The housing market’s crumple zone: part 2
[Continued from part 1]
3. Home builders stop building new. Land prices drop. Well documented is the preternatural sensitivity of home builders — if they have not gone in the ground on a new property, they can stop almost immediately, and simply hold the land in inventory. As the Wall Street Journal sonorously intoned last July:
Already reeling from slowing housing sales and worries about the economy, shares of home builders face another issue: the value of the land on their books.
Adjusting to new land values
Observe that because new home development is a highly professionalized sector, home builders tend to be large, publicly-traded companies. This means professional management. Risk has migrated to those best capitalized and best able to bear it.
Parcels are valued at their purchase price on companies’ books, so there isn’t any way of determining the land’s true market value until they sell houses on it. Older purchases are likely worth far more than their listed value on balance sheets, but newer land buys are probably worth less.
The financial markets are notoriously bad at evaluating companies with large real estate holdings.
“We give up … let’s sell”
For that reason, some years back Marriott divested itself of all its real estate; today Marriott basically owns no hotels, having turned itself into a franchisor and brand even as the real estate migrated to long-term institutional investors.
Shares of the nation’s five biggest home builders trade at about 1.3 times their book value, compared with two times book on average over the past five years, according to
Anything the capital markets cannot evaluate, they write down.
How the capital markets see home builders
Pulte Homes Inc. and Beazer Homes USA Inc. trade at about 1.2 times book, while shares of M.D.C. Holdings Inc. trade at 1.1 times and shares of Standard Pacific Corp. trade at about book value.
Home builders are seen as uncontrollable, highly risky, and unpredictable [Hey, what’s wrong with that? — Ed.], so their stock always trades at a low multiple.
Home builders always have had a hard time getting respect on Wall Street, where investors often take a short-term view of the sector’s performance potential.
“The adage has been ‘buy them at book value and sell when they get to two times book value,’” says Arthur Oduma, a senior stock analyst who covers the home builders at Morningstar. “So, that would tell you it’s time to buy.”
A contrarian within the contrarians?
4. Interest rates drop. This last is the most significant. As recently reported on CNN:
The 30-year fixed-rate mortgage averaged 6.18% for the week ending Nov. 22, down from 6.24%, according to Freddie Mac’s (Charts) Primary Mortgage Market Survey. A year ago, the 30-year averaged 6.28%. The 30-year peaked for the year in July, at 6.80%.
Compilation of Weekly Survey Releases for 2006
|
30-yr |
15-yr |
5/1-yr ARM |
1-yr ARM |
|
|
Average Rates: |
6.18% |
5.91% |
5.99% |
5.49% |
|
Fees & Points: |
0.5 |
0.5 |
0.6 |
0.6 |
|
30-yr |
15-yr |
5/1-yr ARM |
1-yr ARM |
|
|
Average Rates: |
6.24% |
5.94% |
6.04% |
5.53% |
|
Fees & Points: |
0.5 |
0.5 |
0.5 |
0.5 |
|
30-yr |
15-yr |
5/1-yr ARM |
1-yr ARM |
|
|
Average Rates: |
6.33% |
6.04% |
6.08% |
5.55% |
|
Fees & Points: |
0.6 |
0.6 |
0.7 |
0.8 |
The rates are dropping steadily …
Scraped from Freddie Mac web site, 11/25/06
Let’s convert that to home price support.
|
12 |
months in a year |
|
|
Price |
300,000 |
320,004 |
|
Rate |
6.80% |
6.18% |
|
Term |
30 |
30 |
|
Constant |
7.82% |
7.33% |
|
Payment |
1,956 |
1,956 |
|
|
|
|
|
Equivalent price rise = |
6.67% |
|
Using a standard 30-year loan, the 62-basis-point drop in rates is equivalent to a hidden 6.7% boost in price affordability. It won’t translate right away, because it applies only to new mortgages, and people who recently bought houses accepted prepayment lockouts or yield maintenance provisions that will inhibit them from refinancing, but still — it’s material hidden relief to the marketplace. The affordability might even be a smidgen better:
That’s about what you get
The 15-year fixed-rate mortgage averaged 5.91% this week, down from 5.94% last week. A year ago, it averaged 5.81%. This is the lowest the 15-year has been since the week ending
Money is a commodity, and the absolute worst yield is that of doing nothing.
Not only is there no interest, sometimes the money actually disintegrates
Home markets are good for an economy, since they move money around, and create demand for capital, but when that sector slows down, the demand for money drops, and its price drops:
“Housing starts in October were down more than expected, which the market saw as an indication housing would be a bigger drag on the economy than had previously been thought,” said Frank Nothaft, Freddie Mac vice president and chief economist, in a statement. “Slower growth usually means less inflation and less inflation means lower interest rates. Hence, the drop in mortgage rates this week.”
Nothaft explains the past.
Thus, the home ownership markets are already adjusting four different ways — in sales homes, the shape of sales prices, delivery of new supply, and the cost of capital. While some of these, like the individual home prices, may have rocky landings, the market as a whole is shifting through its crumple zone.
Even housing crash-test dummies can survive