Thursday, August 13, 2009

We Still Have a Long Way to Go (With Apologies to Alice Cooper)

***System Administrator Warning***

The Following Column Contains Positive Statements about

the Economy in General
and the Housing Market in Particular…
Cranky Individuals Who Think America Hasn’t Suffered Enough to Justify a Recovery
Should Avoid Sharp Objects While Reading.

***System Administrator Warning***

That’s right: this is going to be another positive piece about housing.

Only this time we've included a warning, because the last couple of times we highlighted a positive data point on the housing markets we got bombarded with virtual scoffing, snorting and downright hostility from some readers—particularly those who weren’t around when we were writing about the housing bubble back in 2005 (see in particular “The Last, Best Hope For Prosperity,” from June of that year)—who perceived us to be wearing a Pollyanna-ish set of rose-colored glasses.

Still, we here at NMTU are data-driven, not consensus-driven, and the consensus seems to be that while maybe this housing thing seems like it’s stabilizing, we still haven’t seen “The Bottom.”

After all, goes the Roubini-led thinking, how can it be a bottom with all the foreclosures yet to come, plus the unemployment rate still going up, not to mention the budget deficit that will keep us forever in hock to the Chinese and that rigged American Idol contest?

Well, it can be a bottom because—looking at the demand side of the equation for starters—it’s now cheaper to buy than rent for first-time home buyers, and
because housing prices, which peaked at close to 4-times median family income during the glory days are now down to a bit under 3-times income.

That's a level not seen since the early 1980s.

Looking at the supply side of the equation, it can be a bottom because we’re only building new houses at an annual rate of a little over half a million units, compared to an average rate of about a million and a half annual units from 1991 to 2007.

The result, a non-interested observer might conclude, is the potential for some sort of housing rebound, if only consumer confidence might be restored.

And listening to the Toll Brothers call yesterday, we’d say the confidence-restoration process is fully underway, for home buyers if not for Wall Street’s Finest—those analysts so burned by the housing collapse that they refuse to acknowledge clear signs of a housing recovery.

Toll Brothers, as anybody watching the tape yesterday knows, came out with what The Market considered surprisingly good numbers in its preliminary third quarter press release: orders up 3% versus an expected decline of 20% by Wall Street’s Negative Finest; and a net loss of 77c a share instead of the $2.50 or so loss foreseen by WSNF.

Most important, in our view, was that on a per-community basis—the homebuilders’ equivalent to the retailers’ “same-store-sales” numbers—Toll’s orders jumped 32% year over year.

That kind of increase is very good for everything: sales, margins, and future profits. It also heralds good things to come from other American businesses that have similarly slimmed down to meet reduced expectations.

But you wouldn’t know it, based on yesterday’s call.

Wall Street’s Negative Finest, clearly shell-shocked by the sharp improvement in business for a company whose key product—McMansions—was viewed as a dinosaur in a dying industry, seemed not to want to hear about it.

Here’s how one analyst framed the question, courtesty of the indispensible Street Events:

I was hoping you can comment a little bit about the high end market in general. I think there has been a lot of -- a lot written out there that the entry level is performing pretty well given the tax credits that are out there and some other stimulus and the perception is that the high end has been performing much weaker and your order results this quarter seem to refute that.

So I am curious if you attribute it more to share gains either from private builders that simply can't afford to compete or from publics that have, seemed to have kind of exited the high end market in general and made an exodus towards entry level. Or if you think this is more a sign of a stabilization in the high end.

Bob Toll, the CEO of the eponymous company and about as straight-shooting a CEO as they come—in lush times as well as non-lush times—said simply, “I think it is the latter.”

Then he elaborated:

[The] stock market has been going up. Most of the upscale luxury home is impacted one way or the other with the stock market. There's a better feeling about jobs, better feeling about the economy. Six months ago…maybe it goes all the way back to a year ago. Yes, it was [when] Lehman crashed… we were all scared...that the end was near….

And I think that fear has gone away from the public, which has taken the -- taken the public for the luxury market, especially, from coming back six to -- six to nine times continually asking the same question, do you have any additional incentives, do you have any additional incentives, would you accept an offer of 425 for a home that we wanted to get 650 for. I think the mood has changed and we are making our sales instead of six to nine, probably three to six visits.

Straight-talker that he is, Toll bluntly added, “Our traffic still stinks compared even to those lousy days of '89, '90, '91, but those people that are coming in are more serious.”

As you’d expect, Wall Street’s Negative Finest latched onto the “traffic stinks” comment, and asked for clarification, which Doug Yearley, a Regional President, provided:

Traffic has not increased in numbers. The quality has increased significantly. The people are not coming in looking for a public restroom asking the name of the decorator, asking the name of the deck builder, they're coming in -- they're coming in asking good questions that show us that they're seriously interested in buying.

This prompted one of Wall Street’s Not-so-Negative Finest, who’s been recommending Toll stock of late, to ask the unknowable:

First question, Bob, is about what really makes you comfortable that this isn't just kind of hanging out on the ledge for a while and that we don't have another leg down versus it seems like you think this is probably close to bottom and things are getting better and that leaves you comfortable in opening new communities and putting some more money to work in the housing market. I mean, how do you know this isn't just a blip on the radar at this point?

To this, Mr. Toll reasonably responded, “We don’t,” and expanded on this, about as frankly as possible:

We are as scared of a 'W' recovery as the next man. However, the number of weeks of improvement that we have had, as I said in the monologue, are certainly more than anecdotal. You are talking about a whole lot of communities in 40, 50 markets in 20, 22 states. So we are getting – we’re getting pretty deep information and we are going to react not on the basis of a month or two, but we have got about a quarter and a half.

All of which is why we offered our apologies to Alice Cooper right at the top, for as we listened to the Toll Brothers conference call—in which undeniably good facts were being regarded with suspicion, fear and some denial even by those reporting the undeniably good facts—a song lurking in the dark recesses of our brain came to mind.

The song, “Long Way to Go”, is an old Alice Cooper semi-hit (look him up, kids).
And by “old” we mean nearly forty years old.

Why we can still conjure up the melody of a really terrible song—not to mention half the stupid lyrics—from forty years ago, is beyond comprehension, although it did bring back one good memory. (That memory,The Time Jed Drake and I Stole Alice Cooper’s Mailbox, is, however, a story for a different column.)

In the meantime, with even the CEOs still scared—not to mention Wall Street’s Negative Finest—of another dreaded collapse in housing, we here at NMTU think the housing market still has a long way to go.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Kieran said...

I think your assertion might require some nuance. As Bill from Calculated Risk frequently points out, there are two bottoms in housing, one in sales, and another in prices. We've likely seen the bottom in sales, but in many markets, particularly on the higher end, we have likely not seen the bottom in prices, as inventories remain elevated above historical norms and continued pressure from foreclosures remain. On the bright side, interest rates remain low and should allow for easy access to mortgages for those who can afford them.

The question of whether Toll Brothers is a good investment is another one entirely. To me, the answer to that question is whether they can make enough money to justify a higher stock price by selling enough houses at whatever "new normal" sales rate develops from 2010 to 2012. My estimate is that this number will likely have housing sales above the '09 bottom, but below the levels from the boom years, and that the profile of sales will include a larger number of lower-priced homes. Whether Toll brothers will make sufficient profits to justify a higher stock price at those levels is a question I simply don't have the level of detail to answer. I shorted TOL in 07 and 08, but I'm agnostic on it now. The evidence doesn't seem strong enough for me to go either way.

But that's what makes a market. If you think you know the answer and you're right, you'll make money. If you're wrong, you'll lose it. No need to get emotional. Mr. Market will be the final arbiter in this debate. said...

Hi Jeff -

How would you feel about having this posted to as a guest commentary?

Anonymous said...

Clearly, the quantity demanded of houses is going to be higher now that prices are ~30% off peak. Also clearly, the quanitity supplied of new houses has dropped. We appear to be hovering at a new normal, and if TOL, LEN, PHM et. al. can survive and thive at the new normal then great.

How sustainable is the new normal? While home pricing vs. rent has improved dramatically, I would think rent levels are quite vulnerable given that we have a record amount of available housing in most of the country.

The Price to Income level metric is interesting and encouraging, but I think is outweighed by the volume of empty homes, distressed inventory, and yet to be foreclosed homes that are at levels unseen ever, including the early eighties.

Is there enough quantity of demand at current prices to absorb the inventory in the foreclosure pipeline, even with more favorable Price to income or price to rent ratios? Certainly the interest rate situation is helping.

Out here in California, Dataquick has been reporting about 44K Notices of Default (NoD) being sent out each month. (Deliquencies are 3x this rate, but NoDs are lagging because why send out the NoD when you can't handle the REO you already have?) Actual foreclosures have fallen over the last year, probably due to various moratoria and inability to make orderly disposals of greater volumes of foreclosures. Will these deliquencies and NoD get cured or will they persist until the "tenant" is finally kicked out? Many of these homes are burdend with loans that can not be paid back with 0% interest, so I don't see cure rates fixing the situation.

As a comparison, Dataquick also reports that there were a total of 44K Total sales of new AND existing homes in CA in the banner month of June. Its a virual certainty that volumes will have to go up to handle the current NoD levels (also 44K) + non-distressed existing home sales + any new home sales.

Are there enough investors and first time home buyers to absorb the required higher volumes at current prices? What happens if NoDs rise closer to the level of actual deliquency? This seemingly inevitable inventory of distressed homes makes me very cautious about home prices.

All that said, large, diversified home builders have had sufficient time to re-target their efforts toward parts of the country with less dire circumstances, and the current low, low volume of new home sales could certainly rise due to homebuilder efforts to target more favorable geographies. Unfortunately, none of the homebuilder managements have proved to be any more prospective about these issues that your local real estate agent.

In sum, outlook for home prices bad in many parts of the country because distressed inventory in the pipeline seems far higher than the demand at CURRENT prices and rates. Rents are falling and vacancies are very high, so this support of prices seems tenuous. The outlook for individual homebuilders is somewhat better because inventory is way down, community counts are way down, and they don't have to build in lousy markets. I'd agree with the previous poster and claim ambivalence on homebuilder stocks. I'd only buy a HB stock in today's environment if prices came back down, but wouldn't try to short. I am uninterested in buying a bigger house today because I think the big clearance sale is yet to come.

Anonymous said...

Intelligent posts to an intelligent article. What a change!

Ben said...

I coincidentally read the Toll conference call earlier today before reading this and I completely agree. While you've I think prematurely called the bottom in housing a few times, this time it's the real deal. Of course the stock market has already taken up a lot of the housing related stocks a decent amount and the profitability of these companies is in the toilet still until we get to say 1 million homes. But it bodes well for a lot of things, including the banking system.

Trader said...

If Bob Toll is upbeat on housing in general and Toll in particular, why is he selling so much of its stock?

Jeff Matthews said...

Kieran: Your "nuance" is appreciated, as is that of the Anonymous commentator who followed up.

Note, however, that we don't endorse stocks here, and our column was in no way a suggestion to buy a homebuilder stock.

As to "Trader" asking why Bob Toll has been selling stock if he's so upbeat...well, for starters, you always feed the ducks when they're quacking--and investors have been quacking for homebuilders.

Also--and this was the point of the column--even Bob Toll is still nervous!


Nick said...

another variable to ponder- falling home ownership levels, which peaked near 69% and are now falling off rapidly towards pre-2000 levels. courtesy of bond super-stud bill gross:

while this is almost certainly being driven by foreclosures it also reflects the unsustainable efforts of the FHLBB and the federalized mortgage project to give every american a home. with that fantasy now in ruins (or in unfinished concrete foundations, more aptly), i just don't see much upside in the home market for a long time. this is still very much a buyer's market, with home builders and realtors in some of the nation's most affluent communities (greenwich and the boston suburbs i can speak for personally) being forced to rent on a short-term basis to cover financing costs and stay above water. overcapacity is rampant and we've been jamming the system for years- the most liberal of mortgages (interest only et al) were functionally indistinguishable from leases. home ownership in america historically has been at a much lower level and i feel not only have we built too much, we also pushed too many people into houses and now it will take a long time to sort out.