Housing Inventories Hit Record High

"The backlog of unsold new homes reached a record level last month, as sales slipped despite the warmest January in more than 100 years. The Commerce Department reported Monday that sales of new single-family homes dropped by 5 percent to a seasonally adjusted annual rate of 1.233 million units last month. That was the slowest pace since January 2005 and left the number of unsold homes at a record high of 528,000."

The housing boom is over folks. Inventory data is crucial for real estate. There is no magic formula for calculating fair value of residential housing. You can't run a discounted cash flow model, or dividend discount model. Housing prices are simply based on supply and demand. And supply is at an all-time high.

Even here in St. Louis, hardly a booming market, I am seeing more and more houses going up for sale, even though others have been on the market for months. Mortgage rates are up and millions of ARM loans readjust this year. Home equity loan rates are also on the rise. Fed Funds will hit 5% this year, which puts the prime rate at 8% and most home equity loan rates at 9%.

It's not a complex scenario. Supply is high as the inventory numbers show. Interest rates, the cost of money, are going up and will adversely affect demand. Not a good combination. Housing stocks may look attractive with low P/E ratios, but don't forget why housing stocks always have low multiples; because the cycle always ends.

Despite Real Estate Boom, Stocks Still King

Here's a pop quiz:

By how much has the domestic residential real estate market outperformed the S&P 500 index over the past three years?

The U. S. real estate market has seen its biggest boom in history in recent years. Investors who have moved away from the stock market and shifted their assets into housing are probably very happy they made such a move. But should they be? It depends, but the numbers themselves tell an interesting story.

Since 2003, residential housing prices in the U.S. have risen by 10 percent per year. In fact, the annual returns have been accelerating, 7% in 2003, 11% in 2004, and 12% in 2005. Despite such a strong market, investors in the stock market have actually done even better, as the S&P 500 has advanced 13% per year during the same period.

If a huge housing boom can't even match the stock market's performance, it serves as yet another quantitative example of why equities have outperformed real estate by a factor of three throughout history.

More Proof of a Housing Bubble

Kids are graduating college and immediately buying houses. Rent an apartment? What are you, crazy? Extra cash is being invested, not in stocks (by far the best performing asset class since the beginning of time), but rather in real estate.

When people reflect on the Internet stock bubble of the late 1990's, they often recall shares of Yahoo! and Amazon.com being the most common topics of conversations at dinner parties. Nowadays I find myself at poker games where investing in real estate is the main topic of conversation.

A few months ago, I got an email from a University of Missouri student who had been present for one of my guest lectures during his senior year. He had moved back to St. Louis after graduation and, along with a buddy of his, wanted to meet with me to discuss investment opportunities. Maybe they wanted to take my advice and open a Roth IRA, I thought. I was thrilled to sit down with them and offer some advice.

Turns out Roth IRAs were the farthest thing from their minds. Instead, they had assembled a group of 20 or so friends, most in their early 20's. Their plan was to pool money together and invest in real estate. They figured 20 people contributing $200 a month would net them $10,000 within three months; enough for a down payment on a $50,000 house, which they would then fix and resell for a profit.

This is the type of behavior the current real estate market has induced. Amazing really, given what we all experienced just five short years ago. The logic seems to be that stocks were just pieces of paper, but houses are a much safer asset. Houses might be more tangible, but regardless of what you are investing in, the only thing that really matters is how much you pay for it and how much it will ultimately be worth.

Below is a link to an article from Sunday's L.A. Times (free registration required). If you don't think there is a real estate bubble in this country after reading it, I'd be surprised. The author may be highlighting California-specific instances, but something tells me it's happening in a lot of other states as well.

Housing and Rising Interest Rates

After months of baffling investment strategists and economists, long-term interest rates have finally begun to rise. The 10-year bond rate has risen from under 4.00% to nearly 4.40% in a heartbeat. Prospective home buyers are finding their rates rising, putting pressure on them to lock in a low rate as soon as possible.

There is little doubt that higher rates will hurt the housing market. The homebuilding stocks haven't been hit much yet, but it's certainly dangerous to own them for the rest of the year, if this rate trend continues. If you believe rates will continue to move higher, the housing stocks could make for an attractive short (especially with the S&P 500 setting up for a potential triple top).

If you want further evidence to question the sustainability of the homebuilding sector's tremendous run on Wall Street, below is a piece written this week by a very competent hedge fund manager:

"According to the National Association of Realtors, who should know, second homes accounted for 36% of U.S. home purchases last year, up from more than 16% in 2003. That 36% breaks down thusly: 25% of homes were bought for investment; 13% bought as vacation homes.

Think about that for a second. More than a third of all homes bought last year were bought for either speculative purposes or as vacation homes.

This doesn't square at all with the mantra of the home building companies and their fans, which is that the U.S. has a perennial housing shortage caused by job creation, immigration and the deep-seated hunger for home ownership.It has nothing to do, they assure investors, with the recent 4% 10 year treasury yield.

It has nothing to do with adjustable rate mortgages or "IO" loans--interest only loans--in which the only thing the homeowner pays is the interest, leaving the principle for later (which to the buyer means "when I flip the thing for a big profit").

And it has absolutely nothing to do with speculative buying, according to home builders including--and I've heard them all say it--Toll Brothers, Pulte, Lennar, KB and Hovnanian.

But now we know the facts: home purchases were inflated a full 20% (the jump from 16% in 2003 to 36% in 2004) by boomers snapping up spec housing and vacation homes around the country. That's a bubble.

And not for nothing, it seems the average single-family home financed by Fannie Mae or Freddie Mac shot up almost 12% last year, the highest rate since 1979. For those who remember that far back, 1979 ushered in a couple of pretty ugly years in the housing market."