Housing Prices Are Way Up, But Experts Disagree on Why

Photo courtesy of thejewishdenver.com

Photo courtesy of thejewishdenver.com

What is driving the recent rapid rise in housing prices? And is this a sign of a sustained economic recovery? Those were among the questions during a segment covering U.S. housing on CNBC May 28 (http://www.cnbc.com/id/100769361). Home prices during the first quarter of 2013 were up by 10.2 percent nationally, according to the S&P/Case-Shiller Index, the highest since 2007. Phoenix and Las Vegas, two of the regions hit hardest by the recession, were up the most.

Experts point to the very low mortgage rates (held artificially low by the Fed) and the low inventory of houses as among the reasons for the increase. Very few new houses are being built so sales are cutting into the inventory, increasing demand for the few left for sale.

Those who believe the housing market will continue to prosper say population growth will be a driver: One million new households a year are being created. Naysayers, who believe the price increases are not sustainable, say the market is being driven by investors who are buying and renting. They also point to still low construction employment numbers and the fact that college graduates, who should be a major factor in first time homebuyers, are not getting jobs and are shackled with $1 trillion in student loan debt.

While there is little doubt that houses are being appraised at higher prices, the small cap home builders, who had been on a tear since last summer, have seen their valuations flatten out. Here is an update on the home builders we have been following for the past year:

Red Bank, NJ-based Hovnanian Enterprises (NYSE: HOV, http://www.khov.com/) specializes in single-family detached homes, condominiums and town homes and operates in two segments: homebuilding and financial services.  As recently as October 2011 HOV was trading for $0.89. But since March HOV has been hovering around the $6 mark. HOV closed May 28 at $6.15, up 11 cents for the day with a market cap of $856 million. Its 52-week trading range is $1.52-$7.43.

Los Angeles-based KB Home (NYSE: KBH, http://www.kbhome.com/) is a home building and financial services company catering in large part to first time buyers. KB is an old Southern California home builder, founded in 1957 and formerly called Kaufman and Broad. As recently as last Aug. 31 KBH traded for $11.04 with a market cap of $851 million. It closed May 28 at $23.16, up 5 cents for the day with a market cap of $1.9 billion. Its 52-week trading range is $6.46-$25.14.

Columbus, OH-based M/I Homes Inc. (NYSE: MHO, http://www.mihomes.com/) builds single family homes primarily in the Midwest, Mid-Atlantic and southern parts of the U.S. The  company was founded in 1973 and, like most of the other builders, has homebuilding and financial services divisions. It also had a run up into March and closed March 20 at $26.03 with a market cap of $584 million. MHO closed May 28 at $26.47, up 29 cents for the day. Its 52-week trading range is $12.24-$29.07.

Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/) builds and sells single-family and multiple-family homes in 16 states in the U.S. It also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. Back in mid-September BZH was trading for $3.77. It closed March 20 at $16.86 with a market cap of $410 million. On May 28, BZH closed at $21.79, up 44 cents for the day, with a market cap of $547 million. Its 52-week trading range is $3.46-$23.29.

Irvine, CA-based Standard Pacific (NYSE: SPF, http://www.standardpacifichomes.com/) builds single family and detached homes and targets a wide range of homebuyers. It also provides mortage financing services through its mortage finance subsidiary, Standard Pacific Mortgage. SPF closed March 20 at $9.07 with a market cap of $1.9 billion. It closed May 28 at $9.52 down 16 cents with a market cap of $2.1 billion. Its 52-week range is $4.39-$9.97.

Westlake Village, CA-based The Ryland Group (NYSE: RYL, http://www.ryland.com/) is a homebuilder and mortage finance company. RYL covers many aspects of the home buying process including design, construction, title insurance and escrow. RYL closed March 20 at $42.16 with a market cap of $1.9 billion. It closed May 28 at $47.60, down 86 cents, with a market cap of $2.2 billion. Its 52-week trading range is $19.25-$50.42.

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Real Estate Experts Seem to Agree: Home Prices ‘Inching Up’ and Housing Is Back

The housing market is back. That news has been popping up throughout August based in part on the word that storied investor Warren Buffett is “betting big” on housing, according to a Wall Street Journal video featuring housing reporter Joe Light (http://live.wsj.com/video/why-buffett-is-betting-big-on-housing/432BAEE2-88DB-4382-9496-2DA9F86E3047.html?KEYWORDS=joe+light+housing#!432BAEE2-88DB-4382-9496-2DA9F86E3047).

Photo courtesy of 123RF.com

Light brings up some excellent points aimed at the retail investor. They include:

  1. New home inventories are the lowest they have been in almost five decades. As of Aug. 2 there were only 144,000 new homes for sale.
  2. Home prices have started to “inch up,” based on the Case-Shiller Home Price Index and other similar reports.

Light suggests that the most important thing for home prices is momentum, which he says is now in home prices favor. Along with the momentum effect, the other important indicator is price-to-rent ratios, comparing home prices to rents, which are back to the very low level they were at in either 1999 or 2001, depending on what index you are looking at. 

For retail investors, Light says there are two ways to play this improving housing market: either by buying commercial real estate investment trusts which are focused on properties with short leases such as self-storage units where owners can raise the rents quickly as the economy gets better; or by buying home builders. As examples, he listed Lennar and KB Home.

Light’s views on the low supply of newly constructed homes was seconded by J. Allen Smith, chief executive of Prudential Real Estate Investors, owners of about $50 billion in real estate assets. In part of a wide-ranging interview in the Aug. 29 the New York Times, Smith said “new construction starts are so low that even with an anemic economy–one bouncing along at 2 percent growth–the supply-demand fundamentals will continue to improve.” (http://www.nytimes.com/2012/08/29/realestate/commercial/the-30-minute-interview-j-allen-smith.html)

Housing prices, even in the hardest hit areas like Miami, Atlanta and Detroit, seem are “inching up” nationally “for the first time since 2010, when sales were helped by a temporary tax credit for home buyers,” according to another story in the Aug. 29 New York Times (http://www.nytimes.com/2012/08/29/business/economy/home-prices-rise-survey-shows.html).

There are several  small cap home builders to choose from, including four we have covered in the recent past.

Red Bank, NJ-based Hovnanian Enterprises (NYSE: HOV, http://www.khov.com/) specializes in single-family detached homes, condominiums and town homes and operates in two segments: homebuilding and financial services.  The company’s 52-week trading range shows it was trading for as low as $0.89 last October and then went on a tear, going as high as $3.31 in early February. When we last checked on July 11 it was trading for $2.65 and its market cap was about $350 million. It closed Aug. 31 at  $2.92, up 20 cents for the day, increasing its market cap to more than $370 million.

Los Angeles-based KB Home (NYSE: KBH, http://www.kbhome.com/) is also a home building and financial services company catering in large part to first time buyers. KB is an old Southern California home builder, founded in 1957 and formerly called Kaufman and Broad. Back on July 11 its market cap was $754 million and it was trading for $9.74. It closed Aug. 31 at $11.04, up 17 cents for the day, increasing its market cap to $851 million.

Columbus, OH-based M/I Homes Inc. (NYSE: MHO, http://www.mihomes.com/) builds single family homes primarily in the Midwest, Mid-Atlantic and southern parts of the U.S. The  company was founded in 1973 and, like most of the other builders, has homebuilding and financial services divisions. Back on July 11 its market cap was $331 million and it was trading for $17.50. It closed Aug. 31 at $19.30, up 32 cents for the day, increasing its market cap to $352 million.

Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/) builds and sells single-family and multiple-family homes in 16 states in the U.S. It also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. Back on July 11 its market cap was about $283 million and it was trading for $2.86. It closed Aug. 31 at $2.94, up 6 cents on the day, increasing its market cap to $297 million.

Two home builders we didn’t cover previously, that are both trading near their 52-week highs include:

Irvine, CA-based Standard Pacific (NYSE: SPF, http://www.standardpacifichomes.com/) builds single family and detached homes targeting a range of homebuyers. It also provides mortage financing services through its mortage finance subsidiary, Standard Pacific Mortgage. It’s market cap is currently $1.34 billion and 52-week trading range is $2.17-$6.71. It closed Aug. 31 at $6.70 up 14 cents for the day.

Westlake Village, CA-based The Ryland Group (NYSE: RYL, http://www.ryland.com/) a homebuilder and mortage finance company. RYL covers many aspects of the home buying process including design, construction, title insurance and escrow. Its 52-week range is $9.15-$27.15 and its market cap is $1.21 billion. It closed Aug. 31 at $26.81, up 81 cents for the day.

That Light at the End of the Recession: Who Is the Levi Strauss of the Recovery?

There are articles this morning with significant news for the economy as a whole and for the investment community in particular.  First of all, the job market improved more than expected, and is back on the curve it was on earlier this spring, with job creation in the private sector at 176,000 jobs, and new applications for unemployment well under the “magical” number of 400,000. 

Early gold miners wearing Levis. Photo courtesy of andrewhennigan.blogspot.com

Second, and possibly more important, the number of business bankruptcies has fallen and is on track to finish the year at its lowest level since prior to the beginning of the “Great Recession.”  The comes chockablock on top of a truly boffo month of June for consumers, especially people buying cars.

There are storm clouds — European and Chinese wobblies specifically, with interest rates dropping, which is likely to push the value of the US dollar up, making our goods more expensive overseas.  Actually though, two of our biggest trading partners are virtually (but not officially) pegged to the US dollar (Mexico & Canada), and many other economies, such as Australia — resource rich and recessionless — are fairly stable with regard to the greenback. 

So the question is, if we are seeing all these lights at the end of the tunnel — what should we be doing as investors?  We at SmallCapWorld have no answers, no recommendations, because we are not financial advisors,  but we are finding some areas more interesting than others.  Infrastructure continues to be a big agenda item, for instance.  For those with a longer horizon and some patience, homebuilders are looking more interesting.  And an intriguing article in the New York Times last weekend theorized that the electric vehicle market, in spite of the highly publicized obituaries of the lithium-ion battery companies,  may not be dead in the water: http://www.nytimes.com/2012/07/01/automobiles/evs-are-merging-into-californias-traffic.html?_r=1&ref=automobiles.

Many investors look at sectors like these when economic reports are positive, hoping to find bargains like four-leaf clovers.  An article this morning in Motley Fool may be a case in point, for instance: http://beta.fool.com/jonathanyates13/2012/07/05/it-time-togo-sir-john-templeton-european-stocks/6140/?source=eogyholnk0000001.  Heck, even Warren Buffett is out in the weeds looking for something special, buying up newspapers (talk about last century!). 

I’d like to suggest that there is a larger pond to splash about in, and it is not sector-specific: cross-border companies, especially those trading in the USA as ADRs (American Depositary Receipts).  It seems as though ADRs tend to trade at a significant discount to the valuations given their peers on US markets.  That is less true of largecap ADRs, a fast-growing group, by the way, but largely controlled in valuation by trading in their home exchanges.   But it seems to be increasingly true across the board in smallcap ADRs.  After all, what was the biggest success story of the California Gold Rush?  I think it was Levi Strauss, which did nothing more than invent blue jeans for the miners.  Facilitators tend to be ignored at times.

Why would this be so?  Well, maybe it is that they are farther away than US-headquartered companies; they use currencies that may be more volatile these days; they tend not to market themselves well to US investors; they seldom trade on Nasdaq or the NYSE.  In fact, most of them trade in the regulatory twilight zone that used to be universally referred to as The Pink Sheets.  However that may be, there are some very big, very prosperous, very well-known companies now trading on the “pinks” after having delisted from the big exchanges when Congress started tightening the regulatory screws a couple of financial bubbles and several Ponzi schemes ago.

If there are bargains in the ADR world, they will be found eventually — at least that is the theory behind the “if you build it they will come” philosophy that used to be called “build a better mousetrap” or “stick to your knitting.”  And for the Sherlock Holmes types among us, there are all kinds of companies worth looking on the upgraded “pink sheets” listings called OTCQX and OTCQB.  With the not-so-slow decline of the Bulletin Board, these listings may look like the Wild West, but they are not the typical old “pennystocks” that many investors remember.  And the JOBS Act is breathing new life into these small newcomers by suspending a lot of the draconian rules that govern fund-raising for larger companies:  http://www.forbes.com/sites/alanhall/2012/06/28/hearings-on-jobs-prepare-the-u-s-for-expanded-crowdfunding-accelerating-startup-activity-creation-of-jobs/

Anyway, the point of this article is not to pick out stocks in the pink sheets, it is to look for stocks that could benefit from a gold rush pointed at the pink sheets.  The first and most obvious is OTC Markets Group itself (OTCQX: OTCM), the proprietor of the Pinks, the OTCQX and OTCQB.  OTCM, headquartered in New York City (http://www.otcmarkets.com/home) , is chugging along at an increasing revenue rate that looks to be in the range of at least $32 million to $35 million this year, and bringing about 15%  (or $0.12 per share) to the bottom line in the most recently reported quarter.  Just to put this in perspective, the market cap is around $73 million and OTCM is handling 10,000 over-the-counter securities.  The volume of trading in OTCM is under 1,000 shares per day, which puts a bit of a technical barrier up for some people — but it is hard to imagine this part of the market NOT growing.

Another you-never-heard-of-it company that stands to benefit is one of the Fortune 500: INTL FCStone Inc (Nasdaq: INTL).  One of the busiest traders in the market, INTL is said to be the largest marketmaker of cross-border stocks in the US, and they are an increasingly prominent advisor to OTCQX and OTCQB companies under the “PAL” or Principal American Liaison designation.  They are also one of the largest buyers of gold in the world.    The shares are trading at $19.61, not far off their lows; the market cap is $375 million, and the average daily trading volume is 84,000 shares.  This article in SeekingAlpha addresses the value that might be there: http://seekingalpha.com/article/667071-4-undervalued-small-cap-financials-with-analyst-love?source=yahoo

There are some very small dark horses, like San Francisco-based Merriman Holdings (OTC: MERR; http://www.merrimanco.com), which claims to be the largest PAL operation with regard to OTCQX companies.  MERR is quite small and has a recent history of management change and financial distress, but their newswires are busy virtually every day with new OTCQX clients. 

And there are some much larger companies that stand to benefit, like the Australian whiz-kid, Computershare Ltd (OTCQX: CMSQY and ASX: CPU).  Their market cap is well out of our ballpark at $4+ billion, but they have come out of the pack like Secretariat at the Derby, recently taking over the stock servicing portfolio at Bank of New York Mellon.

We own none of the securities discussed in this article.