Tuesday, March 20, 2012

Smart Money Betting on Housing?

Yahoo Daily Ticker reports, The ‘Smart Money’ Is Betting on Housing (Yes, Housing):

In the past six months, nearly every aspect of the economy has shown surprising strength, including auto sales, consumer confidence, weekly jobless claims, manufacturing, exports and retail sales.

Now, some of the smartest of the so-called smart money on Wall Street is betting on a recovery in the ultimate lagging sector: Housing.

Tuesday's housing starts data came in slightly weaker than expected, at 698,000 units. But January's tally was revised up and building permits jumped 5.1% to the highest level since October 2008. Much of the gain was in permitting for multi-family units. Single-family units rose 22,000 last month, its highest level since April 2010.

"The thinking is we've bottomed out and we're going slowly start rebounding in terms of pricing," says Greg Zuckerman of The Wall Street Journal. "Over the last couple of months some of the best investors on the street…have been making big bets on homebuilders."

Zuckerman cited SAC Capital, Blackstone and Caxton Associates as among the funds making big bets on homebuilders, like Beazer Homes (BZH) and Pulte (PHM). Generally speaking, homebuilder stocks have been on a tear, with the S&P Homebuilders Index (XHB) up nearly 70% since its October low while the iShares Dow Jones US Home Construction ETF (ITB) is up more than 75%.

The bullish cash for housing rests largely on record levels of affordability, thanks to a combination of low rates and a steep decline in prices since the highs of 2006. In addition, bulls are betting on pent-up demand for housing from new families and young adults.

This week also brings data on existing home sales (Wed.) and new home sales (Fri.) which will put the optimists' thesis to the test, as will next Tuesday's Case-Shiller Index.

Of course, homebuilding stocks are not the same as housing and calling a "bottom" in housing is a parlor game on Wall Street that no one has won in the past five years, though many have tried. More fundamentally, there's a strong case to be made for why any recovery in housing will prove fleeting. (See: Barry Ritholtz: A Housing Bottom Is Nowhere In Sight)

First, home prices may be down from their bubble-era peaks but they're still high on a historic basis and they have never fallen dramatically below fair value, as is typically the case after a bubble bursts.

Second, the "shadow inventory" of homes (those currently not on the market but likely to be put up for sale at the first sign of a upturn) could suffocate any recovery. Separate but related, the foreclosure pipeline is filling up again after the moratorium last year brought a brief hiatus to short sales, which can significantly depress prices in local areas.

Third, unemployment remains staggeringly high and many Americans are stuck in homes that are underwater and/or unable to get financing to fund a new home purchase, which is gumming up the gears of a housing recovery. (See: Getting a Mortgage Shouldn't Be This Hard: Housing Finance Gets 'Taken to Task'

Fourth, an improving economy is already resulting in rising Treasury yields, which cuts into the "affordability" case for housing.

Fifth, any near-term strength in housing has been artificially boosted by the Fed's extreme aggressiveness and winter's extreme mildness in much of the country.

That said, housing will recover at some point and perhaps now it is (finally) getting to a place where it'll no longer be a big drag on the economy, which itself would be something to cheer.

I've already discussed how top hedge funds were buying homebuilders back in Q3. For example, Citadel bought Lennar (LEN), Paulson & Co. bought Beazer Homes (BZH) and Renaissance Technologies bought Toll Brothers (TOL). All these stocks doubled and more in the last six months as the S&P Homebuilders index (XHB) has been on fire.

But homebuilders isn't the only way to play the housing recovery. US Financials are also benefiting from this recovery, which is why many top funds have been busy buying big banks like JP Morgan & Chase and Bank of America.

Other housing related stocks have also been on a tear in the last six months. Just take a look at the one-year charts of Home Depot (HD), Lowe's (LOW), and Masco (MAS), and you get the idea that top funds have been all over this housing recovery theme.

But while housing may be slowly recovering, some sharp analysts believe that cheap apartment loans are creating a bubble in multifamily properties. Oshrat Carmiel of Bloomberg reports, Apartment Loans by Agencies Creating Bubble, Chandan Says:

Low-cost financing backed by the U.S. government is inflating the values of apartment buildings and threatening to create a bubble, according to a report by Sam Chandan, a real estate economist.

Multifamily loans issued by government-sponsored agencies Fannie Mae and Freddie Mac are buoying the price of apartment buildings to the point that buyers may not be able to refinance once interest rates rise, according to the report by New York- based Chandan Economics LLC, released today.

Getting a new, pricier loan for an apartment property bought at today’s prices would require an income increase “stronger than what we think of as a sustainable level of rent growth,” Chandan said in an interview. “Are we making loans today that we are not able to easily finance when they mature? The finding is yes.”

Investors are rushing to acquire U.S. apartment buildings as the homeownership rate hovers near the lowest level since 1998 and government-supported mortgage companies provide record levels of financing for multifamily properties.

The dollar volume of apartment loan originations by Fannie Mae and Freddie Mac reached the highest level in at least 11 years, according to the Mortgage Bankers Association. The government-supported entities boosted lending by selling $33.9 billion of bonds tied to apartment buildings last year, an increase from $21.6 billion in 2010, according to data compiled by Bloomberg.

Easy financing helped push sales of apartment buildings to $3.8 billion in January, a 53 percent increase from a year earlier, making it the best-performing type of commercial real estate, according to Real Capital Analytics Inc., a New York- based research company.

Interest-Rate Decline

The interest rate for a 10-year, fixed multifamily loan designated for purchase by Fannie Mae and Freddie Mac was 4.1 percent on March 2, according to Cushman & Wakefield Sonnenblick Goldman, a real estate investment banking firm in New York. The rate is for a mortgage that covers as much as 80 percent of a property’s value. That same loan was 5.6 percent a year ago, the company said.

“We see interest rate risk right now as the most significant risk,” Chandan said.

Chandan Economics analyzed 1,594 apartment mortgages originated in the third and fourth quarters of 2011, with an aggregate original balance of $12.7 billion. For each loan, the firm applied a “stress test” to see how much rents and resulting cash flow would have to rise for the owner to be able to refinance at a higher interest rate without adding equity.

“In scenarios where Treasury rates reverted to long term averages by the point of maturity, cash flow growth consistent with prevailing forecasts was generally insufficient to support refinancing,” the firm said in the report.

Rising Rents

Apartment rents in the U.S. climbed 4.1 percent in the 12 months through December, according to Axiometrics Inc. Multifamily landlords probably will have rental revenue growth of 6.7 percent this year, as few new buildings come to market, according to the Dallas-based research company.

Last year, 37,678 new apartment units were completed, the lowest annual total in 31 years of data compiled by New York- based Reis Inc. (REIS)

“With so much attention focused on improving apartment fundamentals as a rationale for competitive bidding, market participants are at risk of underestimating the critical role of low-cost financing fueling current apartment trends,” Chandan Economics said.

Below, watch the Yahoo Daily Ticker clip on smart money betting on housing. Also, Robert Shiller, an economics professor at Yale University and co-creator of the S&P/Case-Shiller home-price index, talks about the U.S. housing market. He spoke with Tom Keene on Bloomberg Television's "Surveillance Midday" at the end of January and warns buying real estate isn't clever.