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US Economy

US Housing Market: Rising Prices, Weak Starts

By Elliott H. Gue, on Jun. 18, 2014

The US housing market has been a weak spot for the US economy thus far in 2014.

However, contrary to popular belief, the problem isn’t a surfeit of housing supply or weak prices.

Based on the S&P/Case-Shiller 20-City Home Price Index, residential housing prices have increased steadily over the past two years.

Source: Bloomberg

This popular gauge of sales prices hasn’t approached the highs hit during the housing boom, but its recent year-over-year gains of 10 percent to 12 percent are some of the highest since that speculative bubble.

And after rallying by almost 25 percent since its early 2012 lows, the index has returned to levels that prevailed in late 2004.

In short, the recovery in housing prices hasn’t slowed this year.

A House Divided by Supply and Demand

That being said, housing starts–the number of new homes on which construction commenced–have fallen short of expectations.

In May, total US housing starts came in at just over 1 million, down from 1.072 million in April and below the consensus expectation for 1.03 million starts.

Even more worrying, construction of multifamily units–not single-family residences–has emerged as the lone pocket of strength in this market. Starts for multifamily properties are notoriously volatile because each unit in an apartment building counts as an individual start.

Since the 2007-09 financial crisis, construction of multifamily properties has accounted for a growing proportion of US housing starts.

Source: Bloomberg

This trend primarily reflects a handful of factors:

  • Weakness in new construction of single-family housing while the market worked through a glut of unsold homes;
  • Consumers’ preference for renting in an uncertain economy where unemployment levels remain elevated; and
  • Tightening mortgage lending standards that effectively reduce the pool of potential buyers (recall that some of the riskiest loan structures during the boom were pitched as “affordability products”).

Although total US housing starts have recovered from the depths of the 2007-09 financial crisis, this metric remains at levels more consistent with the bottom of a recession than the middle of an economic expansion.

Source: Bloomberg

Housing construction should recover haltingly over the next few years, but a long time will transpire before this market returns to its historical average.

The US housing market finds itself in an odd position.

With only five to six months of supply in many key markets, the inventory of existing homes for sale remains tight–especially now that the overhang of foreclosures and other distressed properties has cleared.

A paucity of supply explains much of the recovery in home prices, a trend that usually supports housing starts.

But homebuilders have reported intensifying competition for land in key markets, a challenge that has driven up costs.

Persistent labor shortages likewise have lengthened construction times in some areas, while a lack of construction financing erects another major impediment.

And having been burned badly during the housing crisis, most builders have also demonstrated a reluctance to build communities on a speculative basis.

Against this backdrop, many homebuilders have focused on raising prices for new homes, as opposed to increasing the number available for sale.

Barring a major spike in US interest rates (an unlikelihood, given the Federal Reserve’s measured approach to tightening monetary policy), home prices and construction activity should continue to recover.

That being said, investors shouldn’t expect housing to become a major growth driver over the next few years.

Cars, Not Houses

Whereas the housing market will continue to recover haltingly, sales of new cars should rev up.

The median age of passenger cars operating in the US stands at 11.4 years–a record high and up from about nine years old in 2000.

Many consumers put off buying a new car during the Great Recession. But these deferred buyers will look to replace their aging vehicles as the economy continues to improve.

And now is the time to buy. The average rates on US car loans continue to hover near record lows, while leasing terms also remain attractive. In fact, the percentage of leases as a percentage of all vehicle purchases stands at more than 27 percent–near an all-time high.

Source: Bloomberg

With financing readily available at attractive terms, car sales have soared as the US economic recovery picks up steam.

Source: Bloomberg

Annualized car sales stand at about 16.7 million units; we expect this figure to climb to about 18 million over the next few years, driving earnings growth and price appreciation for names leveraged to this powerful uptrend.

Earlier this year, we booked a 46.1 percent gain on BorgWarner (NYSE: BWA), a leading supplier of transmissions and turbochargers.

Our latest play on this trend, a stock that’s at the heart of a revolution in automobile manufacturing, presents an even bigger opportunity for savvy investors. And we’re not talking about the hype-driven Tesla Motors (NSDQ: TSLA).

Check out my Free Video on the US auto industry to learn more about this stock and why it’s ready to peel out.

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