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Should Investors Buy the Housing Recovery?

U.S. News and World Report Smarter Investor

The recovery is real, but so are the risks that remain.

After Wednesday’s report of a better-than-expected number of new housing starts, I took a look at homebuilders to see if I could find a few reasonably priced names. Many were trading near their 12-month highs, but I was a little surprised at the percentage gains that most have turned in this year. Many are up over 100 percent. Clearly, there are plenty of people who believe we have seen the bottom in the housing market.

Housing starts last month were the best in four years and are only running at only about 50 percent of their historical average on an annual basis. What that tells me is that there is still plenty of room to run as housing continues to improve.

It might seem counterintuitive. We have been struggling through this economic recovery for several years now. Lots of people have been, in one way or another, forced from the housing market. Those who lost their homes are in no position to come up with the often-required 20-percent down payment to buy another. At the same time, banks are now sitting on way more real estate than they ever wanted and aren’t anxious to put themselves at further risk. As a result, lending requirements became very strict, furthering the housing decline.

So where is recent demand coming from? Simply stated, it’s the backlog! It’s people who are now in apartments, or have moved in with friends and relatives. Given the opportunity, many would prefer to be back in a home trying again to live the American dream. Add in the growing population along with the number of recent graduates trying to avoid moving back in with Mom and Dad, and you have a sizeable backlog of possible buyers.

Another tailwind for housing, in addition to those prospective buyers, is the changing economics of owning a home. It is now, in many cases, cheaper to buy than to rent. Mortgage rates are extremely low. Thirty year conventional loans are currently at 3.25 percent for up to $417,000, 3.5 percent from $417,000 to $625,500, and 3.875 percent for loans over $625,500. If you can afford a 15- to 20-year mortgage, rates are even lower. Could they decline further? Maybe a bit, but it is also possible that they will soon begin to move higher. A sustained upturn in economic data could prompt an uptick in mortgage rates, even if the rate-setters at the Federal Reserve keep their rates ultra-low. It’s to the point that even people like me, who have enjoyed the benefits of a floating rate mortgage over the last 10 years, are now refinancing. I believe the trend in rates from here is more to the upside than the downside.

So, before you load up on housing stocks look carefully at what else could derail those gains. Higher unemployment, tighter credit or a decline in consumer sentiment could all hurt the recovery. Regulatory changes, such as what defines a “qualified mortgage” in the 2010 Dodd-Frank financial reforms, are still far from clear (though the Consumer Financial Protection Bureau is scheduled to weigh in during early 2013). The fate of the mortgage interest deduction (MIT) could also be an issue. For the first time in recent memory, taxpayers’ ability to deduct mortgage interest from their income is in jeopardy—a deduction that affects the 30 percent of the population that itemize deductions on their tax returns. It’s a deduction that likely impacts the decision of every homebuyer who wants to return to the market now.

How Congress will handle mortgage-debt-forgiveness tax provisions for owners whose mortgage lenders agree to write off portions of their debt are uncertain as well. Without an extension, borrowers who receive a reduction will be hit with federal taxes on the amount forgiven. Throw in questions over what Congress will decide on the ability to write off mortgage insurance premiums, tax benefits for homeowners and homebuilders that install energy efficient products, and the current relief for middle income wage earners from the dreaded alternative minimum tax (AMT), and the regulatory risks to share prices loom large.

So before you jump in and load up on the homebuilders and related companies, pay attention to the elections and the actions of Congress. Given that uncertainty, many homebuilders are priced as if there were no storm clouds on the horizon. It’s possible their rally will continue, but it’s possible we may need to batten down the hatches for a while before we continue this journey.

Timothy S. MicKey, CFP®, is a Managing Director and co-founder of Alexandria, VA-based Monument Wealth Management, a full service wealth management firm located in the Washington, DC area. Tim and the rest of the Monument Wealth Management team can be followed on their blog at “Off The Wall”, on Twitter @MonumentWealth, and on their Facebook page. Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Past performance is no guarantee of future results. No strategy assures success or protects against loss. Stock investing involves risk including loss of principal.

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