“Sino-Texas Fusion” is not the hottest new culinary craze; it is a recipe for a toxic housing market in 2015.
First, a little background…
Six months ago, at The Oxford Club’s Private Wealth Seminar in Québec, Canada, I addressed the upbeat attendees from the podium and issued a downbeat prediction for the U.S. housing market.
In a brief presentation titled “The Housing Bust of 2015,” I asserted that the U.S. housing market was “not as robust as advertised” and that home prices “might actually fall… or at least stop going up for a while.”
“Here’s the problem,” I explained, “too many all-cash buyers, not enough mortgage-financed buyers…
“While it’s true,” I continued, “that home prices have bounced from their 2010 lows and that sales volumes have picked up somewhat, the structure of this rebound is not ideal. The traditional ‘core buyers’ are missing in action. These core buyers are the young couples and young families who use mortgages to purchase homes… Even with mortgage rates near the lowest levels in a generation, mortgage originations continue to languish near 17-year lows.
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“The U.S. housing market may not be in any immediate peril,” I concluded, “but like any structure that sits atop a shaky foundation, you probably don’t want to put too much weight on the floorboards.”
So now that we are six months into this “crazy” prediction that home prices would stop going up and that homebuilding stocks would start going down, let’s check up on the housing market and see how it’s doing.
On the plus side, mortgage rates have been tumbling recently. That’s definitely a good thing.
But on the minus side, all-cash buyers are becoming somewhat scarce, while first-time homebuyers are still missing in action.
In fact, that’s the exact term that Lawrence Yun, chief economist of the National Association of Realtors, used last Friday when discussing the “mildly disappointing” housing market of 2014. “First-time buyers are still missing in action,” Yun said flatly.
First-time buyers accounted for only 33% of all home purchases in 2014 – the lowest percentage in nearly three decades. Even worse: This percentage continues to drop – hitting 31% in November and 29% in December. Traditionally, first-time buyers purchase about 40% of all homes.
“In a healthy economy,” I explained in my Québec presentation, “young adults leave the nest to form households. We all know the story… Boy meets girl; girl gets pregnant; boy and girl take out a mortgage to buy a home they can’t really afford. But in the current economic environment, something different is happening: Boy is still meeting girl, and girl is still getting pregnant, but then boy and girl are moving in with the parents of either boy or girl. They are not securing a mortgage to buy a house they can’t really afford.”
Clearly something is not quite right with the youngest generation of homebuyers.
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And now, as we enter 2015, the housing market faces a new headwind… Let’s call it the “Sino-Texas Fusion.”
First, the all-cash Chinese buyers who had been snapping up homes throughout Southern California are doing a lot less snapping these days. Chinese buyers, who purchased one-third of all the California homes sold to foreigners last year, have taken a step back from the market, according to Jeffrey Mezger, the CEO of KB Home (NYSE: KBH).
On the company’s recent quarterly conference call, Ivy Zelman, founder of the independent real estate research firm Zelman & Associates, asked Mr. Mezger, “[A]re you concerned about… Southern California, where we’re hearing that Asian buyers are starting to pull back?… Are you hearing anything that would confirm that?”
Mezger replied…
One of the things we’ve picked up on, Ivy, relative to Orange County [Southern California], there has been a pullback on the new home side with the Chinese buyer… There’s a ripple that occurs when Orange County softens a little, and it did, and I do think it was in part that Chinese buyer demand softened. It ripples inland and the further inland you go, the more the ripple is felt. So, we had some areas in the far eastern end of the Inland Empire… say, 60 miles, 70 miles from the coast, where there’s been price pressure, new and used, on the magnitude of 8% or 10% in the last six months, where prices went down that much. So, it hit pretty hard out there… It’s just some short-term market dynamics that we’re facing.
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Meanwhile, in the state of Texas and in other “oil patch” regions of the United States, homebuilders are facing a different kind of “short-term market dynamic.”
The price of oil is plummeting.
A falling oil price is helpful for most facets of the U.S. economy, but it is definitely not helpful for the facets of the U.S. economy that derive their livelihoods from the oil and gas sector.
As Jeffrey Gundlach, the outspoken manager of the $41.8 billion DoubleLine Total Return Bond Fund (Nasdaq: DBLTX), put it recently, “The joyous part of the decline in oil prices is that the consumer feels the savings in their pockets. The sinister side is the effect it might have on employment in the energy renaissance.”
The nation’s homebuilders are now facing this sinister side.
“All the job growth [in the nation] from 2007 until today can really be attributed to the shale boom,” Gundlach observed. The chart below supports Gundlach’s observation.
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The energy-focused economies of Texas, Oklahoma and North Dakota have generated nearly all of America’s net employment growth since 2007. So a reversal of fortunes for the energy sector could well produce negative effects that ripple far beyond the oil patch. The entire country’s employment and/or GDP growth could slow to a crawl.
But even if the economic damage from a falling oil price becomes no more than a “Texas problem,” that would still be a big problem for many homebuilders.
“It is difficult to overstate Texas’ importance to homebuilders,” The Wall Street Journal recently remarked. “According to RBC Capital Markets, Texas accounted for 25% of D.R. Horton Inc.’s completed home sales last year, 23% at Lennar Corp. and 21% at PulteGroup Inc…
“So far,” The Wall Street Journal story continued, “big builders have said publicly that they haven’t noticed a drop-off in Texas sales.”
That’s little comfort, given the fact that many homebuilders are grumbling already about “price pressures,” even before any drop-off in Texas sales… and homebuilding stocks are clearly reflecting those pressures.
Last week, Lennar Corp. shares suffered their biggest one-day drop in nearly two years after reporting pricing pressures and narrowing margins. Two days later, KB Home shares plunged the most in two decades, after the company said it wouldn’t meet profitability targets for the year.
During the last two weeks, the shares of almost every major homebuilder have dropped, even though the S&P 500 Index has gained ground.
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Bottom line: These may not be the worst of times for the homebuilding sector, but neither are they the best of times. And whatever sort of “times” they are, they are likely to get worse.
All-cash buyers are stepping back, first-time buyers are “MIA” and now a falling oil price threatens to undermine what has been one of the nation’s largest and most robust markets for new homes.
So it seems like it might be a decent time to buy a new home… but not a great time to buy a homebuilding stock.
Good investing,
Eric J. Fry
for Free Market Café
The post What’s Wrong With the U.S. Housing Market? appeared first on Non Dollar Report.