Tuesday, September 25, 2012

One Bottom - One Top - The Housing Market

Regular readers will know that I normally write about specific value investing ideas that I'm working on, or have a position in. This post will be about neither. It's about housing, on both sides of the border.

It appears the bottom is in for the U.S. real estate market. Prices are rising, sales of new homes are rising and consumer confidence is improving. Combined with an improving domestic economy ( some would argue the U.S. is circling the drain ) and a liquid mortgage market, housing is back - but in the slow lane. For those that think the U.S. economy is in turmoil, just have a look around. Housing is turning, railroad stocks are at 52 week highs, cardboard companies are passing along price increases ( which they can't do in a recession ) and consumer stocks like Whirlpool are also at 52 week highs. The market thinks the economy is slow but moving in the right direction. I've been tracking the U.S. home building stocks for sometime - but due to naval gazing, I missed jumping in at the maximum point of pessimism ( last fall ). The home builders ( see below, second chart ) like Toll Brothers, DR Horton, Lennar have doubled in the past year. Investors have priced in the housing market's recovery. You can still benefit from the recovery in U.S. housing by owning companies like Mohawk ( carpet ), USG ( drywall ), Berkshire Hathaway ( carpet, mobile homes, bricks and paint ) or Bank of America ( mortgages ).

Chart forToll Brothers Inc. (TOL)

On the other side of ledger is the Canadian housing market. I've been "pounding the table" for the last year or so, suggesting that the bubble is ready to burst ( ok, maybe just deflate a little ). It appears that is starting to happen. Recent reports indicate prices falling 2% across Canada and up to 12% in pricier markets like Vancouver. There's likely more downside. I'm willing to bet 10-15%, then a long period of flattish prices. Why? Well, Canadian home prices have risen at well above average rates for the last decade. The well regarded Yale economist Robert Shiller ( yes the same Shiller from the Case Shiller home index ) concluded that home prices roughly tracked the inflation rate over the past 100 years. The chart below shows just how prices have disconnected from the longer term inflation rate over the past 10 years.

canada house price inflation

Other indicators backup Shiller's argument. House prices as measured by a multiple of household income have also risen well above the "norm". For example, in Vancouver, house prices are currently almost 10X household income (current national average: 5X eek.), compared to a long term average of 2.70-3.0X. Consequently, homeowners have record debt levels and a negative savings rate. When interest rate rise, highly levered homeowners will feel additional pain. If you are in the market for a home, it would be prudent to not to exceed the 3.0X of household income and put as much cash down as possible. Equity is a cushion that you don't appreciate until you need it, and it prevents you from being forced to do something at the precise moment you don't want to ( sell under pressure ). There are opportunities in this housing market. Some Canadian financials have underperformed as the market has punished them ( more than necessary, creating opportunity ) for their exposure to the housing market. Companies like Genworth MI ( MIC.TO) a Canadian mortgage insurer and Home Capital ( HCG.TO ) an alternative mortgage lender both have good management and significant market share in their respective areas of the mortgage world. I don't own them - yet.

Chart forGenworth MI Canada Inc. (MIC.TO)

Remember: the word mortgage is French for " agreement until death ".

Disclosure: I own Berkshire Hathaway, Bank of America and USG shares.

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