by Charles Zentay
October 15, 2007
Originally published at Charles's blog, Thinkinvest.Blogspot.com [1]
For years, I bored my friends with talk that housing was in for a downturn. No one believed me, and people urged me to buy in before I was shut out of the market.
Despite the obvious slowdown in housing, I continue to sing the same tune. I've been doing a lot of reading this weekend about the housing market, and I've concluded that we still have a long way to go before housing reaches bottom.
Why? The main reason is that in spite of all the whining and moaning about the housing slowdown, prices haven't come down that much (maybe 10%) and affordability is still very low by historical standards.
Here are some other reasons to be wary of housing:
- There is a ton supply out there (supply is at a record, and 2x its normal rate over the last several years). It has just skyrocketed and it is not going down.
- Affordability for new home buyers is still at lows.
- More people own houses than ever before (meaning fewer buyers out there).
- The Fed will have trouble lowering interest rates in the face of $85 oil and a Euro of 1.42.
- Credit standards are tightening, meaning fewer mortgages and therefore fewer buyers.
- A large amount of ARMs are still resetting, with a tremendous amount due to reset in the second half of 2008. ARM resets are leading to more foreclosures, and therefore even more supply.
- Homebuilders are under enormous pressure with debt coming due and therefore will be willing to dramatically lower their prices.
- The economy seems to be softening, with economists raising the chances of a recession.
- Cap Rates (the income from rents) are still very low, making housing an unattractive investment.
- All of the above is leading to a change in the mentality towards housing. It is going from something people want to own to something to be wary of. This change in attitude towards housing can take a long time to set in and have a tremendously negative effect on pricing.
Frankly, the only bright spot I see in housing is that the weak dollar is leading to more foreign buying of U.S. real estate (in places like New York), but the effect of this buying is minimal compared to the other negatives. I just don't see other positives.
I think owners are stubborn and resistant to lower prices. Therefore, the market is not correcting itself quickly. The slowdown is likely to last several years.
Until Cap Rates are higher than Mortgages Rates (meaning it actually pays to be a landlord), I think the market will continue to head down. Unfortunately, we're not even close to having attractive Cap Rates. Right now, you have to PAY to do the job of being a landlord. Your only reward is the promise of future appreciation. With housing prices going down 10% a year and still overpriced, that is some reward indeed!
I wouldn't be surprised if a major homebuilder declares bankruptcy in the next 6-12 months. I also wouldn't be surprised if homebuilders and banks start to more aggressively clear inventory, which will lead to big price declines.
As such, I continue to be short the homebuilders. Sure, everyone is in on this trade. I read this weekend that short interest in one homebuilder has climbed to 42%. A contrary investor would say that everyone believes homebuilders are a bad investment and therefore they are a good investment. However, contrary investing has ironically become too in vogue and as such oversimplified. I would ask the contrary investor, so have 70% of Americans sold their homes? 70% of Americans still own homes, which are on average represent the biggest share of their net worth. So you have to ask yourself: how many people are really on the right side of this trade?
Personally, I’m short (via LEAP puts) TOL, DHI, and HOV. Because I don’t believe in market timing (markets are random in the short term), I have been buying long-term puts that expire in 2009 and 2010.
For a more in-depth analysis of housing, check out this great blog I found this weekend: http://reggiemiddleton.typepad.com/
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