Concrete Proof of a Real Estate Reversal

A week ago, I asked “Will Inflation Topple Homebuilder Stocks?” I noted that new home prices jumped 20% during the past year. It has been a seller’s market since the onset of the coronavirus pandemic.

That may be changing quickly. The day that article was published, we learned that the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.6% in May and increased 5.0% during the past year.

The government report noted that “this was the largest 12-month increase since a 5.4 percent increase for the period ending August 2008.” Bear in mind, CPI-U does not include new home prices. If it did, the numbers might have been considerably higher.

You might think that soaring home prices is good for builders. In the short run, they are. But if prices rise too fast, demand plummets leaving builders with a lot of unsold inventory.

That’s what happened 13 years ago, the last time inflation was rising this fast. We all know what happened next. The real estate bubble burst and the stock market crashed.

For that reason, I am watching the real estate market closely. This week, I heard some news that only heightens my concern.

A real estate agent that works in a popular retirement area told me that builders are starting to cancel contracts. These deals were made several months ago before the prices of many building materials took off.

As a result, the cost of building the homes now exceeds the price for which they were sold. Rather than complete those homes at a loss, the builders are simply walking away from them.

Sticks and Stones

Those same builders are now raising prices for identical models by 15%. Part of that increase is to cover the higher cost of materials, especially timber. Some of it is to recoup money lost on homes already under construction that can’t be canceled.

That means those builders need to sell enough homes at much higher prices to offset the losses from the houses that will end up costing them money. If they don’t, we may see some builders run into serious financial trouble.

I don’t like relying on anecdotal evidence when making investment decisions. All too often, what is true in one market does not carry over to the entire industry.

But in this case, I suspect that the same dynamic is at work throughout the United States. Last year, home buyers bid up the prices of houses to escape COVID-19. But with the pandemic winding down, the run on real estate may be drawing to a close.

It appears that the options traders on Wall Street aren’t waiting around for that to happen. Already, the put option trade I recommended a week ago on the iShares U.S. Home Construction ETF (ITB) could be closed out at the start of this week for a 50% gain (put options increase in value when the price of the underlying security goes down).

It’s not too late to get in on this trade. Despite falling 15% during the past month, ITB is still up more than 20% this year. It could be in negative territory by the time this year is over.

Cementing a Deal

My real estate agent wondered if the pending infrastructure spending bill might alleviate the pressure on new home prices. I think just the opposite might be the case. Most of those projects, such as roads, bridges, and airports, will require a lot of cement and concrete which is also used in building the foundations of most homes.

Compared to timber prices, the cost of concrete has been relatively tame throughout the pandemic. Over the past 12 months (through April 2021), the producer price index for concrete rose only 3.3%. Once again, Wall Street is already one step ahead of the game. The second-largest cement manufacturer in the U.S., Cemex (NYSE: CX), is up more than 60% this year.

Watch This Video: The Raw Materials of Wealth

On June 7, Vulcan Materials (NYSE: VMC) revealed that it will buy competitor U.S. Concrete (NSDQ: USCR) for $1.3 billion. That figure represents a 30% premium over USCR’s market cap. Suddenly, cement manufacturers are hot while homebuilder stocks are cooling off fast.

The implication is that construction activity will pivot away from residential real estate towards industrial projects. If so, materials stocks may be one of the top-performing sectors during the second half of the year while homebuilders swoon.

Editor’s Note: Our colleague Jim Pearce just described how increased public works construction is likely to boost the costs of crucial raw materials. A key commodity poised to soar is copper.

The industrial world can’t function without the “red metal.” Copper is vital for building construction, power generation and transmission, electronics, industrial machinery, and transportation vehicles. Copper wiring and plumbing are mainstays of heating and cooling systems, appliances, and telecommunications links.

This year, as the world economy resumes growth and infrastructure spending explodes, so will demand for copper. The metal also makes an effective inflation hedge. For our favorite investment play on this crucial commodity, click here now.