The U.S. housing market, a key indicator of the American economy, is flashing five major warning signals that home prices have peaked despite low mortgage rates and possible future rate cuts from the Federal Reserve. High-flying homebuilder stocks like Lennar Corp. (LEN), PulteGroup Inc. (PHM), D.R. Horton Inc. (DHI) and Taylor Morrison Home Corp. (TMHC) are likely to take a beating as investors become aware of the housing market’s five ominous signs.
These signs include declining home sales in major metro areas, soaring numbers of houses listed for sale in the hottest markets, increasing reductions in asking prices, the disappearance of bidding wars in hot metro areas, and a deterioration in mortgage underwriting standards over the past year, according to Barron’s.
What It Means for Investors
A press release last week from Freddie Mac, the government-sponsored enterprise created to support the mortgage market, indicated that the average 30-year fixed rate mortgage was sitting at 3.82%, a full 0.80% lower than last year’s 4.62%. But despite lower mortgage rates that could fall even further if the Fed carries through with expected interest rate cuts sometime this year, potential home buyers aren’t taking the bait.
Data from real estate brokerage Redfin demonstrates that home sales in major metro areas have been declining for about a year, the first sign of housing market trouble. Many previously hot metro areas in California saw double-digit declines in sales in both February and March compared to a year earlier. First-quarter home sales in Orange County fell 20% from a year ago, reaching their lowest level since the 2008 housing collapse. Declining home sales are a sign of less buying pressure.
Another warning sign is the number of homes being listed for sale, which increased in a number of major metro areas in March 2019. Compared to March 2018, listings were up as much as 104% in San Jose, 83% in Seattle, 30% in Portland, and 24% in San Francisco. Increased listings suggest that the number of people who want to sell relative to those who want to buy is growing, which means supply is outpacing demand.
Tanking home sales and soaring listings are a lethal combination that tend to put pressure on asking prices, which is exactly what is starting to happen in parts of Los Angeles, New York City and Fairfield County, Conn. Falling asking prices, the third signal, is a sign that bargaining power is shifting from sellers to buyers, the latter of which may hold off purchases if they expect prices to continue falling.
Greater bargaining power for buyers combined with higher listings reduces the amount of bidding wars, the fourth major warning sign. The number of Redfin real estate agents across the U.S. that had multiple offers on homes collapsed from 60% in April of 2018 to just 15% in April 2019. With buyers no longer trying to outbid each other, sellers are forced to compete by dropping their asking prices further.
Finally, a greater number of the houses that are being purchased are being done so with the help of mortgages whose underwriting standards have sunken to dangerous lows. Indeed, the standards have fallen to lows similar to what existed during the heyday of the housing bubble between 2005 and 2007. As many as 3.3 million mortgages originated between 2014 and 2018 would have been denied had standards not fallen so low, according to a report by the Urban Institute cited by Barron’s.
In light of the warning signs that the housing market is flashing, the outperformance of many homebuilder stocks this year is likely to taper off. Lennar, which is up 34% year to date, D.R. Horton 32%, and PulteGroup and Taylor Morrison both up 27%, could see major losses if the recent trends continue.