Your House Is in a Wealth Spiral

If hope and finger-crossing were a viable investment strategy, about 100 million people across the country would currently be retired. Unfortunately, things in the real world just don't work that way, but good luck telling that to the homebuilding sector.

Homebuilders have been ramping up production as if the market were booming again. The overzealous KB Home (NYSE: KBH  ) unsuccessfully tried boosting the sale price of its homes a few months ago, while Beazer Homes (NYSE: BZH  ) and Hovnanian (NYSE: HOV  ) have seen their stocks rebound considerably off their lows despite heaps of crippling debt and an endless sea of losses.

There are exceptions in the sector with Lennar (NYSE: LEN  ) demonstrating the highest homebuilding gross margin of the group and D.R. Horton (NYSE: DHI  ) noting solid new home order growth. But once again, the macroeconomic picture is pointing decisively against the homebuilders over the next few quarters.

Data released last week from RealtyTrac indicate that 26% of all first-quarter home sales were foreclosed properties. That figure is a moderate boost from the 25% in the year-ago period and a significant reversal of the 22% noted in the fourth quarter.

Short-sale, anyone?
At the heart of the increase was a 25% jump in short-sale properties. However, an increase in properties being short-sold shouldn't come as a surprise to anyone for a number of reasons.

First, banks are growing weary of the increasing length of time it takes to take possession of a home. Taking a loss upfront and getting the asset off its books is proving more efficient for banks than taking possession of the home itself.

Secondly, the jobs picture has grown particularly pessimistic of late. Employment data last week indicated one of the lowest job totals added (69,000) in a long time and included an uptick in the unemployment rate back to 8.2%. In short, job opportunities may be drying up for some homeowners who need the income to make payments on their home.

Finally, wage growth has been anemic in relation to the inflation rate. With the rising prices of fuel and commodities outpacing wage growth, homeowners are choosing necessities over their mortgage payment, especially considering banks' lack of motivation to foreclose these days given the new foreclosure regulations.

It gets better, in a sarcastic sort of way
On top of this, according to Zillow, and as reported by the Fool's Morgan Housel, 31% of all mortgages are now underwater -- myself included. That's up dramatically from just 22% of all mortgages one year ago. With few repercussions to homeowners other than a temporary credit ding, we've seen a spike in those walking away from their mortgages again.

The icing on the cake was seen in the foreclosure prices themselves, which fell an additional 2% year over year to $161,214. These foreclosures were sold at an average discount of 27% below non-foreclosed properties and represent a major drag on current and future pricing.

The wealth spiral
So there we have it, a major disconnect between foreclosure pricing and new home pricing. My assertion is that something is going to have to give, and my research into the glut of foreclosed and pre-foreclosed properties that are waiting in the wings to hit the market leads me to believe that homebuilders are living in fantasyland. With little foundation under housing prices and homebuilders building like everything is hunky-dory, don't be surprised if the value of your home continues to spiral lower.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. Perhaps he finds himself underwater because he never learned how to swim? You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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  • Report this Comment On June 05, 2012, at 5:46 PM, Darwood11 wrote:

    Anyone who purchased a home in the last ten years is probably at- or under-water.

    However, anyone who rents has been underwater for every year.

    I suggest the author and readers keep that in mind.

    Yes, renting is wonderful, if you want to flush that money each month for the next 60 years. By all means, go and do it!

    Yep, rent at $1,000 a month, inflation ignored, and after 60 years, when you are 80, you will have spent $720,000 in today's dollars and have zip to show for it. Rents in the US range from about $10,000 a year to $36,000 (NYC). So my example is on the low end. Of course, buying in Manhattan or San Francisco is not for the poor.

    On the other hand, you can do what I did, save for a decade or decades, which meant making deep sacrifices, and buy for cash in 2001.

    Am i under water? Nope. That's because I bought "small" and "below my means." In other words, I treated this as 1) a place to live, 2) a small part of my investment portfolio, not to exceed 25%.

    Am I happy paying minimal maintenance and real estate taxes each month? Yep.

    Bottom line: I read a lot at the Fool about taking risks and making investments. Just what the hell are we really talking about? I purchased as a place to live and put at risk the annual difference between renting and buying. That was low risk.

    That, by the way, is the appropriate way to consider this argument, in my opinion.

    $1000 per month for rent for 20 years is $240,000 and all of it is "underwater." Buy a $300,000 home and after 20 years of paying $240,000 it might be "only" worth $240,000. Let me get this straight, It's possible I'll get 75-100% of my "terrible" investment in my house back, as compared to 0% for rent.

    Or, I could buy $20,000 in stock in a home builder, hope he doesn't go under and pray he might become a "10-bagger" while I pay that $1,000 each month for rent.

    And we wonder why so many people in this country are financially floundering?

    Here's the NYT "buy versus rent" calculator. Have a ball!

    http://www.nytimes.com/interactive/business/buy-rent-calcula...

  • Report this Comment On June 06, 2012, at 12:39 PM, booksweread wrote:

    I'm a renter in Los Angeles. I've always been tempted to buy my own place, but I've been too afraid to do it since I am very uncertain about where exactly I will be working. I have 45 mins commute one way to work as of now, and I don't want to be stucked in a nice house where I will be commuting for hours to get home to....if I ever have to change job....

    The inablility for people like us to feel secure about our employment and who will move to different neighbourhoods and even state to get jobs, buying a place is pretty scary....

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