A little over a week ago, rapper Cardi B took to the internet to teach her followers what’s wrong with the housing market.
That “m***** f*****” Inventory” [ED. Note: The inventory of words you can’t say on television in that video is not small.] The problem, as Cardi put it, is at the root of rising home and rent prices, and her tirade was only underscored by this week’s housing market updates.
Although mortgage rates continue to rise to decade highs, home prices hit their 126th month of annual gains as prices continue to climb to record highs.
A supply problem for the housing market has been a long time coming as housing completions have struggled to return to pre-Great Recession levels. As the population grows by a few million a year, the housing supply has only added 585,000 homes in one year.
A so-called “buyer’s market” in real estate refers to when housing supply exceeds demand, giving the buyer leverage because their options are plentiful. In a “seller’s” market, demand exceeds supply and sellers gain leverage, allowing them to sell at a higher price.
Typically, a “balanced market” refers to when the monthly housing supply is between five and seven months. A buyer’s market is when the monthly supply of homes is greater than seven, while a seller’s market is when inventory is less than five months.
Monthly home supply has risen since it bottomed in January 2022 at just 1.6 months, but it remains far from a balanced market as Wednesday’s Existing Home Sales report shows supply in August hovered at remained stable for 3.2 months.
When the housing market has low mortgage rates, not only do people refinance their homes, but they are also more willing to move because, considering the additional interest costs, they may be able to find a better home at a cheaper price.
However, as interest rates rise and the economy looks more uncertain by the second, fewer homes are being put back on the market.
Meanwhile, home builders are grappling with supply chain issues, sky-high material costs, and renewed uncertain prospects that are depressing demand. This has dampened single-unit production as multi-unit launches dwarfed single-unit production with a 28% rise in housing starts and permits on Tuesday, compared to a mere 3.4% growth in starts of single units.
In Cardi’s words, made truer by the report, and real estate stocks being dumped out of fear rather than being viewed as a diversifying hedge, much like value stocks.
While short-term markets are likely to continue trading based on macroeconomic trends, longer-term investors could find bargains in the home construction industry. Given that the US has an estimated housing supply deficit of 3.8 million units, according to Freddie Mac, strong housing demand, even if it eases in the short term due to rising interest rates, would still be poised for big long-term growth. Annually, we add just over a million homes per year, so this increased demand represents several years’ worth of sustained demand.
KB Home (KBH)
KB Home is a large home builder headquartered in Detroit. KB Home has weathered its 52-week high well as it has been floating lower since the turn of the year. While the stock has taken a hit, the company has beaten earnings estimates with margins rising.
KB continues to have a healthy home inventory, which was up 10,756 gains as of Wednesday afternoon. This missed estimates for 12,245 but was muted by a 9% increase in the final residue. The number of homes delivered was just 3,615 (up 6%) so they need to burn some backlog before they feel the heat of the slacking demand. Additionally, the median selling price was $508,000 (up 19%), indicating a more affluent consumer base as this is above the median selling price of new homes.
Probably the most important thing to remember about the company is that it has a “built-to-order” business model. Remember when the pandemic wasn’t an issue for Tesla (TSLA) supplies because Tesla builds to order and hasn’t skipped a step since it was producing at full capacity (except when factories were closed of course)?
Well, as long as that backlog continues to grow, KB Home is buying itself time for rates to come down and demand to pick up again. This could start in the second half of 2023, according to the Fed’s latest rate decision and Wednesday afternoon forecasts.
At a P/E of just 4 compared to the S&P’s median P/E of 14.9, the company’s stock could be relatively oversold relative to the broader market.
Lennar is another home builder that may be poised to take advantage of the current environment, or at least the current price. The company has a P/E ratio of just 5.21, making it an attractive price if it can continue to provide strong earnings reports. Lennar has fallen further than the S&P 500 this year, but that’s misleading as his earnings reports have been far from bad.
The latest report on Wednesday afternoon was mixed. Lennar surpassed earnings and missed earnings. Home deliveries rose 13%, but new orders fell 12%. Undoubtedly, Lennar showed increasing price sensitivity as orders slacked off.
However, Lennar remained optimistic as its CEO noted: “Sales have clearly been impacted by rising interest rates, but there remains a significant national shortage of housing, particularly worker housing, and demand remains strong as we manage the rebalancing between price and interest rates.” “
While KB Home expects the average selling price to increase, Lennar is trying to meet demand. Lennar’s average selling price in the third quarter was $508,700 and is expected to moderate to between $475,000 and $480,000.
Builders FirstSource (BLDR)
In addition to house builders, building material and component companies are also fighting. With a price-to-earnings ratio of 3.9, Builders FirstSource is very cheap. The company is well received by analysts, resulting in a Strong Buy on average, with price targets ranging from $75 to $125, meaning analysts are comparing the stock to gains of between 28.53% and 114.22%.
While the company faces the same near-term uncertainties as the first two, Builders has a unique advantage in its ability to receive transactions from pretty much any housing project. So while multi-unit construction accounts for the bulk of housing growth, Builders FirstSource can still reap the rewards.