Today’s release of the June-2014 Housing Affordability Index shows that the underlying improvement of the residential real estate market is still sustainable, barring any severe contraction in median incomes and employment or a sharp increase in mortgage interest rates. With an affordability score @153.4, families earning at least the median income have 153% of the required amount of income to qualify for a conventional loan reflecting 80% of the home price value. The other 20% needs to come from savings or investment assets, which is admittedly weak but improving thanks to the Fed’s quantitative easing which is reflating assets but hopefully not to bubble-like proportions. For anyone with a stable good-paying job and some savings, this is a great time to buy (unless you happen to be in a hyper-inflated major metropolitan area which lacks a supply of buildable land and has a population and family formation base growing at a faster rate than its housing supply.)
The steadily increasing employment opportunities (see today’s JOLT report in Views From The Hill bullish events section) will give further support to the housing recovery. Employment begets all sorts of things, such as consumer confidence and this tends to have a reverberating effect on the economy and mass psychology of the crowd. Eventually, we will approach levels of excessive exuberance, markets will crash, assets will deflate, and we will start the whole process all over again. However, we have not yet reached this point and there is still time for money to be made.
Thinking along this rationale, my instincts and curiosity led me to review a chart of the ITB (Dow Jones U.S. Home Construction Builders exchange traded fund). What I see is an overextended uptrend that halted and has now zigged and zagged over the better part of the past fourteen months, thus reflecting the uncertainty of investors towards the residential real estate market. What is the market trying to tell us about housing? Only time will tell.
Lastly, I took a look under the hood of the ITB and reviewed its top ten holdings which represent 62% of the exchange traded fund’s allocated capital. Most of these companies are trading at substantial discounts to their enterprise value and also have extremely attractive PEG (price to earnings growth) ratios relative to the overall market. Given the combined macro-economic fundamentals of a strengthening labor market and still affordable housing prices in most parts of the USA, they should directly benefit from this capital market theme and reward their shareholders accordingly.
|Top 10 Holdings for ITB (DJ US Home Construction ETF)|
|Company||Last||62.05 % Assets||Growth Est This Yr||Growth Est Next Yr||P/E||PEG Ratio||Price vs EV||1 Yr Tgt Est||% Pot’l Upside|
|Lennar Corporation (LEN)||$36.55||9.74||19.10%||26.60%||16.39||1.54||-39.37%||$43.79||19.81%|
|PulteGroup, Inc. (PHM)||$17.86||9.33||-83.80%||33.90%||2.66||2.05||-10.65%||$21.79||22.00%|
|D.R. Horton, Inc. (DHI)||$20.27||9.14||17.30%||20.50%||13.09||2.65||-29.21%||$24.13||19.04%|
|Toll Brothers Inc. (TOL)||$33.20||8.33||79.40%||31.00%||23.83||0.39||-34.66%||$39.53||19.07%|
|NVR, Inc. (NVR)||$1,122.95||7.66||16.90%||31.50%||20.83||1.79||-2.69%||$1,053.38||-6.20%|
|Home Depot, Inc. (HD)||$82.92||4.98||17.30%||16.10%||21.08||1.16||-9.70%||$89.85||8.36%|
|Lowe’s Companies, Inc. (LOW)||$49.83||3.83||20.80%||20.30%||22.05||1.16||-15.89%||$52.13||4.62%|
|KB Home (KBH)||$16.31||3.05||173.90%||20.60%||23.54||1.93||-58.45%||$20.07||23.05%|
|Ryland Group, Inc. (RYL)||$33.51||3.04||-59.40%||31.50%||5.01||1.74||-39.62%||$44.04||31.42%|
|Meritage Homes Corp (MTH)||$38.75||2.95||3.40%||23.20%||11.00||0.83||-31.84%||$47.42||22.37%|
In conclusion, the above is my own “back-of the-napkin” analysis to help investors and traders connect the dots and see the bigger picture of a residential real estate capital market theme which is far from over and offers a credible risk-to-reward opportunity. As usual, anyone who seriously considers committing capital to any or all of the securities mentioned in this report is strongly encouraged to perform further due diligence independently or with the assistance of a professional investment advisor.