October 21, 2012
For several months, housing has been on a tear, turning homebuilding stocks into the strongest performers within the S&P 500, helping boost profits at forest products companies and others that benefit from an increase in construction activity and buoying consumer confidence.
Now comes Friday's news that sales of existing homes slipped 1.7 percent in September, with sales of single-family homes — which represent the bulk of the U.S. housing inventory — declining at a more rapid rate of 1.9 percent. Despite what seemed to be a signal that homebuyers are pulling back from the market, stock prices of a number of major home builders fared better than other stocks during a trading session in which the Dow Jones Industrial Average posted a triple-digit loss.
That is because what matters less than the rate of sales is what is happening to inventory levels in the housing market – and the breakdown of those sales that do take place. And both of these appear to be encouraging.
Right now, there are fewer homes available for potential homebuyers than at any time since March 2005, and Patrick Newport, U.S. economist at IHS, predicts that seasonal factors will push the supply level down even more between now and the end of 2012. Inventories are 20 percent below where they were a year ago at this time, while the median price has risen 11.3 percent — and those trends are more important than a one-month dip in the rate at which existing homes are changing hands.
Indeed, the inventory data can help explain the September dip in sales. Fewer available homes, obviously enough, means homebuyers are chasing after fewer properties. In an environment where mortgage lending is still constrained – or in which wary homebuyers don’t want to take big price risks – they may well take to the sidelines and wait it out until more inventory comes on the market and there is less pressure on them to bid against rivals for the house of their choice.
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That is likely to remain good news for homebuilders. To the extent that inventory remains low or declines even further, potential homebuyers – couples who have lingered longer than they would have liked in one-bedroom apartments; 20-somethings eager to flee their parents’ home and buy their first place – may end up turning to builders and purchasing a new home.
As panelists at the National Association for Business Economics conference pointed out earlier this week, that’s the one sure way to get what you want and not be disappointed when someone else steps in at the last moment – over and over again – to offer a higher price.
But the question of inventory has another, darker side to it: The debate over what is happening with what has been dubbed the “shadow inventory.” The shadow inventory is to the housing market what the disaffected jobless workers are to the jobs market. The latter have become so frustrated by their difficulty finding work that they have retreated from active searches and thus seem to vanish from the ranks of the unemployed, making it hard for economists to understand how many people really are out of work.
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Similarly, it’s hard to gauge just how many properties that are in foreclosure or in distress may find their way into the market as conditions improve – or when they’ll finally move out of the shadows. The question is at what price level a new surge of properties might hit the market, whether from banks that have foreclosed or from distressed homeowners desperate to get out from under oppressive mortgages.
Estimates classify about a quarter of the 4.75 million annual rate of existing home sales as distressed, down from about 30 percent of the 4.28 million annual rate of sales a year ago in September. That’s a solid trend: If the housing market’s recovery is going to keep on track, it hinges not just on a rising rate of sales or prices but on an improvement in the mix of “distressed” and “conventional” sales. That seems to be happening.
John Canally, an economist and investment strategist at LPL Financial, suggests that while the debate over the dimensions of the shadow inventory remains intense in the marketplace, investors – whether in real estate or in homebuilding stocks – may have less to fear than many prophets of doom might suggest. “While some of that shadow inventory may exist in pockets around the nation, clearly the market doesn’t think it is as significant an issue as it once did,” he says. “In some cases, this ‘shadow inventory’ exists in places where people no longer want to (live) and many of these homes may be left vacant or bulldozed.”
We may well never get back to the days where an annual rate of existing home sales hovered north of 6 million units, as it did during the go-go days of subprime “no doc” mortgage loans. But for those wary of owning homebuilding stocks after their recent runup, simply being able to put aside any immediate concern about the shadow inventory may be enough to give them some greater visibility.