Three Signs of a Bottom in the U.S. Housing Market

We have been hit with bad news after bad news regarding foreclosures and the U.S. housing market sector for years. Just recently a report by the National Association of Realtors stated that they have revised down the number of homes sold since 2007 by 14.3%. Data out in the beginning of January 2012 reported that applications for U.S. mortgages fell 4.1% in the last week of December 2011, as demand continues to be poor in the home sale market. With all of the negativity and pessimism surrounding the U.S. housing market, what’s driving up the home construction index?

If you were to look at some of the components of the home construction index, you would see that home improvement retailers like The Home Depot Inc. (NYSE/HD) and Lowe’s Companies, Inc. (NYSE/LOW) have been strong performers since the lows of the year. These firms are up anywhere between 40% and 50% from the yearly lows; but why and is it sustainable?

The reason why home improvement firms have done so well is found through an interesting phenomenon related to the high level of foreclosures in the U.S. housing market. Once foreclosures start, and someone is about to be evicted, they will not put any money into the upkeep of the home and, in many cases, ruin large portions of the home through theft and vandalism. There are reports of appliances missing, cables and fixtures taken when the evicted person leaves, and carpets destroyed. The first thing people do when purchasing foreclosures is to fix them up, either to live in or rent out.

This “fix-it-up” stage of the U.S. housing market still has quite a while to go, as the number of foreclosures is still quite large and will take several years to get these homes off the books of banks. However, these stocks are certainly not cheap, as many investors have figured out this market for the home improvement firms.

With mortgages still near record-low levels, homebuilders certainly can’t complain about high interest rates. Currently the average U.S. 30-year mortgage is around 4.07%, well below 4.82% of 2010. But many mortgage lenders require more money down, and buyers either can’t afford to buy new homes or are worried that prices will continue to decline, holding down sales in the U.S. housing market. With a glut of foreclosures still to hit the market over the next couple of years, this will put a lid on prices in the U.S. housing market.

I would wait for three things to signal the housing bottom: 1) a substantial increase in the number of new jobs; 2) mortgage applications will start rising dramatically; and 3) the inventory of foreclosures will start to decline significantly.

You can be right in the long term, but early in your call, which will cost you a lot of money. As the saying goes, “The market can remain irrational far longer than you can stay solvent.”

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