Housing Market Booming, But New Home Construction In Trouble

by Ross Heart on August 19, 2013

housing market boomOn July 27th, the Wall Street Journal’s Weekend Investor section advised home buyers with the headline: “How to Win a Bidding War.” When newspapers pump out top-of-the-fold headlines like this, you can rest assured that the housing market is most definitely back.

Recently, I’ve covered a number of longer-term themes that I’m watching through 2013’s second half and potentially beyond – Margin Debt, Apple’s Success, and Where’s the Beef?  This fourth theme revolves around real estate’s renaissance, but identifies an emerging market change that may quickly evolve and has the potential to create interesting dynamics.

When commentators have spoken of “housing market is back”, it usually refers to a catch-all mentality encapsulating the entire housing market (and sub-markets). There is no dispute that housing has rebounded, but going forward I believe a distinct split within its markets is developing. This sharp break could provide a distinct 180° difference between “the existing housing market” and “new home construction” to a point where future attempts to casually combine the two would lead to head-scratching and confusion.

First, let’s tackle the existing home market. Given these bidding wars and numerous reports of houses selling over their offer price, it is obvious that a dearth of inventory is contributing to these positively affected prices. Also, underwriting the housing market’s recovery has been private equity, hedge funds, foreign investors, and other institutional demand for single-family housing, as low interest rates has prompted an all-out search for many non-traditional investments. This has only helped to stoke demand for already supply-challenged markets.

Prevailing wisdom is pointing toward higher interest rates as the reason the housing market may begin to cool off. But I’m not so certain. There is a natural demand for existing housing regardless of conditions, and today’s underlying supply issues leads me to believe prices will hold, or even continue to accelerate higher from current levels. We may even be on the verge of a new housing market bubble (existing housing) from these levels. And, unlike the last demand-driven one, this one would be born of supply issues. What I think is most likely, though, is a sharp divorce of the existing housing market from new home construction.

This brings us to tackling home construction. Building a home, or going through the process of designing/purchasing a new one takes a lot more confidence to initiate than purchasing an existing home. Given the recent volatility in interest and mortgage rates, and the longer time frames and potential frustrations involved with locking in financing, will potential home builders simply gravitate to shopping for already existing housing? If we are still lamenting individual investors not being lured back to the stock markets after setting new highs, it is doubtful that home building could escape the skittishness any economic, stock market, or interest rate shocks would bring.

There are also sociological shifts that have taken place that will solidify for home builders the second any of those potential shocks occur. Scars of the last housing market bubble are still there under the surface for the majority of Americans, and regardless what an index of home sale prices indicates, consumers have become more frugal, more attentive to debt and more financially cautious especially in light of continued stagnancy in the job markets.

Obviously, a sharp division of the existing home and the home building market would have a number of effects. First, and foremost, this could be a massive positive for current home owners who may see continued price appreciation. Most negatively affected would obviously be home-building related stocks (disclosure: at the time of this post, I held a short position in Toll Brothers). There would be numerous off-shoot ramifications to consider in your investing outlook, both positive and negative, if this break were to occur.

Changes are brewing within the housing market (and to home builders), and there has been some great See It Market content recently (Korey Bauer’s Real Estate Stocks Flashing Warning Signs – Andrew Kassen’s Is the Housing market Recovery Faltering and Kelly Hodges’ 5 Tips for New Home Buyers) If you are a home owner, potential buyer, or an investor in housing market related-stocks, I would highly encourage you to keep this possible issue on your radar screen. Housing market may have recovered, but as those recoveries mature and other factors start to take hold, it is quite possible the existing home market and home building markets could be two very dissimilar things.

Heart Capital does not offer investment advice via this medium. Under no circumstance whatsoever do these postings, opinions, charts, or any other information represent a recommendation or personalized investment, tax, or financial planning advice.

Twitter: @heartcapital

Heart Capital holds a short position in Toll Brothers at the time of publication.

Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.

 

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