Read this before loading up on homebuilding stocks
The housing market is strengthening, but can it handle tens of thousands of homes unleashed back onto the market?
Coming out of the housing crisis, hundreds of thousands of homes could have been bought on the cheap. And some of the world's largest investors did just that.
For example, we noted earlier this year that the Blackstone Group (BX) spent roughly $100 million per week buying distressed real estate in 2012. Another company, American Homes 4 Rent (AMH), was formed in 2012 with the sole purpose of buying up cheap properties. The fact the company pulled off an IPO roughly a year after its founding tells you how hot the trend became.
And the timing was surely good. Fast-rising home prices have already made the moves look quite savvy. According to the Standard & Poor's/Case-Shiller home price index, home prices rose 12% in July from a year earlier. In markets where firms like Blackstone were especially active,(such as Las Vegas, Phoenix and Los Angeles) year-over-year gains range from 19% to 27%.
There is cause and effect supporting this dynamic. The vigorous demand for cheap real estate helped take many homes off the market, creating enough scarcity to lift prices. But considering these investment firms now own tens (or hundreds) of thousands of homes, it has a pair of negative implications.
First, they are unlikely to be as aggressive in terms of purchases, now that the bottom-fishing process is in complete. Second, they are sitting on such solid profits in many markets that they are likely to start looking to unload some that built up housing inventory. We may already be seeing the impact, according to Goldman Sachs.
"The softness in the latest housing activity data has added to concerns that the housing recovery in 2012 was entirely driven by low interest rates and institutional investors," noted Goldman's analysts.
What are these institutions doing now? Oaktree Capital (OAK), is already looking to cash in on its housing portfolio, and other institutional investors may soon follow suit.
Make no mistake: The housing market is healthy and likely to stay that way. Sales of existing homes rose 7% in the past three months, compared with a year earlier. And Goldman's analysts remain generally bullish on housing.
"A combination of pent-up housing demand and loosening of mortgage lending standards is likely to drive continued housing recovery," noted Goldman's analysts.
Yet here's another stat top digest: Sales of new homes slid 2% this summer, which indicates that the real action is among existing homes. Blackstone and other institutional investors (besides Oaktree) haven't talked about their pivot from buying to selling, but such a move appears inevitable in light of higher real estate prices and still-affordable mortgages.
This move to unleash tens of thousands of homes back onto the market in coming quarters and years spells real trouble for homebuilders. New homes are typically more expensive than existing homes, which is a real challenge for a millennial generation that is saddled with a hefty amount of school debt. They'll still be buying homes, but if the recent housing stats hold up, they'll be buying lower-priced existing homes, and not pricier newly built homes.
The Market Reaction
This backdrop should give you pause as you are tempted to load up on homebuilding stocks. They've pulled back from their recent peaks but are still trading well above tangible book value (the total value of real estate they own and unsold homes in the building process).
Source: Company reports
Are these companies poised for solid growth in the year ahead, now that the recent new home sales figures are starting to weaken? Well, as far as Wall Street analysts are concerned, the year ahead is expected to be very strong for these homebuilders, as revenues are expected to rise 15% to 40%.
Source: Yahoo Finance
It appears as if the recent slowdown in new home sales has not yet been incorporated into their forecasts. Of course, some of the projected revenue gains will be coming not just from volume but from firmer pricing, as has been the case for the past year. But the S&P/Case-Shiller housing report should dampen that view as well. Home prices rose 0.6% sequentially in July (on a seasonally adjusted basis), compared with 0.9% in June and 1% in May.
Risks to consider: As an upside risk, a much firmer U.S. economy would embolden many on-the-fence homebuyers to buy new homes, though recent signs point to another year of tepid economic growth in 2014.
Action to take: The Blackstone Group will be holding its quarterly conference call on Oct. 17. This call could mark the first time the company articulates its home sales strategy, after several years of being an active homebuyer. If you are tempted to load up on shares of homebuilder stocks after the recent pullback, you may want to wait until analysts have lowered the bar for 2014 growth forecasts, which looks too high right now.
David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.
More from StreetAuthority
- The top 10 stocks for 2014
- Want a piece of Twitter's IPO? Look here first
- This momentum play is poised for another quick pop
At best, inflation rates of year over year house price gains from here on out (4-5%) with seasonal rises and dips.
At worst, a free-fall if the REITs start to dump properties and the economy worsens. A return to Fall 2011/Winter 2012 is not inconceivable.
MORE ON MSN MONEY
Copyright © 2013 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
John Stumpf acknowledges that growth has been slow, but he says he's still optimistic.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.