, I would expect the stocks with the strongest relative strength in 2014 to continue their superiority for at least the first quarter of 2015, and possibly beyond that.

While many in the industry see the current decline in oil prices as positive and putting more money into the hands of first time homebuyers, Arian Hovanian, CEO of Hovanian Enterprises, recently expressed concern over the potential loss of oil jobs in previously strong housing markets such as Houston having a negative impact upon new home purchase numbers. Others say the collapse of oil prices could affect home price appreciation nationwide.

Another concern for the real estate market relates to possible increases in the premiums and high deductibles within Obamacare and other insurance plans, cutting into down payment and closing cost funds among first-time homebuyers.

Tougher standards within the housing market may also dampen the desire among investors to purchase pre-existing homes. Take the investors out of the 2014 numbers, and the year would have been a disaster. In 2015, investors who flip homes will face tougher FHA rules and new appraisal standards in conventional loans backed by Fannie Mae or Freddie Mac that could diminish their ability to profit from quick re-sales of foreclosures and short sales.

The biggest unknown for the 2015 housing market continues to be the Millennial population. Scores of questions still remain about their ability to qualify for mortgages or come up with funds for down payments and closing costs, given their abundant debt from student and auto loans, as well as credit cards.

President Barack Obama’s directive to FHA this week to cut PMI premiums by 50 basis points sounds great, but in reality it only saves buyers about $41 per month for every $100,000 of loan amount. Although the announcement triggered substantial buying in the homebuilding stocks on Wednesday of this week, the impact of that decision will clearly not make or break home sales.

What it mostly accomplishes is to counter any moderate rises in interest rates, but a byproduct of that decision will be to put FHA at greater financial risk should defaults increase in the future.

So 2015 shapes up to be a questionable year for the real estate market, and likely to be even tougher for the homebuilder stocks.

If you really want a portion of your portfolio in real estate stocks, I continue to prefer the apartment related ETF’s like iShares FTSE NAREIT Resi Index Fund (ETF) (REZ), or REIT stocks such as Equity Residential (EQR). It is likely that most of the Millennials who manage to leave home in 2015 will be renters rather than homeowners, and pre-existing renters seem to be in no hurry to own a home.

However, neither REZ nor EQR look cheap right now and both seem to be a bit overextended, so buying on a pullback is a must.

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

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