Daily Gains Letter

U.S. Housing Market About to Be a Big Disappointment?

By for Daily Gains Letter |

Mortgage Lending Plunging Home Prices Driving HigherHome prices are surging in the U.S., which is usually indicative of more investments flowing into the housing market. However, if one looks at the mortgage industry, it points toward the complete opposite.

Mortgage originations have seen a sharp decline in the fourth quarter of 2013 and major banks, including but not limited to Bank of America Corporation, Wells Fargo & Company, and JPMorgan Chase & Co., will be threatened by a further decline in profits if this trend continues into 2014. (Source: Mantell, R. and Rexrode, C., “‘Worst of all worlds’ for mortgage lending in fourth quarter,” MarketWatch, January 15, 2014.)

If mortgage lending is plunging, then what’s driving home prices higher?

In reality, it isn’t the average American Joe buying homes that is driving home prices higher; it’s the institutional investors who are buying homes in bulk—with cash.

Mortgage rates increased around 30% during 2013. With higher rates, fewer people could afford to buy homes, which initially pushed home prices lower, creating a window of opportunity for deep-pocketed institutional investors to lock onto residential properties in cash. This increase in buying took home prices back up to levels out of reach of an average homebuyer, who can seldom buy a home entirely in cash.

About 50% of all home sales in September of 2013 were in hard cash, confirming the growth in buying from institutional investors. (Source: Federal Reserve Bank of St. Louis web site, last accessed April 17, 2014.)

All-cash home sales rose to 35% of total transactions in February of 2014, compared to 32% in February of 2013. However, individual investors only purchased 21% of all homes sold for cash in February 2014, versus 22% during the same time in the previous year. (Source: “February Existing-Home Sales Remain Subdued,” National Association of Realtors web site, March 20, 2014.)

Potential homebuyers are renting homes from institutional investors as mortgage rates are skyrocketing, which is clearly what is deterring these now-renters from getting mortgages to buy residential properties. But let’s not forget: institutional investors are speculators. If their investments start losing money—they cut their losses and walk away.

This is exactly what we are seeing in the housing market right now as the sector turns jittery. Companies like The Blackstone Group L.P. (NYSE/BX) and American Homes 4 Rent (NYSE/AMH), which were major players behind the home price rally of 2013, are now reconsidering their established positions in the market. (Source: Fottrell, C., “Institutional investors cool on housing market,” MarketWatch, March 28, 2014.)

If one major institutional investor exits the market, we could see confidence in the housing market sagging very quickly. Such a situation can induce other players to take their investments out of the industry, too.

Investors interested in taking advantage of this situation may consider shorting companies involved in building new homes or renovating existing properties. Why? Over the past few years, homebuilder stocks had the run of their life. Companies like D.R. Horton, Inc. (NYSE/DHI) and Toll Brothers, Inc. (NYSE/TOL) have seen their stock prices increase at least two-fold in the last five years. Just take a look at the chart below of D.R. Horton.

DR Horton ChartChart courtesy of www.StockCharts.com

If home prices collapse following a decision by major investors to sell off their stakes in the housing market, homebuilder stocks will see a major correction. Investors might see gains on their shorted homebuilder stocks if home prices fall.

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