What do we make of the recent 'housing recovery'?

by Wayne Ferbert on July 11th, 2012

There has been a chorus of commentary on the supposed ‘housing recovery’ going on in the United States. Many pundits have been on-air talking about it. It has been driven by the many signs in economic data that point to a potential recovery.

The signs have been compelling:
  • Building permits in May ‘12 were up 7.9% over the April ‘12 rate
  • The May ‘12 housing starts number was down from April ‘12 but was still up 28% over the May ’11 number
  • Construction job growth has grown year over year for 10 months – even if the rate of growth is slowing

This kind of data can make you optimistic. But is it realistic?

My own personal observations in my community are still very mixed. I still see homes sitting on the market – though not for as long as last year. I don’t see as much new construction – or the demand for new construction. I also still see just as many empty store fronts as ever before. That hasn’t changed in my town at all.

It all kind of throws me for a loop. Experts have said that the lack of new home construction during the Great Recession has created pent up demand for new home construction. I am not as convinced that demand will ever re-surface anywhere near levels in the 1990s – much less the credit induced pace of the 2000s.

My hypothesis is the following: it wasn’t just easy credit that drove new home construction. It was the trend to build new homes with newer designs that were more attractive to the Modern Family. These included great rooms, high ceilings, larger kitchens, kitchens as center of home, and open floor designs – among other features. Now that many homes have been built with these features and supply is plentiful and the seller lacks pricing power, the incentive to build custom shouldn’t be as robust.

But I do think home sales (along potentially with prices) will recover – even if not as many will likely be new. I think the new home sales that occur will be those people were going to build to suit no matter what inventory looks like.

So how do we play it? I think you count on the housing price and sales recovery – without playing the new home sales trend. The new home builders have already gone on quite a ride that was driven by this economic data. I think you can make a pair trade out of this. You can pick the home retailer you like (ie, Kohls, Home Depot, Walmart, etc) and pair it up against the home-builders that have run too far and too fast (the ETF of homebuilder from iShares – XHB, comes to mind).

Long the home goods retailer and short the home builder ETF.

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