Housing is the Business Cycle, So Where are We Now?

- Please Act Accordingly Page 1 of 11

Please Act Accordingly

One Good Investment Idea a Week, That’s All We Ask

About How Are We Doing? The Library Disclaimer Contact Us SEARCH

« A Pair Trade with Some Sparkle -

Long Signet Jewelers/Short Blue Nile
Recent Posts
 Housing is the Business Cycle, So Where are
We Now?
Housing is the Business Cycle, So Where are We  A Pair Trade with Some Sparkle - Long Signet
Jewelers/Short Blue Nile
Now?  Recent Correction in ARP Shares Brings the FCF
Yield Back to 20%+
As we’ve mentioned in the past, we are firm believers in Edward Leamer’s  What To Do About Smith and Wesson (SWHC)
thesis that “Housing is the Business Cycle“.  It continues to shape the prism Now
 Causality in the Natural Gas Pit - How the UNG
through which we view the economic cycle. The relative stability in new and
Works in Theory (And Why it Doesn’t)
existing home sales VOLUME (not price) has, in part emboldened the bulls who
most certainly will look to the housing market for the first signs in a broader
economic recovery. We thought it might be interesting to take a top-down look Popular Posts
at the housing market through an analysis of national level statistics and a more  Revisiting Our Mean Reversion Pair Trade from
detailed review of new and existing home sales in the former bubble states: the Energy Pit - Long Natural Gas/Short Crude
Arizona, California, Florida and Nevada. We continue to believe that volumes Oil: We Still Like It
for both new and existing home sales have bottomed, but we are still a year or  A Pair Trade with Some Sparkle - Long Signet
two away from a bottom in pricing. Before we get into greater detail, we wanted Jewelers/Short Blue Nile
 Housing is the Business Cycle, So Where are
to provide you with our key conclusions on the state of the housing market: We Now?
 Causality in the Natural Gas Pit - How the UNG
1. The inventory of new single family homes is in very solid shape, but that Works in Theory (And Why it Doesn't)
doesn’t make us bullish on homebuilders  A Mean Reversion Pair Trade From the Energy
2. There are actually three separate housing markets now: a) The market Pit: Long Natural Gas/Short Crude Oil
for foreclosure/distressed sales, b) the traditional resale (existing home)
market, and c) the market for new homes. The national data can be Join Our Email List
misleading as to the overall state of the housing market because it is not
capturing the cross-currents in each of these markets.
Your email:
3. Existing home sale volumes in former bubble markets likely have
bottomed but will not increase at the same pace going forward as the Enter email address...
type of foreclosure properties move to higher price points.
4. Any sequential improvement in median existing home prices in former
Subscribe   Unsubscribe
bubble states should be taken with a grain in salt. As argued brilliantly by
Whitney Tilson, of T2 Partners, the sequential improvement is largely a
function of more higher priced homes entering foreclosure, which we will Subscriber Count
prove out with an analysis of the data in Arizona.
5. Concerns about defaults down the line from investors that have 95
purchased foreclosure properties and then rented them out in the past
year appear to be unfounded. Based on current mortgage rates and the
median price for a distressed sale, the average high school graduate in Archives
this country can service a mortgage on these properties. Talk about  June 2009
 May 2009
unintended consequences.
 April 2009
6. An environment with steady to slightly improving volumes and rising
median prices in former bubble markets still appears to be favorable for
ZipRealty (ZIPR 2.65 ↓7.02%) Market Quotes and Current Investment
7. Finally, the prospects for housing suggest some level of economic Ideas
stability but a pretty tough slog for the next 2-3 years.

On a National Level - New Single Family Home Inventory Is In Good Shape,

Existing Home Inventory Not So Much DJIA 8417.68  

Let’s start at the highest level before we dig down into some very revealing state
level data. The chart below is probably familiar to many of you. It displays -1.31%
existing single family home sales as provided by the National Association of
Realtors over the past 40-years. As you can see, existing single family home

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 2 of 11

sales have been stuck in a range of 4.0-4.3 million on an annualized basis for
about a year now. This puts the number of existing single family home sales at
the top end of the range witnessed in the late 1980’s through the mid 1990’s.  
We anticipate sales will remain at least at these levels for the next 12-18 NASDAQ 1829.58  
months, barring a major change in the interest rate environment (click on chart
for full image view).
-0.79%

S&P 500 915.60  

-1.25%

THQI 7.24  

-2.43%
Source: National Association of Realtors

The inventory situation for existing single family homes is not yet encouraging -
ESI 101.82  
inventory on an absolute basis and months supply is still well above historical
norms.  The one encouraging sign has been that existing single family inventory
has declined on an absolute basis. At over 9-months supply and 3.2 million
single family homes, we think inventory needs to decline by approximately +7.08%
750,000 homes to return to a more normal environment (click on chart for full
image view).

ARP 8.39  

+0.72%
chart

CLM09.NYM 59.65  

+0.00%
chart

Source: National Association of Realtors

NGM09.NYM 3.54  
Existing single family home inventory has been declining on an absolute basis
for 10 straight months now, which is encouraging. To the extent that Obama
and leading lending institutions can stem the tide of foreclosures, existing single +0.00%
family home inventory could be reduced far more rapidly than 15% on a YOY
basis.  Based on the number of option-ARM resets over the coming 18-24
months, this could be a very tall order (click on chart for full image view).
ZIPR 2.65  

-7.02%

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 3 of 11

RGR 12.60  

+2.69%

SWHC 5.67  

+2.53%

Source: National Association of Realtors, PAA

Research HURN 46.46  

The situation in the market for new single family homes is much more
encouraging from an inventory perspective, although demand remains weak. -1.09%
The management teams of the home builders have always argued that there will
always be a certain segment of the population that just wants a new home.
This has been put to the test over the past 12-18 months and it looks like in an
environment of great distress, there are approximately 300-350,000 families or BCO 29.06  
individuals annually who want a new home, no matter what the economy is
doing.  This is the worst environment for new home sales in the past forty
years.  -0.48%

NILE 43.28  

-0.07%

SIG 20.40  

-2.02%
Source: US Census 2009-06-30 13:49

The good news is that many leading home builders have reported positive Categories
sequential improvement in order trends from late winter/early spring to late  Books We've Read and So Should You
spring/early summer. However, the availability and price points of existing  Business Services
homes available in the resale market continues to strip away demand from the  Commodities
new home market. From an inventory perspective, the new home channel looks  Firearms
clean.  Even though the supply stands at more than 11-months, at the current  For-profit Education
pace of sales, the absolute level of inventory is consistent with bottoms in other  Housing
economic downturns (click on chart for full image view).  Industrials
 Initial Investment Idea Write-ups
 Jewelry
 Long Ideas
 Short Ideas
 Uncategorized
 Video Games/Interactive Entertainment

Tags

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 4 of 11

APOL
Activision ARP ATVI BGG Briggs and
Stratton Business Services CECO COCO Crude Oil
ESI Firearms
DV Electronic Arts ERTS
For-profit Education
Housing HURN Huron Consulting Group
Inc. Industrials Interactive Entertainment ITT
Educational Services Natural Gas Q ratio
Reprographics RGR Ruger Shiller
Short Ideas Smith and Wesson Sturm
SWHC Take-two Interactive THQI Tobin
Source: US Census
UFC Ultimate Fighting Championship
TTWO
We expect inventories to stabilize at current levels or perhaps even go lower,
which would be encouraging. Many privately-held homebuilders have gone into UNG USO Video
bankruptcy and the remaining players are highly reluctant to take on “spec”
inventory.  Looking at it another way, this is the biggest inventory correction of
Games/Interactive
new homes in the past 50-years (click on chart for full image view). Entertainment Video
Games/Interactive Entertainment WWE
ZIPR

Blogroll
 Bronte Capital
 Joystiq
 Naked Capitalism
 Seeking Alpha

Finance and Stock Related Blogs

 Bronte Capital
 Calculated Risk
 Citron Research
 Naked Capitalism
Source: US Census, PAA Research  Stock Blog Directory

We do not foresee a meaningful uptick in new home sales until the inventory Industry Blogs
issues in the existing home market are addressed, which still will likely take 18-  Reprographics 101
24 months. The national level data leaves us encouraged about the overall
level of inventory of new homes, but not much else.
Video Games/Interactive Entertainment
 Joystiq
Trends in the Former Bubble States Look Eerily Similar - They Have Been
Driving the Improvement in the National Level Data

We have reviewed home sales data for Arizona, California, Florida and Nevada

and we are surprised how similar the markets look. California appears to be Subscribe to feed
further along in churning through inventory financed by subprime and alt-a
issuance.  The volume of existing home sales appears to have bottomed in the
fourth quarter of 2007 in California. The affordability equation improved over
the following 12-18 months and existing home sales took off.  However, not 
until the past three months did the median sales price show any signs of stability
(click on chart for full image view).

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 5 of 11

Followers (21)

Source: California Association of Realtors

Follow this blog

It is important to note that stabilization of the median sales price is not

synonymous with a bottom in home prices. The mix of homes can impact
median price dramatically and mask what otherwise might be overall price Spam Blocked
weakness (more on this later). The inventory of existing homes for resale 58
stands at 4.2 months, levels not seen in more than four years. This can be spam comments
attributed to several factors: 1) an overall improvement in the pace of sales
(obviously) 2) a reduction in foreclosure activity due to government efforts and
3) more proactive policies from banks to reduce the number of foreclosures.
We think the median sales price has improved sequentially over the past three
months due in large part to a lack of new foreclosure inventory coming to
market. 

The chart below compares the YOY change in median sales price for existing
single family homes to the months supply of inventory. It is interesting to
observe that in 2007 the median price of an existing single family home in
California continued to increase even though the supply of inventory
approached a year. Over the past three months, the M/M change in median
sales price has improved. Price trends in real estate aren’t nearly as dynamic
as other markets, so this might suggest the median sales prices could continue
to increase sequentially for a few more months even if California gets hit by a
new wave of foreclosures in the second half of 2009 (click on chart for full image
view)

Source: California Association of Realtors, PAA

Research

The situation in Las Vegas appears eerily similar. The volume of existing single
family home sales bottomed in the fourth quarter of 2007 and have since
surged in large part in response to lower prices. However, unlike California there
are no nascent signs of price stability.

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 6 of 11

Source: The Greater Las Vegas Association of

Realtors

The situation in Florida looks similar, although the magnitude of recovery in

existing single family home sales volume has not been as strong. Whereas, the
volume of existing single family home sales has increased YOY for 14-
consecutive months in both Las Vegas and California, Florida has only seen
improvement for 9-months and sales at their most increased 40% YOY. As you
might expect, prices have not declined as much so it is possible that many
home buyers and investors are waiting for more attractive entry points (click on
chart for full image view).

Source: Florida Association of Realtors

Arizona Under the Microscope - Median Price of Foreclosure Sales Higher

Than That for Traditional Sales

 The housing data for Arizona looks very familiar - existing single family home

sales bottomed approximtely 14-months ago and since that time sales volume
has more than doubled. The median price has declined approximately 50% from
the peak and median prices have declined approximately 35% on a YOY basis
(click on chart for full image view).

Powered by WordPress. Search engine optimization by SEO Design Solutions.

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 7 of 11

Source: Arizona State University Realty Studies

Looking at the chart above one could be encouraged by the strong YOY
increase in existing home sales volume (73.9%) and sequential month-to month
improvement in median price (4.2%). However the top-level data masks some
divergent cross-currents between traditional home sales and foreclosure sales.
According to ASU Realty Studies, foreclosure/REO/short sales represented
approximately 6.2% of total existing single family home sales in May 2007. By
February of this year foreclosure sales represented more than 50% of total
existing single family home sales in Arizona. However in the past three-months,
the pace of foreclosure home sales has slowed and in May only represented
30% of total existing single family home sales.

Source: ASU Realty Studies

 We can only attribute the slowdown in foreclosure sales to efforts made by

banks to modify mortgages and the Administration’s $75 billion loan modification
plan.  We anticipate theses efforts could stem the tide of foreclosure for a period
of time but given the magnitude of employment weakness and continued
weakness in home prices, we do expect foreclosure activity to reaccelerate,
particularly for higher priced homes.

As one would expect, the increase in foreclosure home sales over the past two
years brought the median sales price down precipitously. Once foreclosure
homes as a percentage of existing single family home sales exceeded 40%,
median home sales price started to drop by double digits. This is true for both
the median sales price for foreclosure sales AND traditional sales. For
example, a year ago foreclosure sales in AZ represented 40% of total existing
single family home sales. According to ASU Realty Studies, in May 2008 the
median sales price for a foreclosure sale declined 17.4% YOY while that for a
traditional sale declined 15.7%. In terms of cause and effect, a big increase in
foreclosures will drive down prices almost immediately. Looking at the chart
below, it is interesting to note that the median sales price did not change
dramatically until foreclosure sales represented more than 40% of total sales for

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 8 of 11

a number of months.

Source: ASU Realty Studies

An interesting dynamic has developed in Arizona and we think trends are likely
similar in California and Las Vegas. The median price of foreclosure sales is
now higher than that for traditional sales. It sounds completely counter-
intuitive, but for the past four months the median price on foreclosure
sales in Arizona have been $23,000 higher on average than traditional
home sales - wow!

Source: ASU Realty Studies

There are a few factors contributing to this seemingly counter-intuitive dynamic.

First, the type of home entering foreclosure has changed. A high percentage of
the smaller, lower priced homes which were originally sold for $200-$300,000
have been flushed through the system already and foreclosures are now
capturing homes that were once sold for high-six figure prices, if not $1 million-
plus.  Second, a number of traditional home sales are actually foreclosure home
sales that are being sold for the second time. According to ASU Realty Studies,
the markdown on a formerly foreclosed home that is sold again is approximately
24%.  Finally, the median sales price for a traditional home sale has a
downward bias when prices are declining. Unless an individual or family is
forced to sell for economic or relocation reasons, they are highly unlikely to
consider selling a home in this environment. This leads to a greater percentage
of home sales at lower price points as affluent families sit on the sidelines to
wait for a better price environment.

In California, foreclosure home sales over the past few months have been as
much as 50% of total existing home sales and a similar dynamic exists in Las
Vegas.   Foreclosures have pressured home sales prices and there is increased
convergence between the price of foreclosure and traditional sales. Looking at

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 9 of 11

the median home sales price data for California again, it seems highly likely that
a shift in the type of foreclosure property towards homes that were originally
sold for a higher price, has caused the month-to-month improvement in median
home prices. We expect this dynamic to manifest itself in Florida and Las
Vegas as well.

 Foreclosure Sales Drag Down the New Home Market, but It Still Is a

Separate Channel

As we discussed earlier, the volume and price of new home sales has been
negatively impacted by the glut of inventory in the resale channel. However,
new home sales continue to command a premium price and there is a baseline
level of demand. According to the Greater Las Vegas Association of Realtors,
approximately 378 new homes were sold in the month of May, down 58% from
May 2008. The median price declined 23% YOY from May 2008 to 212,000,
but was still 68% higher than the median price for an existing single family home
sold in Las Vegas last month. As we stated earlier, we do not expect an
improvement in new home sales and the prospects for homebuilders until the
overhang from foreclosure inventory wanes materially. In the coming months, it
will be interesting to see how homebuilders respond to higher quality inventory
(higher original selling price) coming through the foreclosure channel.

Embracing Whitney Tilson’s Views

 If you haven’t had a chance to review the lengthy but persuasive presentation
by Whitney Tilson of T2 Partners, you can find a link to it here.  It is hard to 
dispute Mr. Tilson’s arguments about the likelihood that the downturn in the
housing market, particularly as it relates to home prices could extend for 3+
years at a minimum due to a surge in the number of option-ARM’s that will
reset.  Mr. Tilson estimates there are more than $200 billion in option-ARM’s
that will reset over the next 3-4 years. In many cases the mortgage payment
reset amounts to a 50-100% increase in the monthly payment. Given the state
of the job market this will result in a high percentage of defaults. Depending on
your view of default rates, this could mean as much as 250-750,000 additional
homes nationally could become distressed sales. Additionally, as described by 
John Hempton on his fantastic blog Bronte Capital, delinquency rates on
traditional mortgages continue to tick higher. According to Freddie Mac, the
number of single family mortgage loans that were 90-days or more delinquent
increased to 2.62% in May from 2.44% in April, which is the largest sequential
increase thus far this year.

Home prices are likely to decline a bit further from current levels and then
stabilize at low levels for an extended period of time in our view. As we’ve
demonstrated, investors need to “peel back the onion” a  little bit when 
evaluating changes in median sales prices. We do expect the median sales
price to increase as the foreclosure plague starts to capture homes backed by
prime mortgages and homes that were originally sold for a higher price.

ZIPR is One of the Few Housing Related Stocks That Will Benefit from
Stable to Rising Volumes and a Change in the Sales Mix

As we highlighted in our original post on the housing market and ZIPR, we think 

the company is well positioned in former bubble market’s where activity has
been the strongest. ZipRealty has over $2.00+ in cash per share and no debt,
which we think positions the company well to take advantage of market
opportunities as other brokerage firms flounder. A shift in the median price of
foreclosure sales towards higher priced homes would directly benefit ZIPR. The
company generated approximately 37% of its transaction volume in California in
the first quarter. Looking at the number of unique visitors to the leading
residential real estate brokerage websites, ZipRealty still has a one of the most
popular sites. According to Compete.com, the number of unique visitors to
ziprealty.com increased 10.8% YOY for the month of May (click on chart for full

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 10 of 11

image view).

Source: Compete.com

In terms of overall engagement, as measured by the number of monthly visits,

ZipRealty still has a strong lead over its competitors (click on chart for full image
view).

Source: Compete.com

As always, please act accordingly….

Disclaimer: The author of this report owns shares of ZIPR. Positions can
change at any time without notice.

Related Posts:
 Affordability Still Matters, VOLUMES in the Housing Market have
Bottomed, In Search of a Forgotten MicroCap
 ZIPR Missed, but the Long Term Thesis Remains Intact
 Another Decline in Traffic to Leading Online Gun Dealers, Query Data
Suggest Gun Sales Will Continue To Slow
 A Pair Trade with Some Sparkle - Long Signet Jewelers/Short Blue Nile
 More Evidence the "Obama Effect" On Gun Sales Has Peaked - NICS
Background Checks Decline 16.5% M/M from April to May

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009
Housing is the Business Cycle, So Where are We Now? - Please Act Accordingly Page 11 of 11

This entry was written by PAA Research, posted on June 29, 2009 at 12:45 pm,
and filed under Housing, Long Ideas and tagged Homebuilders, Housing, ZIPR,
ZipRealty.

« A Pair Trade with Some Sparkle -

Long Signet Jewelers/Short Blue Nile

Post a Comment
Your email is never shared. Required fields are marked *

Name *

Email *

Website

Comment

Post Comment

Wikinvest Stock Quotes data delayed at least 15 minutes for NASDAQ, 20 mins for NYSE and AMEX, provided by Thomson Reuters.

http://pleaseactaccordingly.com/2009/06/housing-is-the-business-cycle-so-where-are-we-now/ 6/30/2009