Major public home builders are positioned for continuing growth in market share and profitability, and the industry “should continue to prosper” for the next decade, a global ratings agency reports in its fall 2005 report on the home-building and construction industries.
But no analysis of the housing market is complete without a caveat, and in this case it’s the uncertain future of interest rates, the dangers of loose lending practices, and the escalation of home prices, according to the Fitch Ratings report, “U.S. Homebuilding/Construction: The Chalk Line – Quarterly Update Fall 2005.”
Home builder stocks “continue to be relatively volatile, principally because of fears that with the Fed steadily raising short-term interest rates, mortgage rates will follow, and that will lead to diminished housing demand.” Fitch analysts are also “sensitive to concerns that the liberal and innovative lending standards of recent years could become more of a problem if the economy dips again.”
There are persistent jitters that fast-inflating home prices could burst, Fitch noted, though “recurrent mortgage rate and national home pricing bubble concerns appear to be overstated.”
“Good demographics, low mortgage rates and, perhaps, even a deepening view that housing is a better investment than stocks, have supported the demand for housing. Importantly, the cost of owning a home has not been meaningfully rising relative to the cost of renting equivalent units,” according to the report.
The report also states that local real estate bubbles do exist, and popped up “most recently and notably in the San Francisco Bay Area and in Las Vegas.” Home prices shot up about 50 percent from spring 2004 to spring 2005 in Las Vegas, with speculators moving in for a quick buck. The Fitch report notes that new homes were springing up in the Las Vegas area, which boosted the supply of available homes just as existing homeowners were putting their homes on the market.
“Home prices sharply contracted in Las Vegas (particularly at the high end of the market) as speculators exited,” the report states, though the market there appeared to stabilize by the second quarter of this year.
Meanwhile, the New York Times reported last week that executives and directors at major public home-building companies have profited hugely from a widespread sell-off in shares so far this year – to the tune of about $952 million worth of shares sold. The article stated that the “staggering level of insider sales has analysts and investors wondering if home builders see something menacing on the horizon, like a cooling of the real estate market,” while also noting that “home builders say the stock sales are not a signal that they believe the property boom is waning.”
Fitch found that home builders’ backlogs are growing substantially – the average backlog of units ordered but not yet built was up 21.6 percent from second-quarter 2004 to second-quarter 2005, and the value of these backlog units was 36.9 percent higher in second-quarter 2005 than in second-quarter 2005.
Robert P. Curran, a Fitch analyst, said Friday that there are some markets that may be at risk of over-pricing or over-building. “It’s pretty obvious that we’ve had pretty significant price inflation in a variety of the coastal markets. In some of those markets production has expanded sharply and some of those markets haven’t increased as one might have expected.” A few markets in South Florida, the San Diego market in California, and the Greater Boston market could be problematic “in terms of either supply in the market or prices that might influence demand,” he said.
Nationally, though, demographic trends are expected to fuel continuing, long-term housing demands, and Curran said that home builders could disprove the notion that the financial strength of home-building companies is largely a cyclical phenomenon.
Several major home builders experienced an annual peak in stock prices in July or August this year, with some declines in September and early October. “Concerns about a topping of the market (prompted by recent modest erosion in seasonally adjusted housing-start numbers) and a media barrage about a potentially bursting price bubble have led to a significant sell-off in these stocks over the past month or so,” Fitch analysts said of the recent drop in stock prices.
But Fitch expects this is just a minor glitch.
“Almost all of the public home builders that Fitch follows are anticipating robust gains in home prices, deliveries, margins and profits in 2005,” Fitch reports, and several companies project record earnings in 2006 despite higher materials costs and “less robust pricing.” And the ratings agency agrees: “The public home builders as a group are capable of further growing market share, expanding profits and maintaining current credit metrics.”
The housing boom is largely credited for carrying the economy through some otherwise tough times, and Fitch acknowledges that the public home-building sector “was one of the best performing of all industry groups” in 2004 and continues to perform well this year. Home builder stocks are up 13.2 percent so far this year, the report states. New-home orders may drop in the third quarter compared with third-quarter 2004, Fitch reports, due to some expected slowing demand in at least some real estate markets and a conscious effort by builders to stem growth in backlogs.
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