Homebuilders' Long-Term Foundation Could Be Built on Shaky Ground

The latest housing numbers don't tell the entire story about the future landscape for homebuilders in the next year or so.

Jan 3, 2014 at 10:23AM

The new home sales numbers for September and October came out the first week in December. The raw numbers say that the housing market is on a roll and still gaining steam. This is great news for homebuilders like Toll Brothers (NYSE:TOL), Hovnanian Enterprises (NYSE:HOV), and PulteGroup (NYSE:PHM), right?

Well, maybe not. If you dig a little deeper into this and past reports, and take a look at what the Federal Reserve released that same day, there's a different story of where this market may be heading.


The story behind the story
The Census Bureau estimated that the month of October saw new home sales run at an annual rate of 444,000 -- that decisively beats September's rate of 354,000 and is a rise of 25% on a month-to-month basis.

It was the most dramatic uptick in more than 30 years. This was the follow-up to a September that saw these same contract numbers drop 6.6% from August.

Sounds good. Housing is on the right track. But that's just taking those headlines on face value. As with all reports and numbers, you need to dig a little deeper. If you do, you'll find these three things:

1. Cancellation rates among homebuilders is a growing concern.

There's been an unsettling trend with the Census Bureau estimates of new home sales since July. They have a lot of significant downside revisions that can be attributable in part to rising cancellation rates.

The numbers mentioned above are based purely on signed contracts, not closings. Some homes have not been built, and completion could be months away. For those buyers just starting the process, it's most likely they couldn't lock in a rate. And rates have risen. So some of these contracts will not come to fruition because of financing, and it seems to be a growing trend over the past few months

We can see the most significant revisions starting in August, where the original seasonally adjusted annual rate came in at 421,000. That was revised down to 379,000 units, and finally further down to 354,000.

2. The trend in declining mortgage purchase applications tells us that traditional buyers can't afford homes.

We may have reached a point where the Fed's easing policies are no longer an enticement to buy a home. Higher mortgage rates spell disaster to a real estate sector that's been buoyed by policies to keep them historically low.

Over the last five years, we've been feeling a real loss in purchasing power. In September, another Censes Bureau Population report: "Income, Poverty and Health Insurance Coverage in the United States: 2012" reported that median household income dropped to $51,017. That's the lowest it's been since -- adjusted for inflation -- 1995.

3. The October new home sales gain came courtesy of a decrease in median prices.

If you look at the second page of the Census Bureau new home sales report, it shows us that median new home prices dropped 4.5% from September to October from $257,400 to $245,800. If this was just a one-month anomaly, we shouldn't be that worried. However, since the 2013 high in April of $279,300, that's a decline in price of 12% over that six-month period. It looks like builders are cutting prices to get sales. But how low can they go until a lack of profitability tells them enough is enough?



Why? Well, investors took a closer look at the numbers, but also saw another report from the Federal Reserve, the Beige Book. The report is distributed eight times a year and gives a subjective overview of the economy.

The December 4th edition was interpreted negatively for homebuilders. It actually said the economy was improving. This seems counterintuitive at first glance, but it was a sign that the Fed could soon taper back asset purchases.

The lower demand for mortgage-backed securities translates into higher mortgage rates going forward. The Beige Book report incited a homebuilder stock sell-off that weighed more than any housing sales numbers.

Tapering starts the beginning of tenuous times
On December 18, Fed Chairmen Ben Bernanke announced that there would be a $10 billion decrease in the rate of asset purchases. It's a mild taper, but higher rates are coming, and that's not a good look for a real estate market artificially propped up by the government.

And here's the takeaway. Without QE, the housing market will have to depend on falling household incomes, rising mortgage rates, and more stringent mortgage regulations in the very near future. And with these traditional market forces driving said market, you should be wary of the homebuilder industry as a whole.

Start 2014 the right way
There's a huge difference between a good stock, and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Fool contributor Jason Jenkins has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers