Home buyers applying for a mortgage are familiar with the agglomeration of the terms Principal, Interest, Taxes, and Insurance (PITI). PITI is used by the mortgage industry to calculate the minimum mandatory monthly carrying cost for an improved property.
Obviously, there are many other costs associated with owning a property. Corrective and preventive maintenance along with energy consumption for heating, air conditioning, electricity, and refrigeration are among the largest expenses that owners incur.
But these expenses have never been calculated as a direct part of the carry-cost of a home and mortgage in any way. It has always been considered to be an issue to be handled at the discretion of the mortgagor.
Although that is still the case for maintenance issues, two weeks ago, the U.S. Senate introduced bill S.1737, also known as the Sensible Accounting to Value Energy Act of 2011 or SAVE, which would require Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) to add the cost of energy consumption to PITI, making it PITIE.
The idea is to promote energy efficiency and conservation in residential properties, which is where most energy is consumed. The federal government has enacted several short-term programs targeted at promoting energy-efficient homes in the past by way of offering tax credits to home owners installing new windows, doors, refrigerators and air conditioners.
I wrote about this last May in the column Merging Housing and Energy Concerns. This new tact, however, is far broader in scope than anything the federal government has attempted in the past. Although the goal of energy conservation is admirable and necessary as strains on natural resources and the energy infrastructure are increasing there are consequences to the passage of this Act for investors to be aware of.
By adding energy costs into the calculation for mortgage payments the income necessary to qualify for a mortgage has been increased. By increasing the income necessary to qualify for a mortgage the demand for the purchase of residential properties will be decreased and that will put downward pressure of valuations in aggregate.
However, because the Act calls for energy costs to be property specific, older properties with less energy efficient windows, doors and appliances, will experience a reduction in value versus newer homes. Compounding the issue is the fact that the income necessary to qualify for an older versus newer home will increase.
Therefore, investors should consider this proposed legislation to be "the Home Builders Support Act." I do not offer that disparagingly. The Act itself will cause the rate of depreciation and life expectancy of existing homes to accelerate. That will cause the rate of replacement of the existing housing stocks to increase from 1% annually to 2% or more within just a few years.
That would clearly be a boon for the economy -- especially for everyone involved in real estate both commercial and residential. This gets a bit tricky, but the net effect should be that the value of existing improvements decreases; that is, the value of the physical structure will depreciate much more rapidly. Offsetting that however, should be a corresponding increase in the value of the land the existing improvement is built on. Most established suburban neighborhoods of single-family dwellings with the oldest improvements are the ones closest to urban centers, especially on the East Coast.
This Act could become the catalyst for the largest private-sector urban and suburban revitalization since World War II. The pill box homes built back then to house GIs returning home from that war are now being razed to make way for building new neighborhoods with more energy-efficient homes.
There is no assurance that this Act will pass Congress but it should be watched very closely by everyone, in keeping with the adage: "As goes housing, so goes the economy."
If it passes, this could signal a secular buying opportunity for the homebuilders. In addition, there will almost certainly have to be an amendment allowing for greater tax incentives for upgrading individual properties.
In the homebuilders space, keep an eye on Toll Brothers (TOL), Hovnanian (HOV), KB Home (KBH), Lennar (LEN), PulteGroup PHM, DR Horton (DHI) and Beazer Homes (BZH). For home upgrades, watch Home Depot (HD) and Lowe's (LOW).