US Housing Reaches A Turning Point

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– US housing market appears to have troughed
– Rental demand will lead a recovery
– Oz building material companies will ultimately benefit

By Greg Peel

The iShares Dow Jones Home Construction ETF – a basket of US home builder stocks – is up 125% from October. Nice work if you can get it, but the same ETF lost 86% in value from its 2006 peak to its early 2009 trough. Remembering that percentage falls are measured from the top down and rallies from the bottom up, the ETF remains 67% below that peak today. It's a long road back.

As the Home Construction ETF was hitting its low, the NAHB housing market sentiment index fell into single digits. This is a 50-neutral index. This month the index has risen to 29 to mark a five-year high. The index dropped through 50 in April 2006 after the US house prices peaked and had reached a boom high of 72 in June 2005.

So like the ETF, the sentiment index is much improved but still at the beginning of a very long road back. For the US economy, however, this is a very good sign, and economists are now bold enough not to call a blip but a genuine reversal. “When you have the dynamics of higher rental rates and lower home values at attractive financing rates, there's a point in time when the market is going to clear…I think we're getting very close to that tipping point. We have a pretty good pipeline,” said the CEO of leading US mortgage bank Wells Fargo, John Stumpf, recently.

When Stumpf says “clear” he is referring to unsold housing inventory which has hung over the US like a cloud since the GFC, creating fresh ghettos in Detroit to suburban ghost towns from California to Florida, either never occupied or abandoned by Americans who could never afford a house, armed with freely distributed mortgages they could never service. Mortgage foreclosures continue to grow in the US but the rate of growth is declining, suggesting a turning point is near. Hedge funds have been accumulating cheap property, looking for a future “flip”, while individual investors have also seen an opportunity. The Fed is holding interest rates at exceptionally low levels at least until mid-2014, making for cheap finance. A large proportion of Americans are being forced into the rental market, offering a decent yield for property investors.

“In these initial years, the prime driver of recovery won't be new home construction but rather demand for rental properties,” says Louise Keely, chief research officer at The Demand Institute. The Institute is a not for profit, non-advocacy organisation set up to identify consumer demand trends around the globe. It has just released a report in which the conclusion is the US housing market has finally reached a turning point, with rental demand set to lead the recovery.

In previous cycles the turn in the US housing market has been led by owner-occupier buying. Surveys show that 80% of Americans still believe buying a home is the best investment they can make, but the depth of the last recession and the level of austerity in its wake means of all Americans planning to move home in the next two years, 50% say they will rent. That means this recovery will be led not by owner-occupiers but by investors. Yet investors will still need to spend money on buying and renovating those homes while renters will join in with furnishing and maintaining. The US consumer will rise from the ashes, and the impact will resonate across the globe.

It will be a long time before we ever see another US housing bubble. Yet as the following graph provided by boutique Australian fund manager Alphinity shows, even a quiet regression back up to the nominal house price trend will mean a significant post-GFC boost.

The Demand Institute predicts US house prices to rise by an average 1% in the second half of 2012, accelerating to a 2.5% rise in 2014 and 3-4% in 2015-17. Rental demand, driven by young people, migrants, and others hard hit by the recession, will encourage investors into the market and demand for smaller residences will see developers leaning towards apartment blocks and other multi-family dwellings. While mortgages are now historically very cheap in the US, lending rules are much tighter.

Alphinity's analysts have recently met with home builders across four US states and the message of improvement is consistent. While off a low base, this spring selling season has been the strongest since the downturn.

US consumer industries including financial services, home furnishings and home remodelling will all experience shifts in demand and new growth opportunities, says The Demand Institute. Part of the spending is linked to increases in wealth from improving home valuations, while an even bigger part is tied to the “transaction” of buying and selling the home which sets in motion increased demand for a wide range of products and services.

A more healthy US consumer means a more healthy US economy, with a spill-over into the global economy. We could go as far as to suggest, for example, an American's new fridge may come from China, constructed with steel made from Australian iron ore and coal. More immediately, however, when one thinks of the US housing market one thinks of US-exposed Australian building material suppliers such as James Hardie ((JHX)), Boral ((BLD)) and CSR ((CSR)).

The real turnaround in the US earnings of such companies will not come from investment in existing US housing inventory per se, but in the construction of new US houses. New housing starts have fallen to the lowest rate in half a century and while existing inventory still overhangs, there will be less impetus to build. However as the following graph from Alphinity shows, US housing starts have indeed begun to recover from a low base.

While the GFC changed the lives of most Americans, it did not alter the US population growth trend. Thus on a per capita basis, US housing starts have reached their lowest level since World War II. The graph also shows a close correlation between starts and the unemployment rate. The biggest pick-ups in starts occur after the biggest falls in unemployment. If the US unemployment rate can continue to fall from its present 8.1% (down from 8.3% when the graph was published), it follows that housing starts should continue to grow. The point at which existing inventory is cleared, one assumes, would see an acceleration.

As a result of its research, fund manager Alphinity holds James Hardie in its portfolio of 14 stocks. James Hardie has significant profit leverage, the analysts suggest, and a lower operating cost per production unit today than at the peak, despite only 40% capacity utilisation.

We can only pray that Europe doesn't spoil the US recovery party yet again, although QE3 is always close at hand. As for an Australian housing market recovery, many analysts retain Buy ratings on building material and other housing related stocks for the sheer balance of knock-down valuations and leverage to the eventual upturn. But all analysts have given up trying to predict when that upturn will be.
 

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