Market Insights – April 3, 2012
“The faintest ink is more powerful than the strongest memory” – ancient Chinese proverb
Dear Clients and Friends,
In episode 3-10 of the AMC hit series “Mad Men”, Paul Kinsey (Michael Gladis) experiences a late night epiphany while racking his brain to produce copy for a Western Union advertisement. There is momentary joy and relief as the idea comes to him, however in all of the excitement there is one problem, he forgets to write the idea down on paper. I digress a bit with my recall of that scene from the “Mad Men” but it reminds me of my posting of February 27, 2012 where I had to “write down” my thoughts regarding the possibility of a housing recovery this year before I forgot about the powerful implications such a recovery would have for employment and the overall economy.
Doug Kass reiterates that “housing is the straw that stirs the economic cocktail and the elements of a self-sustaining recovery in the residential housing market are in place and should continue throughout the balance of the decade”. Here is what Doug means by that statement: Every year there are approximately 1.2 million new household formations that require some form of shelter. Over the last 5.5 years the industry has built an average of 508,000 of new homes per year, or only one half of the homes needed to meet the demand. Foreclosures and rentals have filled some of that gap in demand but now, as the available number foreclosures continues to decline and with new housing starts still running at a 680,000 annual rate, homebuilders should begin to see a rise in new orders. The economic cocktail that Doug refers to should look something like this: At the height of the housing and construction boom in 2007, there were 2.3 million housing starts, there were 11.2 million people employed in the industry, earning an average of $41,823 per year and generating 25% of the total output for the entire U.S. economy in 2007. If you want to get excited about a housing recovery then compare that view from the top to the recent view from the bottom (which seems to have occurred sometime in 2011). At the end of 2010, close to 38% (4.2 million) of those employed in the housing, construction and related industries were out of work. Housing starts plummeted to an annual rate of 510,000 and the annual contribution from the industry to total GDP fell to 3%. In other words, if we were to experience a recovery in housing just back to 50% of the previous high, we are talking about a significant addition to overall economic growth over the remainder of this decade.
Much of this cautious optimism has been re-enforced by recent comments by home building leaders such as Lennar and Toll Brothers. Doug Yearley, CEO of Toll Brothers said recently, “This has been the best spring we have seen in 5 years. In 2012 our orders are up significantly and continue to be up significantly. I am quite optimistic.” The average price of a Toll Brothers house is $575,000 and they seem to be selling quite well. Mr. Yearley goes on to say, “25% of our communities have seen a price increase since January 1. There are some markets where we don’t have pricing power but we are not dropping prices. We haven’t reduced the price of a home in over a year. Our strong regions are: 1.) New York, where we have huge pricing power and we are raising prices every week. 2.) Boston and Washington D.C. which did not have the overhang from foreclosures. We do 60% of our business in these markets and they are strong, land is hard to find and we have pricing power. 3.) Phoenix is back in a big way in 2012. The supply of homes in the Phoenix market has gone from 16 months of inventory down to 4 months currently. 4.) In southern California it is also hard to find land and prices for dirt are soaring. That market is strong. 5.) Texas is booming as well as the Carolinas and Florida where the second-home market is beginning to come back and we haven’t seen that in 5 years.” Lennar Homes reported earnings last week and here is what CEO Stuart Miller had to say about that, ”Lennar had 1st quarter earnings of $0.08 per share, nearly double the expected $0.04. Gross margins were up 20.09 % and new orders jumped 33% for the December-February period. The cancellation rate dropped to 18% from average of 30% over the last year. Sales prices were up 1% sequentially and incentives were flat. In other words, we are not spending more to get buyers to sign.” Speaking last week at a job fair for New York area veterans, JP Morgan Chase CEO Jamie Dimon said, “I believe we are at an inflection point with regard to the housing market. People look at prices that are still coming down but all the other signs are flashing green. The shadow inventory that everyone talks about is lower today than it was 12 months ago and it will be a lot lower still, 12 months from now. Distressed inventory is actually coming down, not going up. The number of homes for sale currently is about ½ of what we saw four years ago. You could come up with a pretty bullish case……if the economy keeps growing, housing gets better quicker. You are already seeing that.”
Given those optimistic comments from a banker and two of the leading builders in the U.S., it is no coincidence that last week’s new home statistics were bullish. Homebuilder confidence stands at a five year high. Permits for future construction jumped to their highest level since October of 2008. Permits surged 5.1% to a 717,000 annual pace, far exceeding economists’ estimates of 682,000 units. Annualized new housing starts for February totaled 698,000 units. Compared to February of 2011, residential construction was up 34.7%, the biggest year-on-year rise since April 2010. Groundbreaking on new multifamily projects soared 21.2% in February as well. The characteristics of this recovery are such that it feeds back in to the remodeling business as well. Residential remodeling, measured by permits pulled in January were up in 13% from December and up 11% from a year ago, with the strongest activity located in the West and Midwest regions according to BuildFax. Sales of foreclosed properties are bound to be helping the activity as well as investors have swarmed the market, buying up distressed properties and turning them into rentals. Many of those properties have either been abandoned or vandalized and need at the very least basic refurbishing and at the most full renovations, according to Joe Emison of BuildFax. This is of course great news for Stanley Black & Decker, U.S. Gypsum, Weyerhaeuser, Masco, Sherwin Williams, Home Depot and Lowes. This entire sector is well positioned because it can profit from not only a recovery in the overall housing market, but from home improvements as well. As homebuyers move into the spring (a traditionally strong selling season), they will fuel further renovations and as banks work through distressed loans and sell off foreclosures to investors, there will be even more housework to be done.
In summary, there are seven reasons we are beginning to see a recovery in one of the most powerful and multiple expanding segments of our economy: 1.) Housing affordability is at a multi-decade high. 2.) New construction has not kept pace with U.S. demographic trends (new household formations of 1 million plus per year). 3.) Rental prices are high and home prices are low. 4.) Mortgage rates are at all time lows. 5.) Builder sentiment has turned positive. 6.) Decisive improvement in the jobs market over the last nine months. 7.) Better consumer confidence driven by #6 as well as a better stock market.
The recovery in housing appears to have legs and its potential effect on the overall economy is big and exciting. There you go. I had to write it down one more time before I forgot.
Sources: CNBC, Real Money, Doug Kass, RICS Americas, Center for American Progress, BuildFax.
Ken Beach, President of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.