Is the housing market moving up too fast? As strange as that sounds, considering the crash in the housing market a few years ago, there is a very real possibility that people are beginning to aggressively speculate once again in the housing market.
That flurry of speculators out for quick cash is partially what led to the boom in the housing market last decade. Many people considered the housing market as a means to get rich, and it was fuelled by very low interest rates. That escalation of buying and selling resulted in prices for the housing market far higher than it could sustain. And to the inevitable crash.
Recent data shows that the housing market, instead of stabilizing, is actually seeing an acceleration of price increases.
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According to the S&P/Case-Shiller report, April 2013 set a record for the greatest monthly increase in home prices nationwide, with a 12.1% year-over-year increase in the 20-city composite index. (Source: “Home prices set record monthly rise in April 2013 according to S&P/Case-Shiller home price indices,” S&P Dow Jones Indices, June 25, 2013.)
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The recent rise in interest rates over the past couple of weeks is now sparking debate over whether the housing market rebound will slow down.
But it will be the refinancing business that will suffer; far more than the housing market. That’s because new single-family home construction is still running below one million units per year.
While that might seem like a large number, new family formation requires approximately 1.3 million to 1.5 million new homes per year. Even with the recent increase in construction for the housing market, there is still a shortage in relation to demand.
Higher interest rates will certainly have an effect on the housing market—but that effect will depend entirely on the extent of the rise. If a 30-year mortgage moves up over four percent, that is a substantial increase in percentage terms; but relative to interest rates over the past several decades, it’s still very low.
The chart for the S&P Homebuilders Index is featured below:
Chart courtesy of www.StockCharts.com
Of course, the stock market is a forward-looking mechanism. Because of this, homebuilder stocks have moved up impressively over the past couple of years as investors anticipated a rebound in the housing market.
While the housing market should remain fairly strong itself, I see homebuilder stocks as being vulnerable to a pullback. The reason is that higher interest rates will slightly slow sales and expectations of future revenues.
The current level for homebuilder stocks shows an anticipation of a huge amount of revenue generation over the next couple of years. While interest rates currently remain relatively low, I can foresee significantly higher interest rates over the next few years.
Even though a slowdown in the housing market can still result in positive gains for homeowners, it would be extremely detrimental to homebuilder stocks. That’s because current investors are anticipating a continuation of the massive rebound in the housing market.
With the index of homebuilder stocks up approximately 300% over the past two years, most of the gains in the housing market have already been priced in. At this point, I urge caution: Many investors will begin taking profits in these stocks.
While there remains strong demand for housing, if investors have priced in this demand, any slight setback will be a large negative for homebuilder stocks. Investing is all about market perception, as stocks swing from under-valued to over-valued.