I have written about a number of housing stocks for Seeking Alpha. Here are their current valuations:
Source: Looking for Alpha
P/E ratios for these housing stocks range from 3.1 (yes, you read that right) to infinity for the two companies expected to lose money this year. How can this wide range make sense? My interpretation is that we investors at this point collectively assume that:
- Residential construction is on the verge of a multi-year collapse.
- A wave of mortgage foreclosures is imminent.
- Despite these cataclysmic real estate events, the real estate industry is undergoing a major restructuring that will soon leave several players growing rapidly and profitably.
Does this wisdom of the crowd make sense? In my opinion, not even close. Therefore, I am maintaining my buying calls with home builders and mortgage insurers and my selling calls with real estate agents.
I will take the hypotheses one by one.
Is residential construction on the verge of a multi-year collapse?
This graph presents two data from 1985 to the present that are relevant to this question. One is the history of single-family home sales, the other is the homebuilding industry’s level of confidence in economic conditions over the next six months.
Sales data shows it just got back into the range before the bubble and bust from 2004 to 2012. Again:
- Census data shows that below-average home construction for the ten years ’08-’18 has pushed the current housing vacancy rate to its lowest level in 60 years.
- Millennials have entered their peak home buying years.
- The phenomenon of working from home has created a demand for housing where the current supply is insufficient.
Additionally, the survey of homebuilder optimism in current sales activity and expected activity over the next 6 months is at an all-time high never. And this despite serious supply chain problems that are causing automakers to deliberately forgo their marketing efforts. And despite higher interest rates. Additionally, a close look at the chart above shows that builders are quite good at predicting near-term sales activity. So at least this year looks pretty bright.
What would it take for home sales to drop 30-50% as investors suggest and stay there for many years? I can only imagine one event: a severe and prolonged recession. If it’s around the corner, do you want to own the S&P 500 at a P/E of 19, or those homebuilders at their 3-5 P/E?
Is an increase in mortgage foreclosures imminent?
Mortgage insurers – MI – are at 8 P/E ratios, or just 40% of the S&P 500. To emphasize how cheap they are, flip the P/E ratio upside down, which displays their earnings yields, which are 13%. Let’s say IMs never increase their profits again. Would you mind having a permanent return of 13%? Personally, I would be everywhere. Investors today therefore assume that MI EPS will be down. This necessitates a sharp increase in foreclosures, which would force IMs to increase insurance claim costs. What could cause a sharp increase in foreclosures?
Overconstruction? Excessive construction is creating downward pressure on house prices. This happened during the housing bubble of ’04-’07. The average vacancy rate for single-family homes since 1965 is 1.6%. It reached 2.9% at the beginning of 2008. It has been 0.9% for two years, lowest vacancy rate since 1965. Following.
Stupid loan? Weak mortgage underwriting standards were an even bigger reason for the bubble/bust from 2004 to 2012. Let’s compare lending standards for MGIC then and now:
Source: MGIC Financial Report
Literally, night and day. Getting a mortgage is harder than ever. Following.
A consumer at risk? Maybe investors are just nervous about US household debt. After all, “Consumers ended 2021 with record debt levels, which stood at $15.6 trillion, according to data released by the Federal Reserve District of New York..” (CNBC, February 8). If so, they must be really nervous about fintechs ramping up unsecured consumer loans like drunken sailors, right? Let’s take a look:
Sources: Looking for Alpha
Even though these stocks are all off their highs, they are still selling as if a lot more good news than bad is ahead. Following.
We return to the thesis of the serious recession. But apparently only for housing stocks.
Is the real estate industry undergoing a major restructuring that will soon leave several rapidly growing and profitable players?
open door (NASDAQ: OPEN) was founded in 2014. New years later, he is expected to lose more money. red fin (NASDAQ: RDFN) was founded in 2004. Nineteen years later, you always expect to lose money. Zillow (NASDAQ:Z) was founded in 2006. It wasn’t until 2018 that its core advertising business started making money, although it delayed earnings for the entire company until this year in losing $1.6 billion in a now closed “iBuying” business. So sixteen years to profitability. And its core business showed clear signs of overtaking market share three years ago.
Do these facts give you a high level of confidence that many years of profitable growth await you? I admit to being a bit skeptical.
So what accounts for biased housing industry ratings? Emotion, not reason.
I describe the emotional driver of homebuilder and mortgage insurer ratings as “housing PTSD.” Many of us remember the housing crisis of ’07-’12 very well. After decades of fairly steady house price increases, it all came crashing down, with five years of falling house prices and a massive increase in foreclosures. Then, a few months into COVID, house prices jumped. It just seemed wrong to many investors. Then mortgage rates climbed in recent months. Again, a warning sign. That PTSD came rushing back – “Sell a place before 2008 happens again!”
But I have given plenty of evidence that this time things are very different from 2008. In fact, the confluence of events that caused 2008 was last seen during the depression of the 1930s, 70 years earlier. Another 2008 is far from inevitable today. In fact, it’s almost impossible. But tell that to PTSD.
For real estate agents, we have an opposite emotional phenomenon that I’ll call “Desperately Seeking Amazon.” How could so many of us miss Amazon (NASDAQ:AMZN) remarkable business history, from a small bookseller to the country’s dominant real estate agent and cloud business? Many investors suspend common sense and overlook facts to chase the next Amazon. And many companies are happy to offer this Amazon-like promise.
Take red fin for example. Here are some quotes from his Q4 21 results press release:
Facts. “ Net loss per share attributable to common stock, diluted, was $1.12, compared to net loss per share, diluted, of $0.23 in 2020.”
“For the first quarter of 2022, we expect a total net loss of between $122 million and $115 million, compared to a net loss of $36 million in the first quarter of 2021.”
The promise. “Fourth quarter revenue and net profit exceeded our expectations,” said Redfin CEO Glenn Kelman… “Entering an uncertain market, Redfin’s pricing power and on-demand service will allow us to gain share and improve operating margins.”
The promise. “Zillow Group’s fourth quarter results met or exceeded the company’s outlook at the consolidated level and for all three reportable segments. » (Q4 press release)
Facts. “Consolidated [Q4] GAAP net loss was $261 million for the fourth quarter and net loss was $528 million for the full year 2021.” (Q4 press release)
The promise: Of his Press release Q1 ’19: “The Incredible Consumer Demand and Rapid Growth of Zillow Offers[son activité iBuying]give us the assurance that we are in the early stages of something important.[itsiBuyingbusiness)incredibleconsumerdemandandrapidgrowthgivesusconfidencewe’reintheearlystagesofsomethingimportant[itsiBuyingbusiness)incredibleconsumerdemandandrapidgrowthgivesusconfidencewe’reintheearlystagesofsomethingimportant”
Facts: As I noted above, Zillow exited the iBuying business (called Zillow Offers) during the fourth quarter with a cumulative loss of $1.6 billion over 3 years.
The promise: Excerpt from Zillow’s fourth quarter conference call transcript:
“We have an incredibly strong base from which to innovate and an excellent track record of growth in our core business…We know price size matters when we become the central integrator, connecting the pieces of the fragmented process and turning dreamers into doers within the Zillow Housing Super App ecosystem… I have 100% confidence in our ability to accelerate innovation in the months and years ahead.
We will see how these new promises will materialize. But I will stick to the facts of the housing market and the actions of homebuilders and mortgage insurers.