Looking Beyond the Housing-Market Hype

Housing Boom

By many metrics, the housing rebound is well under way, and sellers again have the upper hand in the market.

The median closing price for existing single-family homes in the United States hit $176,600 during the first quarter of this year. That's more than an 11 percent gain over 2012's first quarter, and the biggest year-over-year gain in nearly a decade.

But is the bump valid?

Well-funded investment management firms have been buying tremendous numbers of bargain-priced homes, especially in areas hit hard by the recession. That raises the question of whether rising home prices really indicate a sustained market recovery, or if the growth is just a facade fueled by Wall Street.

Playing Devil's Advocate

Around mid-2011, various metrics emerged that blatantly signaled a bottom in the housing market:

  • The Housing Affordability Index showed that the ratio of median income to median housing prices was roughly 40% above its 20-year average, meaning that home prices were much cheaper than usual in comparison to homeowners' capacity to pay based on their income.

  • The break-even appreciation rate for rental equivalent value, an indicator of whether buying is "cheaper" than renting, showed the best value for buying homes since the 1970s.

  • The high number of foreclosures suggested that many homes would be forced to transition to more stable, reliable owners.

  • And, of course, mortgage rates were held so low for so long that the easy access to liquidity made capital-intensive purchases the most appealing they had been in several years.

Like any crashed asset class, the housing market was bound to improve at some point. And based on the measures above, that point seemed to be mid-2011.

But the recovery we've seen might not tell the whole story.

Where Big Buyers are Snapping Up Homes

Phoenix was one of the hardest-hit areas in terms of home prices. And since the recovery began, it has shown some of strongest rebounds.

With plenty of bank-owned homes available at clearance prices, institutional money swooped in fast and furiously. A Forbes article from March quoted an increase in institutional investors from 16 percent of the market in 2011 to 26 percent. In the fourth quarter of 2012, Phoenix's home prices jumped 37 percent over the year-ago quarter.

A similar thing is happening in Miami, where home prices rose 11 percent throughout 2012, while institutional investors accounted for 30 percent of all homebuying activity. Meanwhile, in California, another scene of chaos during the housing crash, affordability is dropping. The California Association of Realtors releases a metric similar to the Housing Affordability Index (solely for California), and in the first quarter of 2013 the index reported that 44 percent of the population could afford a median-priced existing single-family home. In the year-ago quarter, that metric was 56 percent.

So hedge funds and banks are buying plenty of homes, which may make for attractive headlines regarding the housing market. At the same time, the average family is finding it harder and harder to get in a home.

Caution for Investors and Home Buyers?

Homebuilder stocks such as Lennar (LEN) are trading nearly 100 percent higher than they were two years ago based on strong fundamental data. But if this troubling trend proves true, these stocks might not be the no-brainer investment you think they are.

In fact, many mortgage investment funds and smaller real estate players who had been snapping up homes and repurposing them as rentals have stopped the practice, citing eroding fundamentals and sky-high prices. Carrington Holdings, a mortgage investment fund that also owns and manages thousands of single-family rental homes, has stopped buying rental properties. In the words of its CEO, "there's a lot of -- bluntly -- stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible."

If the early institutional money is already leaving housing because it's no longer attractive financially, what does this mean for the average American family looking to get into a home -- rented or owned?

The economy has improved substantially since the depths of the Great Recession, and there are still brighter days ahead. But, at this point in time, it seems that housing has become an overbought, possibly dangerous sector in which to invest.

Other real estate plays, however, still remain appealing.

Two Alternatives

Change your focus from residential to commercial. Giant commercial real estate firms, such as Simon Property Group (SPG), are pushing on the gas with outlet malls across the globe.

Simon is opening new outlet centers, buying existing ones, and partnering with emerging-market firms as part of its projection of increased demand for the retailers.

Technology is fueling growth in certain areas of real estate as well. Firms such as CyrusOne (CONE) specialize in co-location data centers. The growth runway for the industry is tremendous, and third-party players like CyrusOne stand to benefit greatly from the Big Data boom.

Whether either idea is appealing or not, the most important takeaway is that the underlying housing environment may not be as rosy as Wall Street has made it out to be. As an investor or a homeowner, keep this in mind when making your big-budget decisions.

Motley Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our newsletter services free for 30 days.