Housing starts and existing home sales stalled in June. Are rising mortgage rates and the institutionalization of the single-family home market starting to take a toll or is this just a pause?
The country’s housing market has a disproportionate impact on the economy. That was on clear display during the 2007 to 2009 recession. Over the last few months, it looked like things were improving here. However, that was partially driven by institutional buyers cleaning up lower priced and distressed inventory and interest rates sitting at historically low levels.
A look at some numbers
Both of these issues have now turned to drags. With most of the cheap inventory sopped up, first-time home buyers have to look at newly built homes. However, newly built homes are increasing in price. Toll Brothers Inc (NYSE:TOL)‘ second quarter ended in May. Sales were up nearly 60% year over year because of an almost 40% increase in the number of homes delivered and a 13% increase in the average sales price.
With prices for new homes heading higher, it’s getting more difficult to afford a home. Add on increasing mortgage rates and the picture looks even worse. Some of the heightened demand so far, in fact, could have been buyers trying to get in while costs were still low enough to afford, pulling demand from future periods.
That said, new orders at Toll Brothers Inc (NYSE:TOL) in the second quarter totaled 5,705 homes, up 27% versus the prior year. And its backlog was 6,163 homes, amounting to $1.9 billion. That’s an increase of nearly half a billion dollars. If home sales cool off for a period, Toll Brothers Inc (NYSE:TOL) should be in good position to keep earnings headed higher. However, if this slowdown marks the start of another downturn, Toll Brothers Inc (NYSE:TOL) will suffer along with all of the industry. Toll Brothers Inc (NYSE:TOL) looks more like a market timing bet right now than a long-term investment.
Institutional
That said, home prices are yet to fall. For example, according to Bloomberg, the median price of existing homes rose about 13% year over year, roughly matching Toll Brothers Inc (NYSE:TOL)’s experience with newly-built homes. That’s a good sign for the new batch of real estate investment trusts (REITs) that have already acquired big single-family home portfolios.
Silver Bay Realty Trust Corp (NYSE:SBY) and American Residential Properties Inc (NYSE:ARPI) are two direct play home owners in that space. Silver Bay Realty Trust Corp (NYSE:SBY) owns around 3,400 homes in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, and Texas. American Residential Properties Inc (NYSE:ARPI) owns 2,500 homes in the same states, plus Illinois, Indiana, and South Carolina. Altisource Residential is another single-family home REIT, but it’s buying distressed mortgage debt and using foreclosure to build its portfolio. That’s a much different proposition.
The interesting thing about these REITs is that they might actually benefit from a slowing home sale market. Even if people stop buying homes, they still need to live somewhere. These REITs will be there to serve customers who no longer want to live in an apartment, but can’t or are unwilling to afford a home.
Silver Bay Realty Trust Corp (NYSE:SBY) has the most internal growth potential because it started the year with an occupancy rate of about 50%. Its rent roll will improve as it fixes up and rents out the other half of its portfolio. While making those capital improvements costs money, it also means the company can be more selective about acquisitions. That said, with a token quarterly dividend of just a penny a share, this is a growth oriented investment.
American Residential Properties Inc (NYSE:ARPI)’ portfolio was over 85% leased at the end of the first quarter. That makes it a much more stable business today and still provides for some upside as it rents out more properties. Still, it probably isn’t reasonable to expect occupancy at single family home REITs to get much higher than 90% or so. That’s around where roughly similar manufactured home REITs Equity Lifestyle Properties and Sun Communities sit today.
So, American Residential is likely to be more reliant on acquisitions for growth. With prices still heading higher, new properties could be less profitable than old ones. That would be a drag on performance. That said, the company also has a business servicing about 600 properties owned by others. That could provide a nice avenue of growth if new purchases prove difficult. The company doesn’t have a dividend policy yet.
Appreciating assets
Silver Bay and American Residential both have notable portfolios of single-family homes. That puts them in prime position to benefit from a stalled housing market and/or improved pricing. Focused on a new asset class, these aren’t for conservative investors. However, more aggressive types with a long-term horizon should consider them. Home builders like Toll, meanwhile, are a direct play on the health of the new home market. That’s a high-risk market timing play right now that most should probably avoid.
The article Is This the Beginning of the Housing Slowdown? originally appeared on Fool.com is written by Reuben Brewer.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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