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Must-read insights from the May 2014 FHFA Home Price Index

Must-read insights from the May 2014 FHFA Home Price Index (Part 1 of 3)

Home prices continue to climb, pleasing homebuilders like Lennar

The Federal Housing Finance Agency (FHFA) House Price Index

The FHFA House Price Index differs from the other house price indices like Case-Shiller and Radar Logic in that it only looks at houses with mortgages guaranteed by Fannie Mae and Freddie Mac. This means the home prices are below the conforming threshold, which is $417,000. It also means the borrower has a mortgage, which eliminates cash-only transactions. And finally, the FHFA House Price Index eliminates jumbos. This makes it more of a central tendency index.

FHFA House Price IndexEnlarge Graph

Home prices increase slightly in May

In May, home prices rose 0.4% month-over-month. They’re up 5.5% year-over-year. Prices are now within 6.5% of their April 2007 peak.

Real estate values are big drivers of consumer confidence and spending, so they have an enormous effect on the economy. The phenomenon of “underwater” homeowners—homeowners who owe more than their mortgage is worth—has been a major drag on economic growth. Underwater homeowners are reluctant to spend and can’t relocate to where the jobs are. So real estate and mortgage professionals watch the real estate indices closely.

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 reserve funds for losses. Conversely, increasing real estate prices make the collateral worth more than the loan, which encourages banks to lend more.

Implications for the homebuilders

Rising real estate prices are helpful for builders like Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), and Toll Brothers (TOL) because they make it possible for them to raise prices and increase their gross margins. That said, it appears buyers are beginning to experience sticker shock, as both prices and mortgage rates have increased markedly over the past year. Builders are noticing a drop-off in traffic, which may mean the days of double-digit average selling prices (that is, ASPs) are over.

Investors who are interested in trading the homebuilding sector as a whole should look at the S&P SPDR Homebuilder ETF (XHB).

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