By George Feiger, CEO of Contango Capital Advisors. From Contango’s current “Heard off the Street” newsletter
We question whether the widely held judgment that the US handled its banking crisis much better than the Europeans will survive the inevitable upturn in interest rates.
Homebuilder stocks have been on a tear, rising 79% in 2012 and off to a very good start again this year. You have read that the inventory of homes for sale is at the lowest level for years. According to Haver Analytics, median existing home prices rose by about 11% over the last twelve months and in the west by an even larger 20%. Most recently the Census Bureau released in December a very upbeat estimate of annualized seasonally-adjusted starts of 954,000, up over 12% from November. All this sounds wonderful and we agree that the housing market seems to have bottomed. But the picture painted by these observations – that housing is poised for a period of strong growth – is probably too good to be true.
Lies, Damn Lies and Statistics
Starting with the simplest thing, it is hard to interpret construction numbers because “annualizing” and “seasonally adjusting” data given the extraordinary events in the housing market over the last 5 years are difficult tasks. Of that 954,000 starts cited above fully 216,000 came from the seasonal adjustment, according to Business Insider. Similarly, they stated that, over the last 12 months, we observed monthly average 67,000 permits for new privately owned housing, 65,000 starts, 54,300 completions and only 30,900 sales. Moreover, apartments represented well over 35% of total housing starts, a level over 10% more than has prevailed since the mid-1980s. The single family home market still languishes.
More Homes Than you Think are for Sale
Underneath the number are more fundamental issues that are going to take a while to resolve. First, there remains a large “potential supply” of single family homes for sale. According to BCA Research, if one adds existing homes for sale, single family homes for rent and homes held off the market for other reasons, there remain over 10 million vacant housing units or something well over 7% of the single family housing stock. Foreclosures have slowed down but still run around 1.5 million at an annual rate and delinquent mortgages have fallen but remain around 7% of all mortgages outstanding.
There is another “shadow supply”. Somewhere between 25 and 30% of all house sales in 2011 were cash sales to speculators rather than to potential “final residents”. In all likelihood in the Western states hardest hit by the collapse of house prices the percentage of sales to speculators was even higher. These looked like great investments to generate rental cash flow but some of the original buyers now want out, like the Och-Ziff hedge fund which was one of the early bulk buyers. According to Reuters it proved more difficult than originally thought to manage dispersed single family rental properties and the pick-up in prices provided a reasonable capital gain on exit. But this is hardly a permanent solution to the single family housing market since there needs to be a genuine, long-term buyer at the end of the chain.
But Fewer Buyers Than You Imagine
Where will these buyers come from? Optimists point out two factors: the pent-up demand for housing from the rising number of family units that have been kept out of the housing market and are presumably living with families and friends; and the extraordinarily low cost of ownership versus renting. On the latter point, BCA calculates that the typical ratio of hypothetical interest and principal payments to rent of a comparable property is now about 0.35, versus an average of around 0.6. While these things are true, they don’t demonstrate that we will see a rapid upswing in home purchases, as the little table below demonstrates (click to enlarge).
That is, it is no longer easy, or even possible, to get a 95% or 100% loan-to-value mortgage as a first-time (or any time!) buyer. Putting down even 10% appears to be beyond the means of many potential buyers. Why? A combination of two factors. First, household savings rates in the US fell dramatically over the last 15 years as people consumed more, often on credit so that there isn’t much there to make a down-payment. Second, unemployment remains high and people without significant education or highly marketable skills are loath to use all their savings on a home down-payment because they are not secure in their employment.
We think that housing will get better and gradually increase its contribution to economic growth. But after the bounce from a deep bottom we also think that recovery will be slow and will remain more focused to rental units than has traditionally been the case. In the most distressed markets the easy money in buying distressed property has likely already been made and the complexity of renting it out has only now begun to be appreciated.