Time To Cover Those Housing Shorts

by: Cam Hui August 15, 2008 | about stocks: XHB    
Cam Hui

Cam Hui

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I write these words with great trepidation, as I hate to agree with Greenspan and his housing call - he has been consistently wrong in his analysis for a long time.

However, I do believe that the easy money shorting the housing crisis may be over. There are signs that valuations are starting to become more attractive in housing, value players are now entering the space and the homebuilding group is now technically undergoing a bottoming process relative to the market.

In California, which has been one of the hardest hit markets, buying a house is starting to make economic sense again. This recent report shows analysis indicating that in California, “home prices are dropping to a point where the cost of a mortgage and taxes equals rent.”

There is also this report indicating that sovereign funds are buying US real estate: “one sovereign fund, said to have earmarked $29 billion to purchase foreclosed residential real estate, recently hired a West Coast mortgage broker and is starting to search for bargains.”

These funds tend to have a long time horizon and are typically value players. With the caveat that value investors do tend to be early, sovereign funds have the advantage of being not directly constrained by the tight credit conditions that exist in the US right now.

Homebuilders making a relative technical bottom
The chart below shows the chart of the S&P 500 Homebuilders relative to the S&P 500. As the chart shows, the group has broken out of a relative downtrend. The next phase is likely to be a sideways consolidation pattern:
 


Warning: I am not calling a real estate bottom!

The Homebuilders are likely to go from free fall to market performer. Since my belief is that the market has a negative bias, this group is likely to continue to fall. However, the easy money is over from shorting this group. If you are short, cover your shorts.

Substantial downside risk remains in the group. Recently Barry Ritholtz at Big Picture outlined the risks to housing. Though his comments are directed toward the NAR Housing affordability index, these comments are valid with regard to my valuation comments. To paraphrase, my California affordability and valuation analysis:

  • Assumes 20% down payment – who has that anymore?
  • Ignores debt carried by homeowner – household balance sheets have deteriorated substantially
  • Ignores falling FICO scores – see comment above about poor household balance sheets
  • Other ownership costs are rising – e.g. property taxes, maintenance, heating, etc. 

Tightening credit = more downside for housing?
Meredith Whitney, who correctly called the credit and housing crisis, is also forecasting further downside in housing because of tightening credit conditions:

Cover your housing shorts
An improvement in housing would be positive in general for the equity markets and the US economy. Bottoms don’t happen overnight and this is part of a process.

I would cover any housing shorts. The downside here is limited – don’t be greedy.

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This article has 10 comments:

  •  
    Aug 15 02:09 PM
    Mr Hui.. I hope you are right, but as a homeowner and landlord in California, I don't see any movement up here. In fact, with a $15 Billion state deficit, with Arnold looking like he is agreeable to raise taxes on businesses and individuals, as well as stiff State workers ... I only see more pain in the next year. In fact, I'll bet you a double-mocha-latte-fra... that we have at least 15 to 20% more down-side before the end of 2009. At that point, residences are only affordable to anyone that still has anything like a paying job.

    In fact, I personally wish that the home-builders would just bank their equity in Icelandic Krone at 9% (or whatever an Icelandic CD pays these days..) and leave the market. Continuing to build new homes while we have such a considerable backlog of unsold repos just prolongs the agony. Leave it to Congress to pass a bill that seems to encourage new home construction when what we really need to do is relieve the inventory we have. (I am always underwhelmed at our Congress's lack of real consideration when they pass a bill.)

    Thx jegan ;-)
    Reply | Link to Comment
  •  
    Aug 15 02:28 PM
    "These funds tend to have a long time horizon and are typically value players."

    They'd have to be, judging by the prices at which some of them bought into financials.
    Reply | Link to Comment
  •  
    Aug 15 04:23 PM
    I was under the impression that historically foreigners tend to buy real estate at the top of a declining market. Absentee landlords are always screwed.
    Reply | Link to Comment
  •  
    Aug 15 04:52 PM
    Congrats on not calling a market bottom, I think people have finally realized how absurd it is to do that. Good call on the greed...look what happen to the smart money when the oil price reversed.
    Reply | Link to Comment
  •  
    Aug 16 04:39 AM
    Thanks for this article Cam. I appreciate the time you put into it, and are following your work with interest.

    John: I don't think Cam is calling a bottom in real estate, because under the homebuilders chart he writes 'Warning: I am not calling a real estate bottom!', and later writes 'Meredith Whitney, who correctly called the credit and housing crisis, is also forecasting further downside in housing because of tightening credit conditions:'.

    Instead Cam appears to be calling the beginning of a bottoming process in homebuilders.
    Reply | Link to Comment
  •  
    Aug 16 10:37 AM
    I personally think the housing market is still bad and will get worse. I have talked to people who are in the housing industry and things don't look good and the horizon looks worse. Inflation, unemployment moving up, foreclosures, credit is not easy to get...all these variables seem to say that the bottom of the housing market isn't in yet. Yes, the bottom is a process, but I don't think we started the process yet. I think there are more write downs coming from the financials. I am still shorting financials and have been for the last 6 months. I just don't see consumer sentiment getting better any time soon and that means trouble for the housing market. It is still cheaper to rent than to buy with all the expenses around purchasing. Until that changes the market bottom won't be reached. Good luck.
    Reply | Link to Comment
  •  
    Aug 16 10:41 AM
    It is hard to call a bottom in anything these days. I remember the beginning of the credit crisis sell-off a year ago, where anything that was highly liquid was sold off to cover illiquid, over-leveraged positions. Oil stocks went straight down, in the face of rising oil prices.
    Reply | Link to Comment
  •  
    Aug 16 03:18 PM
    "Icouldbewrong&qu... Calling a 'bottoming process' is like Larry Kudlow's 'Cinderalla economy'... Sooner or later you will be right.... (I for one certainly hope Kudlow lives to see it happen..)

    I'm not sure what type of timeframe qualifies as acceptable in bottom picking... But I tend to work within a year's period... I don't see that happening this year for a lot of reasons.

    - Todays' S.F. Chronicle - Califonia's unemployment rate hits 7.2%
    - Yesterdays Fast Money interview with Hudson Bank (I think... ) where the CEO stated that they were funding lots of loans and have **no subprime..** and that the New Jersey area was in a good area not affected by the down-turn. Unfortunately, that was followed by an article that states that the Eastern seaboard is beginning to feel the affects of the downturn, that repos are up, office vacancies are increasing and loan volume is dropping.

    - 20% of more recent homeowners owe more than their home is presently worth.

    - Another SeekingAlpha article recently noted the difficulty that even good borrowers are having in obtaining loans... In effect the loan market has dried up (Well... aside from Hudson Bank that is... )..

    Sorry, I have to disagree with both Mr. Hui and Greenspan. There is no turnaround yet and we have not reached a bottom yet before that happens, we need to sell off our excess repo inventory, allow homeowners a market, get most of the US back to work in jobs that can actually pay their bills, free up credit...... I could go on...

    Maybe a bottom next year? Ummmmm... Maayyyybeeee... Gee I dunno.

    jegan ;-)
    Reply | Link to Comment
  •  
    Aug 17 02:08 PM
    Mr. Hui, well done and fairlly accurate. I will take a risk (not) and call a bottom of sorts... sales have bottomed. I think if you look at the number of housing sales per month over the last several months have stabilized. The folks in real estate, adjusting for typical market adjustment months coming from September to March, can pretty much count on the sales that are taking place today is at bottom. With that said, nothing in that statement should be implying the real estate market has bottomed. Foreclosures are still on the rise and the shadow inventory (homes not on MLS) is huge. The laws of supply and demand are still increasing supply and (now) flat demand. I agree that it will become more difficult to short this market. Regardless of the credit supply, demand, interest rates, once the price hit a debt service plateu equal to rents, even lenders would be better off start renting property than to sell it at a further loss and turn it into a performing asset. I would imagine that even shifting home purchases (reo's) into some sort of alternative investment vehicle may make more sense than to further discount the property.
    Reply | Link to Comment
  •  
    Aug 18 01:14 AM
    See the attached article, the pain is only now starting to "climb the ladder" to higher priced houses.

    money.cnn.com/2008/08/...
    Reply | Link to Comment
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