Unlikely as it seems, a housing market recovery is actually starting to become popular opinion. And its proponents aren’t just being Pollyannaish — they can point to hard numbers, like new housing starts and growing revenue at home builders and construction suppliers. Plus, as they’re all quick to point out, things were so bad — with new home construction at levels not seen for decades — that any increase in activity, no matter how gradual or slow, will help bottom lines. Below, Ian Wyatt makes the unlikely case for one of the highest-end homebuilders:
“For the first time in 10 years I actually think the housing market is finally bottoming and appears attractive. And now is an opportune time for investors to add exposure to the housing sector. ... The fact is that home prices today are cheap. After adjusting for inflation, home prices today are at 2000 levels based on housing price indices from Case-Shiller and CoreLogic. ... This simply means that 100% of the gains in housing prices from the boom of 2000 - 2006 have been completed erased. There has been no net gain in home prices, and they are as cheap as they were in the late 1990s.
"[In addition,] new home building today remains about 1.7 million homes below the peak level, and down nearly 900,000 homes from the ‘normal’ annual building rate of 1.5 million homes. [But] while new homes are being built at a very slow pace, things are starting to pick up. This is in a large part because of simple supply and demand. You see, the formation of new households continues at a normal pace. According to the Congressional Budget Office, roughly 1.3 million new households are being formed every year. ... We are already beginning to see some green shoots in the new home starts data. In the second half of 2011, new home starts increased to 640,000 units, the highest six-month average since early 2009. Recently released data for January indicates new home starts at an annualized rate of 675,000.
“The National Association of Homebuilders reported in February that confidence is at the highest level since May 2007 as a result of buyer activity. This was the fifth month in a row when the confidence among homebuilders increased. ...
“When it comes to building expensive new homes, Toll Brothers, Inc. (TOL) is the leader. The company builds new homes with an average selling price of $550,000 in 50 markets in 20 different states. Furthermore, the homebuilder owns and controls nearly 40,000 building lots.
“Like all homebuilders, the last few years have not been pleasant for Toll Brothers. While new home starts declined by 71% from the peak in 2005, revenues at Toll Brothers declined by an even greater 76%. Even buyers of half million-dollar homes felt the pain of the U.S. recession and abandoned or delayed plans for building that dream home.
“While the economy and housing market have been creating some real headwinds for Toll Brothers, the company has impressively managed its finances and improved its balance sheet. The company’s debt-to-capital ratio is currently at 25%, which is well below its long-term range of 45-50%.
“In spite of a difficult few years, business is now improving at Toll Brothers. In the latest quarter, the dollar value of contracts increased by 45%, and the number of home contracts increased by 19%.
“Investing in Toll Brothers is a direct bet that new housing starts will continue to improve. There are already signs that the environment is improving, and Toll Brothers as a builder of high-end homes should benefit.
“As the economy continues to improve, well-heeled buyers, including baby boomers and retirees, will become more comfortable with the idea of selling their current home and building their dream home. When housing prices are falling, few individuals are willing to spend money to build something that they know will fall in value. However, with inexpensive values and prices stabilizing, potential buyers of new homes will become increasingly comfortable.
“As a well-financed company with a strong management team, Toll Brothers appears well positioned to benefit from the rebound in housing.
“Suggested Action: Buy Toll Brothers shares.”
- Ian Wyatt, $100K Portfolio, March 13, 2012