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Why do increasing home prices matter to REITs and homebuilders?

Why do increasing home prices matter to REITs and homebuilders? (Part 1 of 4)

Case-Shiller climbs, but double-digit appreciation is at an end

Real estate and mortgage professionals watch the Case-Shiller index closely

The Case-Shiller index is the most widely quoted index of real estate values and would be considered the “Dow Jones Industrial Average” of home price indices. Real estate values are big drivers of consumer confidence and spending, and they therefore have an enormous effect on the economy. The phenomenon of “underwater” homeowners—those who owe more than their mortgage is worth—has been a major drag on economic growth. Underwater homeowners are reluctant to spend, and they can’t relocate to where the jobs are. So real estate and mortgage professionals watch the real estate indices closely.

Case-Schiller 2Enlarge Graph

Real estate prices are also a big driver of credit availability in the economy. Mortgages and loans secured by real estate are major risk areas for banks. When real estate prices start falling, banks become conservative and hold reserves for losses. Conversely, increasing real estate prices make the collateral worth more than the loan, which encourages banks to lend more.

Housing continues its rebound off the bottom as tight inventory causes a bidding war

The index decreased 0.08% month-over-month and 13.24% year-over-year. Prices have risen the most in the areas that were hit the hardest—places like Phoenix and Detroit, as well as some of the hot markets in California, especially San Francisco. However, prices haven’t shown as much growth in states where a judge must approve foreclosures. The judicial states are primarily in the Northeast, most notably New York and New Jersey. S&P isn’t expecting prices in 2014 to continue their torrid pace from 2013.

The theme of the real estate market for the past year has been tight inventory. Professional investors (hedge funds and private equity firms) have raised capital to purchase and rent out single-family homes. This trend has been driven by auctions from the Federal Government, primarily the FDIC (Federal Deposit Insurance Corporation) and FHA (Federal Housing Administration). These entities have been auctioning off billions of dollars worth of real estate and have required investors to hold them for three years. This requirement has taken supply off the market (or at least the perception of supply), which has helped the real estate market find some support. These professional investors are competing for properties with first-time homebuyers, which is making the starter home a scarce commodity.

We’ll take a look at another real estate index, which uses a different subset of homes, and then talk about how real estate prices affect mortgage REITs like Annaly (NLY), American Capital Agency (AGNC), and Redwood Trust (RWT) as well as homebuilders like Lennar (LEN) and D.R. Horton (DHI).

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