BUILDERS PREPARE FOR BLOWOUT SPRING SEASON
From my perspective, the housing outlook in January 2014 looks a lot like January, 2013, portending another year of mean-reversion.
In 2014, look for homebuilders to:
- Sell every home they could possibly build;
- At higher average selling prices;
- With surging volumes;
- Margins stabilizing around 20%;
- And demand remaining constant throughout the year
As Donald J. Tomnitz, CEO of DR Horton, said in the company’s recent Q4’2013 conference call, “As a homebuilder, I would say, based upon all my years of experience, …if you’re waiting for a better rate and a better house price (in 2014), you’re going to wait and you’re going to find higher rates and higher house prices.”
At the end of the 2014 Spring selling season the builders will be left with exhausted construction crews working loads of over-time; a land division ravenously searching for more land deals; and lines of anxious people wondering when their new home is going to be built.
This was the situation heading into the Summer of 2013, and it’s likely to return this year also, albeit somewhat less in intensity. As it stands now, inventory is a little better than 2013, but only just a little better, still near the lowest in 50 years, as builders ramp construction to meet future demand.
Last year, the builders took advantage of the Federal Reserve’s taper-talk in May to begin metering-out new home construction in order to retain enough land for new communities. The truth is, they could not build homes fast enough, and demand was so extreme they raised prices almost weekly.
Then in October, Congress frightened would-be buyers by threatening to default on trillions in debt. There was a government shutdown, and then a debt-ceiling crisis that came down to the last moment before being resolved. Foot traffic at housing communities dropped to recession lows in Q3 and new mortgage applications receded dramatically. Homebuilding stocks lost as much as 30%.
Just when it looked like the cumulative effect of the Federal Reserve’s policy debate (“Maybe we’ll taper, maybe we’ll not), higher home prices, higher mortgage rates, and a gridlocked Congress could kill real estate’s golden goose, the December housing starts spiked 23% (200,000) to a post-recovery high. The unexpected spike caught everyone by surprise.
Builder sentiment remained elevated, too, and as you can see from the chart below, starts are running catch-up to sentiment in 2014.
The November/December earnings reports from Toll Brothers (TOL),Brookfield Residential (BRP), Lennar (LEN), Tri-Pointe (TPH), Standard Pacific (SPF) and KB Home (KBH) revealed no hint of a slowdown and were stellar. The home builders proved they were pursuing specific strategies in ideal conditions for expansion.
Now we are poised at the beginning of the 2014 Spring selling season, with the drama of H2 2013 behind us. Foot traffic is slowly increasing and the economy continues to mend. The Congress has worked out a budget and debt ceiling agreement that will fund the government for at least another year. Mortgage rates have stabilized around 4.5% and mortgage asset flow is increasing.
All this is positive for housing. The one single fly in the ointment is the lack of inventory – new, desirable, fashionable, and energy-efficient single-family housing.
In a recent survey of real estate agents by Credit Suisse (January, 2014) lack of quality inventory was the chief complaint of buyers. Buyers have shown a willingness to pay a premium for new construction – and pass over what has become known as shadow inventory – in an effort to acquire the home they want.
The only companies who can answer this demand are the publicly-traded new home builders. They have acquired sufficient capital and land resources in desirable geographies to build the homes that customers want. The current outlook for housing is like shooting fish in a barrel for them.
So what stocks to buy?
The builders with the biggest land banks. A builder leverages and monetizes the value of his land holdings through new home construction, so the quantity, quality, and age (cost $) of the land is key.
As outlined last September in a previous article (see concluding paragraphs); investors should buy the home builders with the largest land banks. This puts Dr Horton, Pulte Homes (PHM), Brookfield Residential, KB Home, Rylant (RYL), Toll Brothers, and Tri-Pointe at the top of the list.
And as I write, some of these stocks are on sale again. Tri-Pointe homes is down 15% since the beginning of the year. It has become the darling of the short-sellers since its recent acquiring of WRECO, and its short-interest has tripled.
When an entry point is right – and at $17.50 I think that’s a right entry point for Tri-Pointe – short interest can quickly morph into short-squeeze.
Brookfield Residential is down 13% from its January highs. Brookfield will be reporting its Q4 in mid-February. Q4 is always Brookfield’s strongest quarter, and they have already stated that this year’s Q4 will equal 2013’s Q1-3 combined. At 109,000 lots and counting it has the third largest land holdings, behind DR Horton (190,000 lots) and Pulte Homes (124,000) lots.
One of the most land-constrained geographies for U.S. builders is coastal and metro CA, and this is where Standard Pacific, KB Homes, Tri-Pointe, Toll Brothers, Brookfield Residential (primarily as a land seller and developer) and Lennar are dominant.
I foresee another strong Spring selling season with the first inklings of solid inventory coming to pass as housing starts push towards 1.2ML.
Disclosure: I am long BRP, NLY, WMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source : Seeking Alpha
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