August 4, 2013

Homebuilding Sector: Time to Buy or Sell?

Housing markets have heated up, but property prices and construction-related investments have different dynamics worth keeping in mind

News alert: The American public’s love affair with housing market has been rekindled. Although it may be difficult to accept, the very same properties they hated from 2008-09 are now increasing in value.

(Click to Enlarge)The latest S&P/Case-Shiller Home Price Indices – a popular yardstick of nationwide U.S. home prices - showed increases of 2.5% and 2.4% for the 10- and 20-City Composites in May 2013 compared to April 2012.

To further understand the velocity of the run-up in property values, not one of the 20 cities posted a loss over the past year. Furthermore, cities like Dallas and Denver have now surpassed their pre-financial crisis peaks established in June 2007 and August 2006!

David M. Blitzer, chairman of the Index Committee at S&P Dow Jones Indices, noted: “The Southwest and the West saw the strongest year-over-year gains as San Francisco home prices rose 24.5% followed by Las Vegas (+23.3%) and Phoenix (+20.6%). New York (+3.3%), Cleveland (+3.4%) and Washington DC (+6.5%) were the weakest. Monthly numbers before seasonal adjustment showed all 20 cities experienced rising prices. San Francisco (+4.3%), Chicago (+3.7%) and Atlanta (+3.4%) were the leaders.”

Most housing analysts expect home prices to keep gaining and so far they’ve been right.

A March survey of home and mortgage analysts by Zillow showed the consensus median appreciation in 2013 was 4.8%, with only two respondents out of 117 indicating a decline. 

Does this make the homebuilding sector and related REITs a buy?

First, it’s important to have some historical perspective.

Although home prices have staged an impressive rebound, the S&P/Case-Shiller 20-City Index is still 22% lower compared to its 2006-07 peaks. And by definition, market losses greater than 20% are still considered a bear market.

The still elevated number of homeowners with a larger mortgage than the value of their homes is problematic.

CoreLogic reports the percentage of all residential mortgages with negative equity or “underwater” at the end of the first quarter stood at 19.8%. Among the 39 million residential properties with positive equity, 11.2 million have less than 20% equity.

Nevada was the state with the highest percentage of mortgaged properties in negative equity at 45.4%, while Tampa-St. Petersburg-Clearwater, Fla. had the highest percentage of top-25 metropolitan areas at 41.1%.

The threat of higher interest rates is another looming risk that could easily derail the housing rally.

A 30-year fixed rate mortgage now costs 4.53% compared to 3.54% before. In other words, the cost of financing homes is more expensive. And it’s already taken a toll on mortgage refinancing. The Mortgage Bankers Association reports its weekly refinance index has fallen by more than 50% since early May.

While it may yet take a few more months for the housing market to feel the pain of higher rates, ETFs closely tied to U.S. residential real estate are already signaling warning signs.

The iShares DJ US Home Construction ETF (ITB), has slid 9% over the past three months, while the iShares Mortgage Real Estate Capped ETF (REM) has fallen 24.84%. And the iShares Barclays MBS ETF (MBB) has fallen 3.5%, which is almost three-years worth of its 12-month trailing yield!

For home buyers, higher borrowing rates will make home affordability harder. And if the 10-year Treasury yield dances with 3%, it won't be good for the rate sensitive housing market.

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The ETF Advisor Pro Newsletter and its Mega Investment Theme Report identifies major market trends along with actionable ETF strategies.

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