Global Market Comments
April 18, 2018
Fiat Lux
Special Residential Real Estate Issue
Featured Trade:
(WHY THE HOMEBUILDERS ARE NOT DEAD YET),
(DHI), (TOL), (LEN), (ITB), (KBH)
Tag Archive for: (LEN)
It was as if someone had turned out the lights.
The homebuilders, after delivering one of the most prolific investment performance of any sector until the end of January, suddenly collapsed.
Since then, they have been dead as a door knob, flat on their backs, barely exhibiting a breath of life. While most of the market has since seen massive short covering rallies, the homebuilders have remained moribund.
The knee-jerk reaction has been to blame rising interest rates. But in fact, rates have barely moved since the homebuilders peaked, the 10-year US treasury yield remaining confined to an ultra-narrow tedious 2.72% to 2.95% yield.
The surprise Canadian limber import duty has definitely hurt, raising the price of a new home by an average of $3,000. But that is not enough to demolish the entire sector, especially given long lines at homebuilder model homes.
Are the homebuilders gone for good? Or are they just resting.
I vote for the later.
For years now, I have begged, pleaded, and beseeched readers to pour as much money as they can into residential real estate.
Investing in your own residence has generated far and away the largest returns on investment for the past five years, and this will continue for the next 10 to 15 years.
For we are still in the early innings of a major real estate boom.
A home you buy today could increase in value tenfold by 2030, and more if you do so on the high-growth coasts.
And while I have been preaching this view to followers for years, I have been assaulted by the slings and arrows of naysayers predicting that the next housing crash is just around the corner - only this time, it will be worse.
I have recently gained some important new firepower in my campaign.
My friends at alma mater UC Berkley (Go Bears!), specifically the Fisher Center for Real Estate and Urban Economics, have just published a report written by the Rosen Consulting Group that is blowing the socks off the entire real estate world.
The implications for markets, and indeed the nation as a whole, are nothing less than mind-blowing.
It's like having a Marine detachment of 155 mm howitzers suddenly come in on your side.
The big revelation is that only a few minor tweaks and massaging of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 could unleash a new tidal wave of home buyers that will send house prices, and the shares of homebuilders (ITB) ballistic.
The real estate industry would at last be restored to its former glory.
That's the happy ending. Now let's get down to the nitty gritty.
First, let's review the wreckage of the 2008 housing crash.
Real estate probably suffered more than any other industry during the Great Recession.
After all, the banks received a federal bailout, and General Motors was taken over by the Feds. Remember Cash for Clunkers?
No such luck with politically unconnected real estate agents and homebuilders.
As a result, private homeownership in the US has cratered from 69.2% in 2006 to 63.4% in 2016, a 50-year low.
Homeownership for married couples was cut from 84.1% to 79.6%.
Among major cities, San Diego led the charge to the downside, an area where minority and immigrant participation in the market is particularly high, with homeownership shrinking from 65.7% to a lowly 51.8%.
Home price declines were worse in the major subprime cities of Las Vegas, Phoenix, and Miami.
There were a staggering 9.4 million foreclosures during 2007-2014, with adjustable rate loans accounting for two-thirds of the total.
Some 8.7 million jobs were lost from 2007-2010, while the unemployment rate soared from 5.0% to 10%. The collapse in disposable income that followed made a rapid recovery in home prices impossible.
As a result, real estate's contribution to US GDP growth fell from 17.9% of the total to only 15.6% in 2016.
That is a big hit for the economy and is a major reason why growth has remained stuck in recent years at a 2% annual rate.
While the ruins were still smoking, Congress passed Dodd-Frank in 2010. The bill succeeded in preventing any more large banks from going under, with massive recapitalization requirements.
As a result, US banks are now the strongest in the world (and also a great BUY at these levels).
But it also clipped the banks' wings with stringent new lending restrictions.
I recently refinanced my homes to lock in 3% interest rates for the long term, since inflation is returning, and I can't tell you what a nightmare it was.
I had to pay a year's worth of home insurance and county property taxes in advance, which were then kept in an impound account.
I was forced to supply two years worth of bank statements for five different accounts.
Handing over two years worth of federal tax returns wasn't good enough.
To prevent borrowers from ginning up their own on TurboTax, a common tactic for marginal borrowers before the last crash, they must be independently verified with a full IRS transcript.
Guess what? A budget constrained IRS is remarkably slow and inefficient at performing this task. Three attempts are common, while your loan sits in limbo.
(And don't even think of asking for Donald Trump's return when you do this. They have NO sense of humor at the IRS!)
Heaven help you if you have a FICO score under 700.
I had to hand over a dozen letters of explanation dealing with assorted anomalies in my finances. My life is complicated.
Their chief goal seemed to be to absolve the lender from any liability whatsoever.
And here's the real killer.
From 2014, banks were forced to require from borrowers a 43% debt service to income ratio. In other words, your monthly interest payment, property taxes, and real estate taxes can't exceed 43% of your monthly gross income.
This hurdle alone has been the death of a thousand loans.
It is no surprise then that the outstanding balance of home mortgages has seen its sharpest drop in history, from $11.3 trillion to $9.8 trillion during 2008-2014. It is down by a third since the 2007 peak.
Loans that DO get done have seen their average FICO scores jump from 707 to 760.
Rocketing home prices are making matters worse, by reducing affordability.
Only 56% of the population can now qualify to buy the mean American home priced at $224,000, which is up 7.7% YOY.
Residential fixed investment is now 32% lower than the 2005 peak.
Also weighing on the market was a student loan balance that rocketed by 400% to $1.3 trillion since 2003. This eliminated a principal source of first-time buyers from the market, a major source of new capital at the low end.
Now for the good news.
Keep Dodd-Frank's capital requirements, but ease up on the lending standards only slightly, and all of the trends that have been a drag on the market quickly reverse.
And yes, some 2.3% in missing US GDP comes back in a hurry, and then some. That's a whole year's worth of economic growth at current rates.
Rising incomes generated by a full employment economy increase loan approvals.
Foreclosure rates will fall.
More capital will pour into homebuilding, alleviating severely constrained supply.
More investment in homes as inflation hedges steps up from here.
The entry of Millennials into the market in a serious way for the first time further increases demand.
Promised individual tax cuts will add a turbocharger to this market.
There is one way the Trump administration could demolish this housing renaissance.
If the deductibility of home mortgage interest from taxable income on Form 1040 Schedule "A" is cut back or eliminated to pay for tax cuts for the wealthy, a proposal now being actively discussed in the White House, the whole party is canceled.
The average American will lose his biggest tax break, and the impact on housing will be huge.
A continued war on immigrants will also hurt, which accounted for one-third of all new households from 1994-2015.
You see, we let them in for a good reason.
Assuming this policy self-inflicted wound doesn't happen, the entire homebuilding sector is a screaming "BUY."
On the menu are Toll Brothers (TOL), DH Horton (DHI), and Pulte Homes (PHM).
You can also add the IShares US Home Construction ETF (ITB), a basket of the leading homebuilding names (For the prospectus, click here.)
To read the UC Berkeley report in its entirety, entitled Homeownership in Crisis: Where Are We Now? a must for any serious real estate professional or investor, please download the PDF file for free by clicking here.
The bottom line here is that after a three-month break, the stirrings of a recovery in homebuilders may be just beginning.
Where It's Hot
It's Always Better on the Coasts
Real estate brokers are still reeling from the news that December existing home sales rocketed by a blockbuster 14.7%, to an annualized 5.46 million units.
And now I hear that Apple (AAPL) is planning on building a second new research and development campus that will need 20,000 new high tech workers. The housing crisis here in the San Francisco Bay area just went from bad to worse.
It is all fresh fuel for a continuation in the bull market for US residential real estate, not just for this year, but for another decade.
Friends in the industry tell me the eye popping numbers were due to the implementation of the TILA-RESPA Integrated Disclosure (TRID) in October.
Dubbed the ?Know before you owe? requirement, TRID is the inevitable outcome of the 2008 subprime housing crash.
If you weren?t born yet in 2008, or were living in a cave on a remote Pacific island back then, go watch the movie ?The Big Short? for a further explanation of those dark days.
As a result, real estate closings now take at least a week longer, and sometimes more, thanks to a new requirement for several three day ?cooling off periods.?
When the new law kicked in, TRID nearly brought he industry to a halt, and firms were sent scurrying to their attorneys to draw up the new disclosure forms to stay within the law.
TRID undoubtedly was responsible for the slowdown in the market in the run up to December.
Although prices seem high now, I am convinced that we are only at the beginning of a long term secular bull market in housing. Anything you purchase now is going to make you look like a genius ten years down the road.
The best is yet to come.
The big driver will be demographics, of course.
From 2022 onward, 65 million Gen Xer?s will be joined by 85 million late blooming Millennials in bidding wars for the same houses. That will create a market of 150 million buyers, unprecedented in the history of the American real estate market.
In the meantime, 80 million baby boomers, net sellers and downsizers of homes for the past decade, will slowly die off and disappear from the scene as a negative influence. Only one third are still working.
The first boomer, Kathleen Casey-Kirschling, born seconds after midnight on January 1, 1946, will become 76 years old by then. A former school teacher, she took early retirement at 62.
The real fat on the fire here is that 5 million homes went missing in action this decade, thanks to the financial crisis. They were never built.
This is the result of the bankruptcy of several homebuilders, and the new found ultra conservatism of the survivors, like DR Horton (DHI), Lennar Homes (LEN), and Pulte Group (PHM).
Did I mention that all of this makes this sector a screaming ?BUY?, once the market moves into ?RISK ON? mode later in the year?
Talk to any real estate agent and they will complain about the shortage of inventory (except in Chicago, the slowest growing market in the country).
Prices are so high already that flippers have been squeezed out of the market for good. Bottom feeders, like hedge funds buying at the bankruptcy auctions, are a distant memory. Some now own more than 20,000 homes.
Income taxes are certain to rise in coming years, and the generous deductions allowed homeowners are looking more attractive by the day.
And let?s face it, ultra low interest rates aren?t going to be here forever. Borrow at 3% today against a long term 3% inflation rate, and you are essentially getting you house for free.
The rising rents that are turning Millennials from renters to buyers may be the first sign of real inflation beyond the increasingly dear health care and higher education that we're are already seeing.
And Millennials are having kids that demand a bigger living space! Who knew?
I may become a grandfather yet!
Looks Like a ?BUY? to Me
It is always a great idea to know how bomb proof your portfolio is.
Big hedge funds have teams of MIT educated mathematicians that constantly build models that stress test their holdings for every conceivable outcome.
WWIII? A Global pandemic? A 1,000 point flash crash? No problem. Analysts will tell you to the decimal point exactly how trading books will perform in every possible scenario.
The problem is that these are just predictions, which is code for ?educated guesses.?
The most notorious example of this was the Long Term Capital Management melt down where the best minds in the world constructed a portfolio that essentially vaporized in two weeks with a total loss.
S&P 500 volatility (VIX) exceeding $40? Never happen!
Oops. Better get those resumes out!
That?s why events like the Monday, August 24 1,000 flash crash are particularly valuable. While numbers and probabilities are great, they are not certainties. Nothing beats real world experience.
As markets are populated by humans, they will do things that no one can anticipate. Every machine has its programming shortcoming.
Given that standard, I think the Mad Hedge Fund Trader?s strategy did pretty well in the downdraft. I went into Monday with an aggressive ?RISK ON? portfolio that included the following:
The basic assumptions of this book were that the long term bull market has more to run, the housing sector would lead, interest rates would rise going into the September 17 Federal Reserve meeting, the dollar would remain strong, and that stock market volatility would stay within a 12%-20% range.
What we got was the sharpest one-day stock decline in history, a 28 basis point spike up in interest rates, a complete collapse in the dollar, and stock market volatility at an eye popping 53.85%.
Yikes! I couldn?t have been more wrong.
Now here?s the good news.
When we finally got believable options prices 30 minutes after the opening I priced my portfolio, bracing myself. My August performance plunged from +5.12% on Friday to -10%.
Hey, I never promised you a rose garden.
But that only took my performance for the year back to my June 17 figure, when I was up 23% on the year. In other words, I had only given up two months worth of profits, and that was at the low of the day.
I then sat back and watched the Dow rally an incredible 800 points. Now it was time to de risk. So I dumped my entire portfolio. The assumptions for the portfolio were no longer valid, so I unloaded the entire thing.
This was no time to be stubborn, proud, and full of hubris.
By the end of the day, I was down only -0.48% for August, and up +32.65% for the year.
Ask any manager, and they would have given their right arm to be down only -0.28% on August 24.
Of course, it helped that I had spent all month aggressively shorting the market into the crash, building up a nice 5.12% bank of profits to trade against. That is one of the reasons you subscribe to the Diary of a Mad Hedge Fund Trader.
The biggest hit came from my short position in the Japanese yen (FXY), which was just backing off of a decade low and therefore coiled for a sharp reversal. It cost me -4.85%.
My smallest loss was found in the short Treasury bond position (TLT), where I only shed 1.52%. But the (TLT) had already rallied 9 points going into the crash, so I was only able to eke out another 4 points to the upside on a flight to safety bid.
Lennar Homes gave me a 2.59% hickey, while the S&P 500 long I added only on Friday (after all, the market was then already extremely oversold) subtracted another 1.61%.
The big lesson here is that my short option hedges were worth their weight in gold. Without them, the losses on the Monday opening would have been intolerable, some two to three times higher.
You can come back from a 10% loss. I have done so many times in my life. A 30% loss is a completely different kettle of fish, and is life threatening.
For years, readers complained that my strategy was too conservative and cautious, really suited for the old man that I have become.
Readers were able to make a lot more money following my Trade Alerts through just buying the call options and skipping the hedge, or better yet, buying the futures.
I didn?t receive a single one of those complaints on Monday.
I?ll tell you who you didn?t hear from on Monday, and that was friends who pursued the moronic trading strategies you often find touted on the Internet.
That includes approaches like leveraged naked shorting of puts that are always advertising fantastic track records...when they work.
You didn?t hear from them because they were on the phone pleading with their brokers while they were forcibly liquidating portfolio showing 100% losses.
Any idiot can look like a genius shorting puts until it blows up in their face on a day like Monday and they lose everything they have. I know this because many of these people end up buying my service after getting wiped out by others.
I work on the theory that I am too old to go broke and start over. Besides, Morgan Stanley probably wouldn?t have me back anyway. It?s a different firm now.
Would I have made more money just sitting tight and doing nothing?
Absolutely!
But the risks involved would have been unacceptable. I would have failed my own test of not being able to sleep at night. That is not what this service is all about.
In any case, I know I can go back to the market and make money anytime I want. That makes the hits easier to swallow.
You can?t do this without any capital.
With the stress test of stress tests behind us, the rest of the years should be a piece of cake.
Good luck, and good trading.
Sometimes It Pays to Be Old
Two years ago, there was an open house listed in the San Francisco Chronicle in my neighborhood for $1.8 million. It offered a cavernous 6,000 square feet, five bedrooms, a generous den I could use as a home office, a gourmet kitchen, and a spectacular view of the entire bay area. It was a slow Sunday, so I went to check it out.
The home offered every imaginable upgrade, including a four-car garage, elevator, and beveled glass windows in the 1,000-bottle temperature and humidity controlled wine cellar. Nobody cared. The building was deserted except for a lonely and depressed listing agent. The only visitors had been a handful of other real estate agents.
The seller gave up, pulled the listing, and rented it to a visiting Oracle executive for two years. I heard the agent got so fed up dealing with people in bad moods that she left the industry.
Last weekend, another open house was advertised for the same exact house. I thought I would drop by and see how the market had changed. There was not a parking spot to be found on the street. After quite a hike, I made it to the house, only to be told to wait in line to gain entry. The rooms were as crowded as a Tokyo subway car at rush hour. I briefly lost the kids in the shuffle. And this was at the new listing price of $3.5 million. Yikes!
I asked a younger, slimmer, better looking listing agent if there had been any interest. She answered abruptly that there had been three all-cash offers since the morning. Unless I wanted to pay over the asking price, I shouldn?t waist my time. Double yikes!
The bottom line of this little interchange is that the recovery in the residential real estate market is real, has legs, and will have a major positive impact on the US economy. The implications for the rest of us are huge.
The turnaround came much earlier than many analysts expected, and has proceeded with an amazing ferocity. Demographic data suggest this wasn?t supposed to happen until 2022, when most of the Baby Boomers have retired and a new generation of homebuyers appears. Home mortgages, especially jumbos, are still hard to get. The banks are still laboring under a stock of 5 million foreclosed homes. Some 20% of homeowners are still underwater on their mortgages and are unable to trade up or out.
It appears that the prospect of the end of the ultra low interest regime offsets all of this. The Fed is certainly putting the pedal to the metal, with 3.5% interest rates charged for 30-year mortgages. Everyone knows these are a once a century occurrence, hence the bubble 2.0. Buyers are ducking credit issues by paying all cash for 50% of recent closing. Hedge funds, private equity funds, and other long-term investors are still generating 30% of purchases, as they see this a one great big yield play.
We learned as much yesterday when the January S&P-Case Shiller data was released. It was a blowout report, with the 20-city index showing an eye popping 8.1% YOY gain in prices. This is three-month-old data, and February and March are expected to be stronger still.
The basket cases of yesterday are delivering the headiest gains, with Phoenix up +23.2%, San Francisco, +17.5%, and Las Vegas, +15.3%. The foreclosure capital of the United States only a year ago, Atlanta, showed a robust +13.4% improvement.
The residential real estate market is not without its shortcomings. First time homebuyers have been conspicuously absent, accounting for only 30% of new deals, instead of 60% during the last cycle. They are, no doubt, being shut out by credit issues. What will happen to the millions of homes that institutions bought, once their have substantial capital gains? My bet is that they sell to realize profits, capping further appreciation.
The snapback in new construction has been even more dramatic. Monthly new housing starts have soared from the low 300,000?s to 800,000 in the last three years, a jump of 167%. That?s still a fraction of the 2.2 million peak we saw in 2006. Surviving homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) so dramatically shrank their cost basis during the dark days that they are unable to meet current demand.
The obvious benefit for the rest of us is the addition of 50-75 basis points to the US GDP growth rate this year. We?ll get a better read with a future GDP announcement, which could bring in a preliminary Q1 number as high as 3%. That will most likely take us to the Fed?s target of a headline unemployment rate of 6.5% sooner than later.
There is a greater advantage for we stock investors. Some two thirds of the home equity lost since the 2008 crash has been recovered. The total value of the US housing stock has bounced back from $10 trillion to $17 trillion. That creates a huge ?wealth effect? that steers more individual investors back into risk assets generally, and shares specifically. Should anyone be surprised that the Dow average is grinding to new all time highs every other day?
Not a day goes by when you don?t hear of shortages of workers in the building trades, such carpenters and plumbers. As a result, the shares of this sector have been the best market performers over the past 18 months, with some issues rising sevenfold. Whatever you do, don?t rush out and buy these stocks. They have run too far, too fast, and the risk/reward is terrible here. You missed it. I missed it.
Better just to bask in the glow of a home that it rising in value daily, and a retirement portfolio that is doing the same.
What Am I Bid?
Before you place a down payment on that next home, consider that you are voluntarily becoming dependent on government welfare, reliant on massive subsidies, and may become the next ward of the state.
Don?t kid yourself that the housing market has become anything but another bubble driven by artificially low interest rates and lax lending standards. Without the wholesale privatization of profits and socialization of losses, the current ebullient real estate market would instantly cease to exist. That cruel ending may be a lot closer than you think, as well.
Some 95% of all home mortgages are now bought by the US home mortgage agencies, Fannie Mae and Freddie Mac. That is up from only 35% in 2006. Never mind that both of these institutions are in conservatorship, which is a polite way of saying they are bankrupt, having burned through all of their capital during the housing bust.
Without this source of government funds, there is absolutely no way banks would be lending anywhere near the amount they are, as the spreads have become too minuscule to make it worthwhile. But by selling loans to the government they can offload their risk and skim off handsome fees along the way.
This is why the balance sheet of the Federal Reserve has grown to a mind boggling $3.8 trillion, on its way to $5 trillion, but we are measuring no real growth in the money supply. The money is simply moving from one government account to another, untouched by human hands.
The current pattern of modest appreciation in the most oversold markets, like Miami, Phoenix, and Las Vegas, will continue, as long as the Fed is giving us money for free and the government is bearing all the credit risk. When that ends, things could turn very ugly, very fast.
Most of my hedge fund friends expect ten-year Treasury yields to be back above 4% in two years. That would take the rates for the conventional 30-year fixed rate home loans from 3.50% to 6%, or more. Double the cost of carry on a house, and you halve the affordability. The effects on the secondary market would be devastating.
While many have nice paper profits on houses they bought over the last two years, that all becomes very academic if you can?t sell. The number of homeowners currently delinquent or in foreclosure would soar from the current 6 million to 16 million. That would be piled on top of the 30 million hapless homeowners, who, despite the bounce, are still underwater on their mortgages.
This is not some wild conspiracy theory that I picked up on the Internet. Since congress is in a cost cutting mood, the chances of Fannie Mae and Freddie Mac getting sufficient recapitalization are small. The home mortgage tax deduction is also on the chopping block. At the very least, we can expect it to get pared back to mortgages of $500,000 or less. That would seriously boost the real after tax cost of homeownership, especially on the high priced left and right coasts.
Of course, the good times will continue as long as the Fed is spiking the punchbowl. Buyers are strongly motivated by existing home prices that are half of the new cost of construction, as well as a fraction of 2006 peak prices. As my friends say in New Orleans, where great deals are still to be had, ?Laissez les bons temps rouler? (let the good times roll).
Current guidance says they will maintain ultra low interest rates until the unemployment rate falls below 6.5%, down from the present 7.8%, which we could see in two years. Those driven more by demographic data, like me, don?t see such a turnaround for five more years.
I am not seeing another crash here. A more likely scenario is that we continue to bounce along a bottom for several more years. Tell me how bullish prospective homebuyers will be after we see a 2,000-point plunge in the Dow, which could come as early as this summer.
What this does illustrate is how grotesquely expensive the homebuilding stocks have become, like Lennar (LEN), Pulte Home (PHM), and KB Homes (KB). These stocks are up as much as 700% in 18 months. This entire piece is in response to a question I got yesterday, Should I be buying the homebuilders here. My answer is a full throated ?NO!?
The only bull market you can really count on is the one for rents, which will accelerate, once the long term decline in homeownership resumes.
