Monday, September 24, 2012

The Truth About The Housing Market

Many of us who have to follow the news closely every day as part of our jobs woke up this morning to headlines of Lennar, the big homebuilder, reporting supposedly robust earnings for the 3rd quarter.  The stock was up over 2% in pre-market trading and the bubblevision news stations were doing cartwheels.  But LEN stock closed down 1.5% from Friday's close and the Dow Jones Homebuilder Index closed down 1.14% from Friday's close.  What happened?

If you peruse LEN's detailed earnings release, some interesting data stand out.  The headline shouts out that LEN's deliveries were up 28% from Q3 2011.  But actual increase in units was 785 homes.  That's 43 homes per State in which Lennar operates.  43 homes per State.  The total number of homes delivered in Q3 was 3,617.  Year to date for 9 months the total is 9,353 homes.  Assume a constant run-rate for Q4 and the total deliveries will be 12,400 for all of 2012 (truth is, Q4 will likely be a lot lower than the run-rate due to seasonality).  That 12,400 compares to 49,568 homes delivered in Lennar's 2006 peak selling year.  That's a 75% decline.  If you put the 49,568 vs 12, 400 in market context, think about what that means in terms of just how overbuilt and saturated the housing market is in reality, beneath the heavy sales-spin being applied by the industry about "recovery."

As for Lennar's reported earinings, again it's well worth looking beneath the ebullient headlines to see what's really going on - and I just happened to do that.  Lennar reported net income of $87.1 million vs $20.7 million in Q3 2011.   However, $25.3 million of that net income came from its mortgage underwriting operations (vs. $8 million in 2011).   Since the average price of a Lennar home is about $250k, we can assume most, if not all, of its mortgages get flipped into FHA, FNM and FRE programs - i.e. get sold to the Government/taxpayer.  I mentioned in a post earlier this month that the liberalized FHA underwriting standards and QE programs would transfer wealth from the Taxpayer to mortgage underwriters/brokers.  Well, there you have it first-hand in Lennar's earnings report.

Furthermore, Lennar's $87 million in reported net income, $12.8 million was derived from a non-cash tax accounting maneuver.  You can read the earnings report for details if you are curious.  But, quite frankly, it's basically the same kind of non-cash GAAP manipulation being used by banks who are reversing out loan loss reserves in order to pad reported income, as opposed to actually getting a cash earnings benefit.  The accounting maneuver serves no purpose other than to pad its bottom line for this quarter, in an attempt to make the stock price look appealing to brokers and investors who do not do their homework. Here's a link to LEN's earnings release today:  LEN

The reason I wanted to spend time shredding Lennar's earnings report was because in the last few months unjustified bullishness for the housing market has invaded the mainstream media and certain widely read blogs, Calculated Risk being one of them.  For some reason Wall Street, the media and Calculated Risk are looking at recent month-to-month data points and projecting a big housing recovery.   The fact of the matter is that most of data is based on accounting and data manipulation schemes, like "seasonal adjustments" and the use of reporting percentage changes rather than actual unit data.

In terms of industry fundamentals - truthful industry fundamentals - it's the same old story.  Yes, there's been a bit of a bounce in the housing market.  We would expect that to happen given that the Fed has successfully engineered record low mortgage rates, there's been unprecedented stimulus injected into the system over the past 3 1/2 years and taxpayer-sponsored FHA has stepped up its rate of subprime financing.

But if you look behind the media and industry spin on the numbers, a different story than what is being promoted emerges.  I've detailed the "shadow inventory" aspect to the housing market inventory several times on this blog.  In terms of unit sales and price increases being reported, I will refer you to a series of three blog posts by Mark Hanson - here are some excerpts:

1) On reported price gains:   When…

1) rates drop by 30% YoY allowing the 70% of buyers who use a mortgage to ‘pay’ 15% more for a house on the same monthly payment;

2)  foreclosures as a percentage of total sales drop 25% YoY lifting the “median” sale price:

3)  and you comp YoY against a stimulus hangover year;

…”prices paid” will ‘rise’ and ‘comps’ will look great.   But the benefits of stimulus and easy comps will soon turn into headwinds and difficult comps, which is exactly what happened in 2011 following the year+ long home buyer tax credit stimulus pump of 2009/10.  LINK and LINK
And on the pending home sale data released by the National Association Realtors:
Pending Home Sales number got everybody hot and bothered because the headline had the word ”higher” in it.  But what everybody fails to understand is that this year over 30% of Pendings fail to close. Last year less than 10% failed.  In fact, contract failures got so bad into Q2 that NAR quit releasing the data.
Here's the LINK

I hope everyone has a chance to read those quick pieces by Hanson - they are quite revealing and contain actual data analysis, rather than the hope-laced garbage thrown at everyone by Wall Street, the media and highly promotional industry associations.

Finally, here's some more cold water thrown on the housing party by Gary Shilling:  LINK  He sees another 20% downside in the housing market.  I think even that projection is optimistic.  I've said since 2003 that I expect to see a 50-75% decline in housing from the top to the bottom.  I am more inclined to bet on the 75% number and I'm beginning to think - short of the Fed printing up money to buy up a few million homes and bulldozing them - that we could see a top to bottom decline greater than 75%.   As I've pointed out before, Sir John Templeton (of Templeton mutual fund fame and one of the "fathers" of mutual fund investing) said in 2002 and before his death that he wouldn't touch U.S. real estate until dropped 90%...


  1. Great piece and spot on. CR fell out of favor with me a long time ago, not because I am a perma bear but seems he is sort of a Fed apologist.

  2. I heard the Lennar report on Bloomberg this morning on my drive in to work... it was presented as a big positive... leave to you Dave.. the maestro of earnings report reverse engineering... to throw cold water on that bit of fresh statist propaganda.

    In a tangentially related note.. I will be adding a nice MS-63 St Gaudens to my stack tomorrow for $80 over spot! 1Kg Lunar Dragon.

  3. Dave,

    Thanks for cutting away the bs and exposing the nakedness. Most people want to believe the easy lie rather than accept the hard reality, I guess that is why MSM is still in business. And movies, etc are popular.

    Can you give your take on farmland? Will it follow RE or is it totally different in your opinion.



  4. I think you have missed CR's position on housing. Whether one agrees with him or not, he's stated multiple times that he believes housing is at a bottom. But he has never said that there will be "a big housing recovery." On the contrary, he's stated that housing will remain weak for years, and the recovery will be anemic. I'm sure you can find plenty of perma-housing bulls in the media, but CR shouldn't be lumped in with them.

    1. CR has been overoptimistic for years, including missing the initial housing crash. Whether his position is bottomed out or recovery, he's still wrong. His biggest problem is that he goes by the published numbers and doesn't look for the real numbers. You can't do accurate analysis if the data you base your analysis on is wrong.

      Housing is going lower. A lot lower. The basic ingredient to support housing values, even more important than credit availability, is income levels. Real income levels are declining - pretty quickly I might add. That plus true oversupply adds up to lower housing prices.

  5. “Legalized Plunder – Why we have all been had, fooled and deceived…. and the surprising reason we keep asking for more of the same bad medicine”

    Griffin: I think there is. I think that Einstein's E=mc2 was the epicenter of all his theories. I think in our case the epicenter was the realization that the Federal Reserve system is a cartel, and not an agency of the federal government. That single fact alone is, when you think about it, so shocking to most people – or it should be, because we have been raised to think that it's the government, that they're looking after us. To think that it's no different than an oil cartel or a banana cartel – it simply happens to be a banking cartel and that we have given them the monopoly to create the money of the United States, and that they can create it out of nothing and charge interest on nothing – all these pieces start falling into place.

    People realize that this is not in the best interest of the American people, was never designed to be from the get-go, and it has been a means of legalized plunder of the American people.

    That all stems from the realization that the Federal Reserve is a cartel and not a government agency. I think that's it.

    L: It's egregious for somebody to lose so much money and then get a government bailout and then get a bonus for that, but who gave them the bailout? The government.

    Griffin: We're back to the realization that the Fed is a cartel; but it's more than a cartel. It's a cartel in partnership with the federal government. We really have kind of a duopoly here. The bankers and the politicians have formed this partnership that works very well for both of them.

    L: The famous revolving door.

  6. Markus Stanley: Derivative bets not a zero sum game, have far reaching real world consequences

    ...very easy to move liabilities throughout the world.