Friday, 17 December 2010
A couple of months back, I wrote about the tremendous deals that can be had if you are an investor buying real estate properties. Obviously, as a qualified, confident buyer, you have quite a selection, as well as many distressed sellers at your beck and call wanting to unload their homes. “Qualified” and “confident” are the operative words — but many Americans still are neither.
Housing Market Pricing Power
Existing new home inventories are high all around the United States. Home sales data does not look like it should in a economic recovery. Year-to-date, there were 4.149 million existing home sales, down 2.9 percent from 4.272 million home sales at this time a year ago.
According to S&P/Case-Shiller, prices are still moving lower: through September 2010, the average home price dropped 2.0% in the third quarter of 2010, after having risen 4.7% in the second quarter, which was probably attributed in part to the special tax credits. Most homes are 1.5% below their year-earlier levels.
Rising Interest Rates
The real conundrum here is the fact that an economic recovery most likely means a hike in interest rates. They have already started creeping up from their lows. The 30-year fixed rate reached a seven-month high, and the 15-year fixed-rate mortgage went above 4% for the first time since the end of July, according to Freddie Mac.
According to Experian, the average mortgage amount is about $137,000. Using that loan amount, the monthly difference in your principal-and-interest payment alone would increase about $90 per month, or $1,100 per year, for every 1% increase in interest rates.
It may not seem like much, but when most Americans are on a budget, every penny counts. Higher interest rates do bring downward pricing pressure.
Use Caution
If you were thinking about buying a homebuilder on the heels of the new home data that was released yesterday, remember that they have to build a home that they can make money on. This means that if prices for homes are low, they may have to scrimp on certain amenities and quality items when building their homes. More expensive layouts, materials, windows and finishes will most likely suffer. This can be balanced somewhat by what they are able to buy the land for. But for the builders who already have land and are waiting to build, the cost of carrying that land will hurt them and cut into profits.
Here is a chart showing the average home value (in thousands) over the last decade. For reference, I drew a line and added an arrow down to the corresponding past-value-and-time frame. We are right back at mid-2003 levels when it comes to the value of your home.
New or Pre-Owned Homes?
As a current home buyer, I can give you an anecdotal example of what’s happening in my world in Dallas. I can buy a pre-owned, 2,100-square-foot home (built in 2003), in excellent condition, with brick construction, loaded with all the amenities that I want, and in the location I want for about $220,000. With all the desperate sellers out there, I may also be able to get some other incentives and contributions to my closing costs, which might knock another $5 to 10k off the selling price (Freddie Mac is offering 4% in closing credits).
Right next door to where I currently live is a nice row of freshly minted townhomes that are about 1.5 years old. Out of the 18 that were built, about nine remain for sale. The quality of construction is comparable to what I found in the other $220k home, only these are stucco (lower quality) and about 200 square feet smaller. They were selling for $379k, but have been reduced to about $330k after seller concessions.
Don’t get me wrong — they are gorgeous homes in a great location and they have never been lived in. But as an American who is still on edge and wary of both the state of the economy and, even more importantly, my job security, do I choose the home that costs $100k (50%) more than the pre-owned home I can buy that offers everything I need? I would choose the larger, pre-owned home.
(By the way, investing doesn’t have to be complicated. Sign up for Smart Investing Daily and let me and my fellow editor Sara Nunnally simplify the market with our easy-to-understand articles.)
Of course, I can’t answer that question for every one of you out there, and at the end of the day, location, price and personal preference prevail. But being a math-and-statistics type, I have to believe that if I surveyed most Americans right now and asked them which they would choose, I have a feeling most would gravitate to a pre-owned home given the above scenario.
To be fair, there are many very affordable new homes in great areas. But the fact of the matter is that in the nation’s densest cities, new, desirable land is hard to come by and still expensive, and there is a slew of pre-owned inventory for sale.
The Bottom Line
Even though housing market conditions seem to have improved somewhat, this is not an environment for the new-home builder to be making big money. There will be exceptions, but until the existing home inventory decreases to an acceptable level and our economy really gets a jumpstart, you can expect companies like Lennar Corporation (LEN:NYSE), Toll Brothers, Inc. (TOL:NYSE), PulteGroup, Inc. (PHM: NYSE) and D.R. Horton, Inc. (DHI:NYSE) to have a tough time getting their stock prices much higher from here. Keep your eye on Home Depot, Inc. (HD:NYSE) and Lowe’s Companies, Inc. (LOW:NYSE), as I suggested a couple weeks ago — they should still reap rewards from all this.
Other Related Topics: Economic Recovery , Housing Market , Interest rates , Jared Levy , Real Estate , Smart Investing Daily
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