The U.S. Housing Market: Three (More) Reasons Real Estate Isn't Rebounding

by Louis Basenese

The U.S. Housing Market: Three (More) Reasons Real Estate Isn't Rebounding

by Louis Basenese, Advisory Panelist

Tuesday, August 3, 2009: Issue #1058

Editor's Note: Yesterday we heard from Martin Denholm. We'll be adding their experts to our esteemed panelists to give you the best investing ideas and advice out there. Today we follow Martin with outspoken favorite, Louis Basenese, who also gives us his take and concern for investors, on the housing market.

If ever an off-the-wall indicator existed to predict the fate of the U.S. housing market, I found it... You see, business is booming in one particular niche of the real estate industry - shrink-wrap.

That's right. Contractors and developers are wrapping mothballed building projects in plastic, literally - from single-family homes to 25,000 square foot commercial properties.

The beneficiary? Privately-held Fast Wrap - a leader in shrink-wrap protection and weatherization. Traditionally its products are used to protect lawn furniture, cars, boats, motor homes or industrial vehicles from the elements. But now, the bulk of its new business comes from the real estate industry...

In recent months, the company has inked deals to shrink-wrap 240 homes in the Northeast, prompting management to double its sales expectations on the surging demand.

Sorry folks. If "shrink-wrapping" homes to preserve them for future use is suddenly a worthwhile idea, then there's no end in sight to the demand destruction. It's akin to airlines "grounding" aircraft during tough operating conditions... or oil drillers "cold-stacking" rigs when exploration plummets.

So if you're thinking of diving into the real estate market to capitalize on the "unbelievable bargains" - via the stock market or your local neighborhood - think again. The outlook for the U.S. housing market remains grim. And the bargains will only get more compelling.

First, let me prove it. Then I'll reveal a few ways to play the enduring housing market downturn...

Housing Market Showing Signs of Stability? Puh-lease!

The mainstream press would have us to believe a real estate market rebound is imminent. They keep glomming onto any data that shows the slightest sign of stability.

  • For instance, Bloomberg jumped all over the July 1 report from the National Association of Realtors that showed pending sales for previously owned homes rose for the fourth consecutive month.

  • Other outlets had a field day with the news out of the Mortgage Bankers Association that refinancings hit a three-month high in early July.

  • And ditto for the news that foreclosures dropped 11% in the second quarter.

But these "signs of stabilization" are bogus. Or to beg, borrow and steal from value-investing legend, Whitney Tilson, they are the "mother of all head fakes."

Fact is, these short-term improvements were fabricated. They materialized because of temporary factors like the $8,000 first time homebuyer tax credit (set to expire November 30), artificially low interest rates (remember the Fed's been buying Treasuries, en masse, since March to suppress rates) and government and bank moratoriums on foreclosures.

In the end, all this massive intervention is doing is propping up short-term results and prolonging the inevitable. Furthermore, to turn a blind eye to all this government meddling and pretend it's not artificially influencing demand and prolonging foreclosures, would be irresponsible.

Don't get me wrong. I'm happy to see an improvement in the market from bad to less bad. But overall, the numbers are still crap.

Three Obstacles to a Housing Market Rebound

Over half of the homeowners who took advantage of loan modification programs, are delinquent again. They weren't paying before they got interest rate and/or principal reductions. And go figure? They're not paying now. Great idea Washington!

On top of that, housing prices are still too high to attract buyers yet too low for sellers who are underwater on their mortgages. Such out-of-whack supply/demand dynamics will only foster more uncertainty.

In my opinion, before any meaningful recovery in real estate prices can take root, we need to overcome three major obstacles...

  • Rebound Obstacle #1: Inventory Glut. Nearly 10% of all homes built this decade are sitting vacant, compared to a historical average of 2.2%. In total, we're sitting on almost 10 months worth of inventory versus a historical average of four months. If we factor in the "shadow inventory" - the roughly 600,000 homes that banks are withholding from the market - the problem worsens. Excess supply always erodes prices.

  • Rebound Obstacle #2: Loan Resets. Forget subprime. We've already worked through 80% of those resets and written down $1.47 trillion in the process. Now we're facing a $2.5 trillion mountain of Alt-A loan resets. The first big wave hits mid-2011, with the peak expected to come in early 2013. So we've still got time, but the early stats hardly instill confidence.More than 20% of Alt-A loans are already 60-plus days late, up from an average of about 3% for the last decade. If interest rates creep up even modestly in the next two years - a near cinch given the likelihood of inflation - payments will increase notably. In turn, so too will default rates.Bottom line, another wave of massive writedowns looms on the horizon.

  • Rebound Obstacle #3: Foreclosures. One in four homeowners are now underwater. If we break it out by loan type the picture gets worse - 25% of prime loans, 45% of Alt-A loans, 50% of subprime loans are severely underwater. Add in the 6.5 million Americans out of work since the recession began and it doesn't take an Einstein to predict where foreclosures are heading. Credit Suisse estimates that we're in store for a total of 6.5 million by 2012.Even the Mortgage Bankers Association (MBA) concedes the obvious in its first quarter update, saying, "Looking forward, it does not appear the level of mortgage defaults will begin to fall until after the employment situation begins to improve." Since the rosiest prediction doesn't expect unemployment to peak until early 2010, as the MBA acknowledges, "...It is unlikely we will see much of an improvement [in foreclosure rates] until after that."The fact that the social stigma attached with "walking away" has been severely (and sadly) diminished over the past decade only adds to the foreclosure heap. And more foreclosures will inevitably push prices lower.

The Housing Market's Reality Bites... But We Can Still Profit

As I've said, a simple supply and demand equation underpins the housing market. Right now, there's way too much supply. Thus, prices can only go lower. And in my opinion, they'll go significantly lower.

Since the peak, home prices have dropped 34%, based on the Case Shiller Index. However, prices still rest roughly 10% above the long-term trend line.

But given the supply imbalance is so dramatic, and the fact that markets consistently overshoot resistance and support levels, I'm convinced that prices will crash right through the trend line, falling another 20% to 30% before we see a legitimate turnaround in 2011.

I'm not alone, either. Mortgage insurer PMI Group estimates that a 75% chance exists that the majority of our metropolitan areas will experience price declines through the first quarter of 2011. And if we experience a double-dip recession, all bets are off on how low prices will go.

The brave at heart can look to profit from the decline by shorting any of the major homebuilders like:

  • Pulte Homes (NYSE: PHM)

  • KB Home (NYSE: KBH)

  • DR Horton (NYSE: DHI)

  • Toll Brothers (NYSE: TOL)

  • Or Lennar (NYSE: LEN)

Be warned, though. The ride will be volatile.

Otherwise, the newly launched MacroShares Major Metro Down ETF (NYSE: DMM) is an option. The exchange traded fund is benchmarked to the S&P/Case-Shiller Composite-10 Home Price Index and features three times (300%) leverage. For every 1% decline in the index (i.e. real estate prices), the ETF should increase in value by 3%.

For the truly conservative investor, I recommend the "nothing ventured, nothing lost" approach. In other words, wait to go long when buying real estate because we're nowhere close to a bottom. At the very least, wait for the prevailing shrink-wrap frenzy to end.

Good investing,

Louis Basenese

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