MT Insider: Goldman Bullish On Housing, Cites Evidence that Recovery Is Not Structurally Flawed
In one of the most read reports out today, Goldman Sachs is optimistic on the housing market and expects continued growth based on evidence that the recovery is not structurally flawed.
As a backdrop, the real estate market has been heavily debated by both the sell-side and the buy-side among the street, hedge funds, and mutual funds as student debt levels have continued to increase (thus negatively impacting potential first time home-buyers).
As an aside, it is worth noting that the introduction of for-profit education has perpetuated this trend as more students have decided to attend online colleges based on the ease of studying online.
Notably, this was also a large short among alternative investors given the demographics of the underlying colleges, the lack of credibility, and number of defaults from government backed student loans. Moreover, the majority of the companies in the for-profit sector used aggressive accounting measures to book revenues.
Moving back to housing, the bear case revolves around the the premise that younger buyers are less affluent as a result of these higher debt burdens. Investors are also wary of the rise in mortgage rates and already high home prices.
That being said, Goldman finds that student loans do not depress expenditures for new homes. This is supported by recent indicators, which convey that credit is still easing.
In fact, a lower home ownership rate in the 25-44 year old segment should actually spur housing demand, as most of the shortfall in home ownership comes from medium to high-income households.
Countering the argument that lower incomes are stalling the recovery, the analyst notes that this is an over-simplification and ignores the impact from mix given that simple median household income tends to understate income growth.
It is no secret that the housing bust and the ensuing financial crisis led the economy into one of the worst recessions since the Great Depression. That being said, the analyst believes that the decline is cyclical and thus, by definition should reverse going forward. GS sees signs of a recovery in the private sector, and the most recent data released by the Census Bureau conveys that household income has stabilized in 2012.
As an aside, annual household income is obviously important, but it is not the only data point used to assess housing affordability and demand. Investors should not extrapolate income growth using the straight-method, as the correlation is not one-to-one.
Moreover, Goldman finds evidence that new homes are still affordable, especially versus historical levels. 30 year mortgage rates are at multi - decade lows.
This was reiterated last week at the Bloomberg Markets 50 Summit, which MT Newswires attended. Panelist members included Richard LeFrak, President of LeFrak Organization and Steven Witkoff, Chairman of Witkoff Group.
For example, 30-year mortgage interest rates averaged 13% in the 1980s, 8% in the 1990s, and 6% since 2000, per the report. Thus, even if median household income stays the same, mortgage interest rates are significantly lower when compared to decades prior. This implies that the median borrower can afford a more expensive house today.
Bottom line, the analyst recommends builders in strong housing markets, especially those that cater to the higher end including Ryland Group (RYL), Meritage Homes Group (MTH), and Toll Brothers (TOL).
From a buyer's perspective, Douglas Yearley, CEO of Toll Brothers (TOL) also spoke last week at the Bloomberg Markets 50 Summit, noting that "rates are back down to 4.25%."
XHB 30.56 +0.06 +0.20
APOL 20.81 0.00 0.00
DV 30.56 0.00 0.00
ESI 31.00 0.00 0.00
COCO 2.19 -0.01 -0.45
CECO 2.76 +0.01 +0.36
RYL 5.62 +0.08 +0.20
MTH 42.95 0.00 0.00
TOL 32.43 0.00 0.00