Sunday, December 24, 2017
By Todd Riddle

The housing rally is the real rally we should pay attention to. And the metrics for real estate look quite strong as we enter 2018.

Just look at some data:

Housing starts: New construction in November was up almost 13% year-over-year, topping expectations and marking the second-strongest month since the market bottomed out for real estate in the wake of the financial crisis. Permitting, a measure of future construction trends, were also quite strong.

Builder confidence: The National Association of Home Builders just reported its highest confidence level since 1999. The reading of its monthly index hit 74 in its December data, up from 69 in November. Any number above 50 indicates optimism vs. pessimism, so the robust reading shows that builders aren’t just confident … they’re downright thrilled about the future.

Existing home sales: It’s not that new homes are selling and old homes sit there. U.S. existing home sales jumped 5.6% in November, to hit their highest level in 11 years. It’s the latest indication that the lull we saw earlier in 2017 caused by tight inventories was just a head fake, and that long-term momentum across real estate is incredibly strong.

Home values: The latest figures are a bit dated, with the Case-Shiller home price index for September not released until after Thanksgiving, but the direction has been consistently higher. The most recent figures showed a 6.2% jump, the fastest annual rate of increase since mid-2014.

Pricing headroom: Lest you think all this is just the inflation of another bubble, consider that markets hardest hit by the housing downturn still have a ways to go before full recovery. This includes Orlando and Las Vegas, are still well short of their pre-crisis peaks and could still take years to get back to those levels.

Possible housing headwinds

Of course, it’s not a slam dunk for housing in 2018. While on balance the real estate market is looking robust, there are a few risks worth considering.

Mortgage interest changes: While the majority of houses are below the cut-off threshold of a proposed $750,000 limit on the mortgage interest deduction, it is increasingly here that high-end properties above that mark but below the multi-million level may see decreased demand. Case in point is a recent Wall Street Journal article that discusses the challenges for New York City real estate amid GOP tax cut efforts.

Continued interest-rate increases: Thanks to yet another recent increase in the fed funds rate, the average 30-year fixed mortgage now is roughly 3.9%, up from a low of about 3.5% at the end of 2016. While that’s still well below historical norms, the increased cost of borrowing is still noteworthy. Will it impact demand if the trend continues?

Inventory shortages: While tight supply does help boost prices, the reality is that a lack of housing inventory — particularly affordable entry-level homes — could make it very difficult to keep up a brisk rate of sales. It’s not just a lack of existing homes on the market, but also the fact that housing starts remain depressed vs. long-term averages.

Household formation: The biggest driver of home ownership is household formation — folks who get married or find a job and move out on their own. And unfortunately, U.S. household formation recently hit the slowest pace in seven years. A lack of new households necessarily means a lack of demand for new homes.

General uncertainty: Of course, everything seemed fine with the housing market in the mid 2000s, right up until it became very clear the financial crisis was about to ruin everything. As MarketWatch’s Andrea Riquier points out this week in an interview with one real-estate expert, numerous factors like the lack of market liquidity make price predictions very difficult and any forecasts necessarily flawed. Keep that in mind despite the bullish narrative.

What’s the trade?

All told, these issues are relatively minor given the momentum for real estate in general.

That’s to say nothing of the momentum for homebuilder stocks, either.

Homebuilder stocks have had a heck of year. D.R. Horton Inc. (DHI) is up 80% since Jan. 1, and NVR Inc.(NVR)  has more than doubled.

For those unwilling to take a flier on individual housing stocks, both of those picks are top holdings of the iShares U.S. Home Construction ETF (ITB) This sector fund has enjoyed roughly 55% gains in 2017.

Valuations aren’t all that crazy in the space either, with D.R Horton trading for just 14 times forward earnings despite its recent run.

In a market where the rule has been “buy high, sell higher,” housing stocks are certainly worth a look given these strong big-picture metrics for the broader home- buying market.