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September 01, 2020 1:41pm
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Home sales hit a 13-year low... what now?

Home Sales outlook

Times when the market begins to send you mixed signals should not be ignored, and today, there is a huge one flashing right at you. Most investors will miss this connection, but you are not like most investors; you came to the right place to get data-driven answers for your portfolio.

The United States GDP reported a quarterly growth rate of 5.2% in the past quarter, which was above economist expectations. This one was a surprise not only to markets but especially to bears calling for a market correction. Considering that inflation was lower than GDP growth, the economy grew on a net basis for the second consecutive quarter.

However, home sales reported their lowest level in thirteen years despite the national economy pushing on. This discrepancy means a few things, which will become apparent in a minute. For now, just know that it is stocks like Pulte Group (NYSE: PHM), D.R. Horton (NYSE: DHI), and Equity Residential (NYSE: EQR) that will likely come out swinging.

Game of chess 

Because there is a large share of homeowners today who decided to purchase when interest rates were at rock bottom, the average mortgage is now below 3.0%, according to the Intercontinental Exchange (NYSE: ICE) database. Seeing interest rates go higher, sending mortgages as high as 8.0%, these homeowners don't have much reason to sell.

Can you blame them? Home prices have been doing nothing but head upward, so these homes have a lot of gains attached to them; at the same time, selling would mean replacing a 3.0% mortgage - or lower - for an 8.0% one! Yeah, there will be no sellers flooding the market any time soon.

In fact, according to the FED, home prices have increased from $503 thousand on average in the second quarter of 2023 to a higher average of $513.4 thousand in the third quarter. Keep in mind, this is compared to an average of roughly $375 thousand in 2019.

Some bears say that this is, in fact, too high of an average, making homes - as well as rents - unaffordable for the average person. While their theory has some juice, things may be different this time.

Because there are no sellers and high rates and prices keep buyers from coming in, the market is at a standstill. Now builders like Pulte and D.R. Horton see no reason to keep building; after all, there will be no room for buyers to take up supply, right? Wrong.

Time to step up

There's a reason why Warren Buffett decided to buy these homebuilder stocks, and it is because of that same question above. If nobody is selling and nobody is buying, how else do you lower prices enough to stimulate the market again? You build the heck out of the market to inject supply.

Today, you can get a head start on those betting against real estate stocks; bears have taken over the Vanguard Real Estate ETF (NYSEARCA: VNQ), judging by its underperformance of 21.2% against the S&P 500 year-to-date. This means markets expected home prices to go down, will they?

Demand needs to decline for prices to go down, right? Didn't you just read that increasing supply through the building will stimulate demand? Yeah, bears take a seat because homes are likely to keep pushing forward, or at least that's what Buffett is betting on, and he's never wrong.

So that takes care of the builders; what about the actual value of homes? With a price target of $65.7 a share, Equity Residential analysts see a net upside of 16.1% in that stock today.

More than that, the stock is cheap enough today (at a 15.0x P/E) that its dividend payouts come to offer you a dividend yield of 4.7%! That beats both inflation and treasury bonds, for sure.

Here's the thing: while home prices are headed up, REITs like Equity Residential have yet to catch up, so they're comfortable paying competitive dividends to call for more investors to bid up the stock price closer to fair value.

Finally, if all this wasn't enough, check the price action on Builders FirstSource (NYSE: BLDR). That stock has risen by as much as 106.4% this year! Do you think that construction isn't going to boom when the very stock allowing for construction activity is booming already?

So look, whether you play Buffett's hand in the builders, like diversifying in the ETF, playing direct exposure to residential property, or maybe even riding the demand of building materials, there is a play for you here, backed by every sensible angle.

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