Housing Market Momentum Bodes Well for Economy and Retailers
MARTINSVILLE, N.J., Nov. 27, 2012 /PRNewswire/ -- With an estimated 13 million homeowners underwater on their mortgages and average home prices nearly 30% below their 2006 peak – a decline that has wiped out $7 trillion in household wealth – it is no wonder that many are still skeptical about a housing market recovery. However, there is reason for optimism, echoed by famed investor Warren Buffett, who remarked earlier this year that he would purchase "a couple hundred thousand" single family homes if it was practical to do so considering depressed real estate prices and the availability of financing at historically low levels. Against this backdrop, recent trends in the housing market not only bode well for homebuilders, but for certain retailers and the broader economy as well, according to Ken Schapiro of Condor Capital Management.
After a precipitous decline following the housing bubble's burst, home prices have seen a slow but steady improvement so far this year. To illustrate, the S&P/Case-Shiller Home Price Index posted its sixth straight monthly gain in September, rising 0.29%, extending the year-to-date increase to 7.04%. Unlike the temporary gains seen in the wake of the first time home buyer's tax credit, this year's recovery appears to be organic and self-sustaining. The average selling price for existing homes has shown even stronger gains, up 11.1% year-over-year in October. This can be partly attributed to a decline in inventory, with the number of previously owned homes on the market declining to 2.14 million in October, the lowest since December 2002. Further, the current inventory of new homes is at its lowest level since data began being collected in 1963. Consequently, new home starts have been trending higher this year and surged to an annualized rate of 894,000 in October, the highest level in 4 years. Although this is a vast improvement over the 478,000 rate witnessed in April 2009, it is a far cry from the estimated 1.2 million that is needed to keep up with population growth and household creation. Given the dearth of building over the last 4 years, it is likely that new home construction will need to accelerate above the historical average to account for this shortfall. Given the immense money multiplier effect of the housing industry, this could provide a meaningful lift for economic growth in the coming years.
However, it is important to note that the pace of recovery could be divergent between states. States such as Nevada and Florida that saw some of the steepest declines are now rebounding as investors have stepped in to purchase large lots of distressed properties. Conversely, more-litigious states such as New Jersey are likely to have a longer road to recovery. Since such states require a court review of all foreclosures, distressed properties take much longer to come to market, something that was only amplified by the recent "robo-signing" scandal. Shadow inventories in New Jersey are comparatively large and may pose a headwind to further price gains since distressed sales are typically executed below a given home's true market value. On the other hand, the devastation left in the wake of Hurricane Sandy could have a silver lining for the state in that reconstruction efforts will spur spending and boost employment of construction workers, one of the hardest hit groups since the last recession.
Looking forward, there are several tailwinds that bode well for sustained momentum in the national housing industry. First and foremost, low mortgage rates and depressed real estate prices have led to a dramatic increase in home affordability and have swung price-to-rent ratios solidly in favor of purchasing in most markets. With the Federal Reserve planning to purchase $40 billion a month in mortgage-backed securities in an effort to boost the economy, mortgage rates are likely to remain low, and could even have further room to the downside. Additionally, forthcoming rule changes should help relax today's strict lending standards and improve borrowers' access to credit. Beginning January 1, 2013, banks selling mortgages to Fannie Mae and Freddie Mac cannot be forced to repurchase defaulted loans that have experienced 36 straight months of on-time payment if they were originated after January 1st. Aside from these monetary factors, certain social and demographic trends that have had a drag on housing since the recession have shown signs of improvement recently. Amid steep job losses, financial strain, and a weak job market for recent college graduates, new household formation trended well below the historical average in the past few years. However, in the twelve months through September 2012, 1.15 million new households were created in the U.S., up sharply from the 650,000 per year created in the prior four years. Although unemployment remains stubbornly high, slow improvement is likely to continue to buoy household creation and drive a move-out-of-the-basement rally.
Despite regional inconsistencies, it is clear that the national housing picture is improving. Given this, investors' optimism has already pushed the S&P Homebuilders Index up by over 50% in the past year. At the same time, home improvement retailers such as Lowe's and Home Depot also stand to benefit from the renovation of foreclosed properties as well as the construction of new homes in the coming years. Other stores, such as Bed Bath and Beyond, will also likely receive a lift from an increase in household formation as young people move out on their own for the first time and purchase household necessities.
A less obvious winner could be non-housing related retailers, as a gain in home prices and a decline in the number of underwater mortgages helps consumers feel wealthier, more financially stable, and more confident to spend their hard-earned money. Economists estimate that for every $10,000 increase in household wealth, including the value of one's home, consumers spend an additional $400 on discretionary purchases. With both home prices and stocks up nicely this year and a favorable calendar – with Thanksgiving falling on the earliest date possible – the upcoming holiday shopping season should prove to be strong. Since wealthier Americans tend to have greater exposure to the stock market, and therefore have benefited more from this year's rally, higher-end retailers are positioned particularly well. To that end, a recent study by American Express Publishing and the Harrison Group indicated that Americans in the top 10%, measured by income, intend to increase their holiday gift spending by a staggering 21.9% this year. At the same time, the survey indicated that the remaining population may spend 11% less. We feel that this could lead to sales that are divergent between retailers. While Wal-Mart recently struck a cautious note in its outlook for the holiday shopping season, those at the higher end, such as Nordstrom and Coach, stand to perform better than expected due to the so-called wealth effect.
At the time of this article, Condor Capital Management held long positions in Home Depot, Lowe's, Bed Bath & Beyond, Coach, and Nordstrom in some of its clients' portfolios.
Founded in 1988, Condor Capital is an employee-owned, SEC-registered investment advisor based in Martinsville, N.J. employing 15 professional and support staff. Since Condor is a fee-only investment management firm, its fees are based on portfolio size, not sales commissions or number of trades. For more information on Condor Capital, please visit www.condorcapital.com or call 732-356-7323.
SOURCE Condor Capital Management