One of the most recent fashionable memes in the financial markets is that housing has bottomed and is set to rebound. In the past few months, home builders stocks have rebounded extraordinarily strongly. Toll Brothers (TOL), Hovnanian (HOV), KB Home (KBH), Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), Beazer Homes (BZH) are all up close to 100%. Still, all that did was put them back to their valuations of last summer.
In November, I wrote "SAVE Act Could Spur Housing Boom." In this article, I discussed how the SAVE Act would require mortgage lenders to include the costs of utilities in the carry costs of a home.
The rationale is simple. New homes are built to be energy efficient and to have lower utility costs. Given this, new homeowners will be the beneficiaries of such legislation. But the rising stocks of home builders does not mean that housing, in general, has bottomed and is due for a rebound.
New homes represent about 20% of the housing market. The other 80% of the housing market will be negatively affected by such legislation, even though this legislation may help to create jobs.
As the saying goes, all real estate is local. There is no national housing market; however, some issues will affect everyone.
The impact of including utility costs for mortgage qualification purposes will cause incomes required to get a mortgage to increase. As a result, this would reduce the number of potential buyers for houses, in general, and put downward pressure on values.
The percentage of gross income eligible to service a mortgage will steadily decrease over the next decade or so, probably back to the industry standards of1980, which were roughly 25% to 30%. That is that 25% of one's gross income could be used to make payments on principal, interest, taxes and insurance. The 30% figure includes the mortgage and all other debt; such as car loans, student loans and credit cards.
To put this in context, borrowers are currently allowed to allocate up to around 45% of their income to their mortgage and other debt. Reverting to 1980 standards would mean that the income necessary to qualify for a set loan amount will have to almost double.
Also, the down payment and credit score requirements needed to be eligible for a mortgage are also rising. That process will be a drag on housing values nationally and on the U.S. economy, in aggregate, for the next 20 years, at least.
On a local basis, the costs of real estate taxes and hazard insurance in most areas will compound the issue of increasing carrying costs on a house and place downward pressure on home prices.
As mentioned at the beginning of this column, the government is considering requiring the inclusion of utility costs for mortgage qualification purposes. On a national average and policy basis this could cause an increase in economic activity.
However, utility costs vary widely around the country. The highest costs are in the northeast, meaning generally all states east of the Ohio Valley and north of Virginia.
This region also claims the country's oldest housing stock and, thus, least energy-efficient housing. It is also represents the highest population concentration in the country.
In the column, "American Idle," Glenn Williams outlined the potential for the old coal-fired electricity plants, which are concentrated in the northeast, to be shuttered and replaced with oil-fired plants. This would cause the cost of retail electricity in this area to soar.
Simultaneously, if Congress passes the SAVE act, requiring utility costs to be included in mortgage qualifications, the income requirement increases could shock the housing industry -- both new and existing -- into an even deeper contraction than what has occurred over the past five years or so.
The SAVE Act has not yet been passed, but the closing of coal plants in this area is inevitable, unless either the EPA changes the emissions rules or Congress steps in to preclude the enactment of the EPA's rules.
What investors in home builders stocks, home buyers, and home owners in these areas should consider right now is whether or not the separate interests that are pursuing the SAVE Act and the EPA rules are aware that their combined actions could be catastrophic for housing in the northeast.
This is not a hypothetical scenario, it's very real. Investors would be prudent to consider, as well, if the hedge funds and institutions that have driven home builders stocks up in the past few months are aware of this situation, as well.
My advice for investors at this stage is simple: Sell the home builders, all of them, and monitor the SAVE and EPA actions.