Gloomy Outlook For Real Estate Market

From Investopedia
by Arthur Pinkasovitch
Tickers in this Article: DHI, JPM, MCO, PHM

The latest real estate research data presents some rather unfavorable/contradictory information. According to the "Existing Home Sales" report compiled by the National Association of Realtors, existing home sales are down considerably on a year-over-year basis, having fallen by 8.8%. While sales are falling, the "New Residential Construction" report indicates that housing starts have actually increased by 16.7% across the nation, and the number of building permits has jumped by an additional 6.7%. Basically, what this is indicating is that due to the lower housing construction figures over the last few years, builders are attempting to build their way out of the economic downturn. As a result, supply is significantly outpacing demand.

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Even the Good News Isn't GreatThe only slightly encouraging news for the building industry came with the Pending Home Sales Index, which surged by 19.8%. However, this statistic must be taken with a grain of salt; the forward-looking Pending Home Sales report, which tracks the number of home sale contracts signed (but not yet completed), was biased downward in June 2010 immediately following the expiration of the home buyer tax credit. Therefore, when comparing the 2011 jump to the 2010 low, the near 20% growth seems artificially inflated. Furthermore, although the chief economist of Fannie Mae appears optimistic about the numbers, he cautions that contract cancellations have been rising in recent months.

Home Builders Cautious Home builders have seen their performance deteriorate as the housing market remains uncertain. D.R. Horton (NYSE:DHI), the largest home builder in the United States, saw its net income fall from $50.5 million to $28.7 million, as revenues fell drastically while margins remained relatively low. Management acknowledges that expected real estate market conditions are likely to be challenging, and thus applies a 14-20% discount rate to determine the impairment to carrying value of certain assets. Likewise, PulteGroup (NYSE:PHM) realized a 15-cent loss in its most recent quarter, compared to a 20-cent profit last year. PulteGroup has experienced a loss before income taxes in every quarter since the fourth quarter of 2006, due to "reduced operational profitability and significant asset impairments".

Weak Economic SituationAn oversupply of housing inventories mixed with weak consumer confidence, an unbending 9.2% unemployment rate and a near 1% foreclosure rate, signal that the real estate market will fail to show significant signs of improvement this year. Foreclosures are unfortunately not expected to stop any time soon; measures to prevent banks and robo-signers from circumventing the legal foreclosure process have created a bottleneck effect, allowing people who are no longer making mortgage payments to remain in their homes. LPS Applied Analytics estimates that there is currently a backlog of over 2 million homes which are in technical foreclosure. Therefore, reported housing inventory levels remain lower than what basic economics would dictate.

The Bottom LineChina's Dagong Global Credit Rating Co. downgraded U.S. debt from A+ to A, as the nation's debt/GDP ratio already exceeds 100% and there is no clear path to achieve a balanced budget. S&P shortly followed with a downgrade and pessimistic outlook, which sent the Dow Jones Industrial Average down 634 points. Similar action by Moody's (NYSE:MCO) or Fitch could potentially have subsequent catastrophic consequences for the already fragile market. Despite that the Fed announced its intent to maintain interest rates below 0.25% until 2013, falling bank confidence could result in a tighter credit environment, along with a spike in mortgage rates. Such action would push people to wait longer prior to purchasing a home, thus decreasing demand for residential real estate. JPMorgan Chase (NYSE:JPM) estimates that the downgrade could cost the U.S. $100 billion. (Make sure you know what your real estate investment is worth before you sign the ownership papers. Refer to Valuing A Real Estate Investment Property.)

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By Arthur Pinkasovitch 

Arthur Pinkasovitch is an Analyst at Investopedia and is currently a CFA level 3 candidate. His investment focus is centered on energy and commodities as well as applying basic economics principles to everyday investment analysis. Arthur teaches introductory corporate finance at a local college and is part-owner of a Russian Grocery Store. You can follow Arthur on Twitter.