Housing Market - The Introduction (Part II)

Basic rule of Supply/Demand states that prices rise/decline to meet demand or supply. This means that although we do not have organic demand right now (Housing Market - The Introduction (Part I)), we are witnessing demand nonetheless, which is resulting in higher prices. Therefore, it is worth analyzing possible sources of demand:

1. International Buyers: These investors have cash and are looking for a place to invest. With global uncertainty only U.S. is the safe haven right now. That is why these international investors are either investing in the U.S. Treasuries or U.S. housing market, with the assumption that the housing market will come roaring back.
2.  Hedge Funds / Private Equity Funds: Hedge funds and private equity funds are investing in depressed housing areas and are eating up inventory in the depressed markets because they have the cash and deep pockets. This demand from wealthy funds is resulting in price increase.
3. Limited indigenous demand because of high unemployment rate
4.  Low demand from first time house buyers (analysis shown above)
5. If you can think of another source, please let us know in the comments section.

This clearly suggests that items 1 and 2 are currently driving the U.S. housing demand. Although this seems good for the market, it should be kept in mind that these are only investors. They will take their money where they think it’s appropriate to make a profit. Therefore, unlike genuine home buyers who stay with their houses for several years and try their best to meet the ends meet, these investors will start dumping their properties if they see market starting to decline again. This could result in a ripple effect, and can cause a lot more housing damage.

On the supply front, one must also analyze possible sources of supply of houses. If supply increases suddenly then demand might be able to match it, which might result in decline in prices. Following excerpt from Minyanville highlights possible sources of supply:

The primary cause of increased supply is "shadow inventory"—a huge number of houses that will eventually be on the market but aren't counted in current inventory figures. For example, a large number of households are behind on their mortgages or have stopped paying their mortgages but the banks have yet to foreclose. When banks are finally forced to foreclose and these houses hit the market, they will cause significant additional price declines. Additionally, some homeowners who want to sell are waiting for price increases. When they finally give up and put their houses on the market, Jurow says, this will add additional supply

In the event, it should be mentioned that some of the primary reasons why investors and families are considering buying a home right now are:

1. Low / Affordable Prices
2.  Very low interest rates

However, even with these legitimate reasons we have recently started seeing extra-ordinary optimism coming back into the housing industry. Some examples include:

1. Multi-Year high of House-Builders sentiment index
2. Issuance of new Mortgage Based Security based ETFs, with 30:1 leverage

This kind of optimism is typically visible at market tops. Therefore, there are reasons for concern as far as the housing recovery is concerned.

As you know that this is a consulting assignment which was asked for by the blog readers. In this analysis, UST will explore the housing recovery and industry from several different perspectives. This will allows us to understands the market in its entirety. Along the way, I will appreciate comments and suggestions to include in the analysis to make it as holistic as possible. As part of this analysis, following topics will be addressed on the blog in December 2012:

1. Housing market analysis in terms of charts ==> Builders (ITB), Real Estate (IYR) – 11/29
2. Case Study: Special House consideration – 12/4
3. Analyze housing growth over last few years and economic impact on housing – 12/7
4. Case Study: R.O.I. from the perspective of renting or salability in comparison with stocks and bonds – 12/13
5. Bond market analysis ==> Charts and Elliott Wave analysis – 12/18
6. Conclusions & Recommendations – 12/20

Note: These are tentative dates, and could change as new data becomes available.


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