Lead Story… Back in mid-December I noted in a post titled Liftoff that the NAHB Housing Market Index had soared to it’s highest level since 2005 despite steadily rising interest rates. That post also had a chart from Numbernomics.com that showed how builder confidence had de-coupled from it’s historical relationship with housing starts:
I want to revisit this issue today since the divergence is substantially wider today than it was back in December. The following chart is from Mark Hanson and highlights just how large this gap has become.
Builder confidence is on a moon shot. I know this is hard to believe but the index is now at a level that it was last at in 2005 at the height of the housing bubble. Starts tracked tightly with the index up until about 2012 but today they are at less than half of their 2005 level and around 65% of their level during the tech boom when the index was in the same territory. Historically, confidence has been an important leading indicator of where starts are heading. Generally speaking, a confident builder is a builder who is acquiring land and ramping up starts. A negative builder is doing the opposite.
So, why is sentiment diverging from starts to such a substantial level? At first glance, there are several likely explanations:
- The housing market is about to go on an epic run, at least when it comes to starts.
- Sentiment is irrational right now for a variety of reasons and will soon come back to earth.
- Builders are overly optimistic due to de-regulation, especially on environmental issues. However, starts aren’t keeping up with that enthusiasm due to a lack of lot inventory.
- Builders are enthusiastic about their business outlook but either can’t find lots that make sense from a financial prospective. This could either be due to a dearth of financing or cost inflation outpacing revenue inflation.
While I hope that the first option is correct, I’m far to skeptical by nature to buy into that theory. I’m also not enough of a Cassandra to accept the idea that builder sentiment suddenly became irrational after tracking starts tightly for so long. Recent conversations with clients lead me to believe that there is some truth to both items three and four. However, it doesn’t seem like either of those would allow for such a dramatic divergence and neither really explains why the divergence began back in 2012.
Let me propose a more simple answer: the index itself is broken. From the NAHB’s own website:
The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.
As CNBC’s Diana Olick pointed out in December, one issue with the NAHB index is that the survey covers mostly smaller private builders and not the large, high production publics. Public builders have always had an advantage in the market due to their scalability and lower cost of capital. However, in the wake of the housing crash, they have taken an even larger market share in the wake of the housing crash. This happened largely because the equity and debt sources that private builders largely dried up, leaving them reliant on capital from private equity funds which are a poor fit for home building finance for a bunch of reasons. As a result, public builders are dominating the market like never before but they are under represented in the NAHB’s survey. In fact, private surveys similar to the one that John Burns Real Estate Consulting conducts that focus more on high production builders have shown substantially less of a change in builder sentiment.
In many markets, private builders could be ramping up production and it would barely register a blip in the starts data since they have become such a small portion of the sample size. The sky-high sentiment numbers may be an accurate reflection of private builders and their pipeline but still not be representative of the market as a whole. The mystery of the historical divergence between builder confidence and starts may not be anything more than an under-sampling of the public home builders who are more reflective of the market as a whole today. I suppose we will find out if this is the case soon enough but the divergence appears to be as much about who is replying to the NAHB survey as it about actual market conditions.
The Surge: Small business confidence has been soaring since the election but can reality live up to expectations?
The Price is Right: Inflation expectations are finally hitting a level where the Federal Reserve is comfortable hiking interest rates.
Uneven Impact: Fed rate hikes from today’s low levels are painful for borrowers who have floating rate debt but do little to help savers when it comes to deposit rates offered by banks. See Also: The Fed raised rates this week and will likely shift forward their plan for future hikes.
The Final Nail? Rising interest rates could speed up the clock on retail’s $3.7 billion bond maturity time bomb. See Also: If retailers tank, it isn’t likely to knock the Federal Reserve off of it’s rate-hiking course.
Off the Sidelines: Contrary to conventional wisdom, rising mortgage rates are pulling buyers off of the sidelines and leading home builder stocks higher.
Can’t Have it Both Ways: It will be impossible for California to meet it’s highly ambitious climate change carbon emission goals unless it embraces density in a major way. See Also: CA growth will will eventually stop without densification in urban areas.
Scheinfreund: LA’s Measure S got absolutely crushed at the polls last week. Bad news for the NIMBYs. Great news for pretty much everyone else. See Also: This map shows how Measure S lost all across Los Angeles.
Back Above Water: Over 1 million US home owners regained positive equity in 2016.
Stunning: New study finds that people are actually bigger assholes than they think they are, shock ensues.
Hypocrites: Battles between a growing homeless population and wealthy homeowners are putting Berkeley’s liberal image to the test.
Chart of the Day
And you thought that it was expensive here….
Source: The Economist
Meanwhile, In Russia: A Moscow petting zoo is suing an ad agency for using one of it’s raccoons in a lingerie commercial. During the shoot, the critter took a model’s bra off and the footage ended up online. The zoo was not amused and filed suit for animal abuse. The raccoon could not be reached for comment but has been offered a spot on the next season of Russia’s version of The Bachelorette.
FAIL: Women’s clothing chain Forever 21 is in hot water after shoppers noticed that some of their shirts have prominent Nazi symbols printed on them. (h/t Trevor Albrecht)
Subtle: A man was arrested at JFK Airport for smuggling cocaine worth approximately $164k. You have to see the picture to appreciate just how obvious it was that he was hiding something.
Landmark Links – A candid look at the economy, real estate, and other things sometimes related.
Visit us at Landmarkcapitaladvisors.com