Buy Housing Stocks… Consolidation is coming

In early 2015, McCall stated that housing would be one of the few sectors to rebound in 2015 and that 2015 in large would be a repeat of 2011.

As a followup housing stocks have generally done well so far in 2015 even as markets have slid sidewise. Housing is going through a period of mass consolidation. The big players have huge advantages in terms of cost and ability to obtain land tracts.

The difficultly with land these days is local government. Moving in exactly the opposite direction, costs of building have skyrocketed with the cost of permits and impact fees. Local taxing authorities have essentially run the small builders out of business, leaving the large builders with their special development deals and grandfathered in projects in the sweet spot.

Further, banks aren’t lending money. Almost 40% of homes sold in 2014 to the present were cash buyers. In previous years hedge funds purchased massive numbers of homes which are now rental properties and REITs. This has left inventory at a near 20 year low. Thus, bad political policy, and poor FED oversight of how the Fed funds at the window are deployed has created an inevitable housing shortage.

The beauty of housing is the stubborn stupidity of local government… to make things more difficult for the small builder.

As real estate prices have recovered in many areas to the 2006 highs, areas with waterfront and specialty properties have done even better.

Consolidation is the only alternative for a small builder or they will be extinct.

At present the balance sheets of most of the large builders don’t look very good. All have debt, all have some backlog of business, and all are showing increased costs of sales. But the good news is the giant perfect storm forming and it has three prongs.

1) The US economy remains on life support and while the Fed can’t figure out how to unwind its Quantitative Easing, the answer is to force banks to lend money rather than all them to speculate in the futures markets or derivatives.  As simple as this seems, the Fed makes no requirement on how their zero interest Fed window funds are to be used. Goldman Sachs, A BANK so they say, became a bank to receive TARP funds. I have yet to locate that fabled Goldman ATM machine but I’m still looking.

Meanwhile, Goldman and JP Morgan have become the largest oil and gas futures contract traders in the world. Though they never take delivery, they trade more contracts than all Major Integrated Oil companies and Saudi Arabia combined. They just don’t seem inclined to make that old slow money lending when they can enjoy the rocket fuel of free FED money poured into the futures pits or hot stocks.

Eventually the FED will have to stimulate real bank lending activity or the housing inventory will form its own whiptail bubble.  Either way, housing prices will rise and large builders that finance their own developments will run the market share until the FED finally stimulates actual lending among their member banks.  But don’t hold your breath waiting for Goldman mortgages.

2) The population of the United States is growing. Whether this is a high quality population or not is not the debate. More people mean more housing demand. Pockets of insanity persist. The New Your City real estate market is on fire as is the demand for multimillion dollar estates in the LA and San Francisco Areas. Unquestionably the subprime financial crisis was good for some even if it decimated the middle class.

Local governments are coping with this growth by increasing impact fees and taxes, effectively increasing the housing shortage. When you have government. This is very similar to the way in which local governments destroyed downtown commerce and why Walmart thrived by moving outside the city limits, out of the reach of the local governments. This becomes a big plus for the builders with projects outside of the reach of local governments.

3) Consolidation. Large builders are attractive even if they have a bit too much debt because size and scale matter. Toll Brothers don’t buy their lumber from Home Depot. They buy their lumber directly from the mills and materials directly from operations like GRACE. The small builder buys his lumber from Home Depot.

Mass production of homes is much more efficient than building one spec home at a time and trying to sell it into a competitive market.

The large contractors have their own labor teams. Advantages, Advantages, Advantages.

Recently Ryland Homes agreed to a merger with Standard Pacific and they will together form essentially the 4th largest residential building firm in America. D.R. Horton Inc., Lennar Corp. and PulteGroup are modestly larger. Hovnanian builds roughly 14000 homes a year and sells most to first time home buyers.

We think two segments of the market will be robust. The low end starter homes and the 55 and over retirement homes. Though luxury homes continue to sell well, those are cash buyers.

Demographics indicate that the era of the fabulous 1970’s retirement is over; there are more people downsizing than buying up. Further, younger populations with starter families are finding rentals rising and showing an interest in home ownership.  Of course Obamacare taxes are essentially condemning this population to rentals unless they work for a larger business that covers their gov. insurance mandate.

We feel that KBH and more speculatively HOV are cheap at this point. These are mid-range size and scale and possible candidates for merger. HOV has a strong east coast presence which would round out a large western builder’s portfolio.

But this all comes with the caveat that the 2015 markets will likely be a repeat of 2011 and downdraft markets can be unpleasant.

 

« Back home