As a homeowner, the announcement that home prices continued to plummet in February was just one more twist of the housing calamity dagger in my side. As somebody looking for a recovery in the housing market and the rest of the economy, though, I can't help but begrudgingly appreciate the decline in housing prices.
Perhaps the unexpected February increase in new home sales -- to an annual rate of 337,000, when a decline to 300,000 had been expected -- is a sign that falling prices are slowly luring buyers back into the market. Of course, let's not prematurely celebrate here -- not only is this only one month's data, but annualized sales were still down 40% from February of last year.
Recovering from a rip-roaring party
For years, the housing market had partied, and partied hard. Picture the guy who has one too many Tom Collins cocktails at the office Christmas party, ends up drinking out of the fish bowl, photocopying his posterior, and then passing out the copies to the entire office … before passing out. The housing market is now not only dealing with the wicked hangover but also being shown photographs reminding it of just how stupid it was acting.
One of the clearest signs of how out of control the market had gotten was the relationship between housing prices and rental rates. Historically, housing prices and rental rates have exhibited a fairly consistent relationship. But in the late 1990s, this relationship began to break down as housing prices skyrocketed. Of course this seems to have had little impact on the availability of financing from major lenders like Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM), and Bank of America (NYSE:BAC).
The good news from the housing slump is that we're now seeing the price-rent relationship reverse course. As prices fall, buyers will once again make sober calculations that were lost in the madness. That means that investors can look at the potential income stream from buying a house and renting it out, and weigh that against mortgage payments and costs.
Likewise, homebuyers are seeing a much more favorable trade-off between renting and buying. According to the U.S. Census Bureau, in the fourth quarter of 2008, the median asking rental rate nationwide was $850 per month. With the median home price in the U.S. now at $209,000, and mortgage rates ridiculously low, a buyer putting down 20% with a 30-year fixed could be looking at a mortgage payment in the $900 range -- which compares pretty well with that median rental rate.
The bottom line is that as housing prices fall we're going to get closer to the point where people start buying houses for the right reasons -- it makes sense financially.
Time to break out the party hats again?
Ready to celebrate? Not so fast. Not only is the real estate market not likely to come roaring back when it does recover, but we still have a long way to go before we can accurately use the word "recovered."
Census Bureau numbers on housing vacancies show that 14.5% of all homes nationwide were vacant during the fourth quarter of last year. That is way above the historical vacancy rate, which was close to 8% in the late 1970s and was in the 11.5% range during much of the late 1990s. Even for the vacancy rate to get back to 11.5%, buyers would have to absorb nearly 4 million currently vacant homes. And that task is going to be all the more difficult as long as homebuilders continue to add hundreds of thousands of new homes every quarter.
What this means for investors
This has numerous implications for investors. Most directly, even though homebuilders like KB Home (NYSE:KBH) and Toll Brothers (NYSE:TOL) are way off their respective peaks in 2005, it's going to be tough sledding going forward as they have to compete with price cuts from competing builders as well as rock-bottom prices that foreclosures offer. Upstream, companies like wallboard manufacturer USG (NYSE:USG) and water infrastructure specialist Mueller Water (NYSE:MWA) may continue to see weakness from their residential construction exposure.
I think the picture is slightly better for the banks. Though they still have to deal with the questionable loans they've already made, new loans are being made against money borrowed at ridiculously low rates and are going to people buying houses that are now much more affordable. Most of the what-were-you-thinking type loans have also been canned -- even though I've heard anecdotally that houses can still be had with far less than 20% down.
For now at least my primary interest in the condition of these sectors -- banking and residential construction -- is as precursors to a broader economic recovery. For new investments I'm sticking to companies that haven't needed hundreds of billions in government assistance and aren't nestled at ground zero of the recent financial nuclear blast.
Further financial Foolishness:
- Was the AIG outrage bogus...
- ...or terrifying?
- And what's up with that Foolish Warren Buffett?
