Looking at the share price performance for the largest publicly-traded homebuilders (excluding CalAtlantic, which is a product of a recent merger between Standard Pacific and Ryland), the divergence in performance among publicly-traded homebuilders is apparent. Since January 1, 2015, LGI Homes outperformed its peers while Hovnanian Enterprises significantly underperformed the peer group. The high levels of divergence among homebuilders' share price performance is a testament to their various market strategies, their diverse geographic as well as market segment exposures, and their disparate levels of operational excellence. Over the past 14 or so months, homebuilders' share price performance has largely been driven by company-specific and/or segment-specific factors rather than broader macroeconomic trends. This should be viewed as a positive development and as a sign of a healthy market.
While the share prices of only 3 of the 11 homebuilders in our analysis are up since January 1, 2015, the fact that there is substantial divergence among homebuilders' share price performance is a sign in and of itself that the market is not anywhere near crisis mode. During the financial crisis, on the other hand, homebuilder share prices were driven by investors' animal spirits rather than by individual company-specific performance or segment-specific trends. When the crisis hit, there was indiscriminate selling and macroeconomic news drove up correlations between homebuilders.
By analyzing the correlation between the daily change in homebuilders' share prices, we are able to better see that share price performance is driven by more than just "risk-on" and "risk-off" trading. The analysis below also shows that similar peers (e.g. LGI Homes & DR Horton, which target entry-level buyers, or Toll Brothers & Taylor Morrison, which predominantly target the move-up and luxury segments) have higher correlations to each other than they do towards the broader group. Thus, for the management of publicly-traded homebuilders, it is as important as ever to pursue the right strategy and to execute it efficiently.
Data Source: Yahoo! Finance
To say that global financial markets are off to a rocky start in 2016 would be an understatement... Oil (West Texas Intermediate) has plummeted to roughly $30 dollars per barrel - the lowest level in over 12 years. Japan, the world's 3rd largest economy, took a great leap into the unknown by lowering interest rates to below 0% in an effort to counteract negative GDP growth rates. Emerging market economies are feeling the impact of a prolonged deceleration of growth in China. Despite these concerning global developments, economists and leading analysts still assert that the U.S. economy, the strongest and most resilient in the world, is likely to see improved economic growth..
We can take some solace that industry titans here in the U.S. are not running for the exits. For example, Jamie Dimon, the CEO of JP Morgan Chase, just last week purchased over $26M in JP Morgan shares. That is certainly putting your money where your mouth is! Other more technical indicators suggest that the U.S. economy is on relatively solid footing. The U.S. economy added over 150,000 jobs in January of this year, and unemployment is down to 4.9% (although one should take into account that many people are still underemployed or have already left the job market). The U.S. consumer also remains relatively strong. Retail sales were up 0.2% in January - beating analyst estimates. To conclude, most market participants believe that the U.S. economy is doing "OK", and that barring any global economic calamities domestic growth should accelerate. So in which direction is one to reallocate their portfolio in today's market?
U.S. debt and equity markets have not been immune to the global market turmoil. Year-to-date, the Bloomberg High Yield Corporate Bond Index is down over 4% for the year, and the S&P 500 Index is off roughly 8.5%. The sharp swings in global markets have left many investors shell shocked and fearful that we are on the cusp of another 2008-style financial crisis. U.S. equity markets are still historically "expensive" on a price/earnings ratio basis, and continued global market volatility makes for a wild ride.
Other than as a "safe haven" hedge, U.S. Treasuries or investment grade corporate bonds are not very appealing given that interest rates should eventually rise in the medium term. Commodity markets are still reeling from unprecedented structural shifts in global oil markets as well as the slowdown in China's economic growth. As with oil, those without a long-term investment horizon and a strong stomach are also hesitant to invest in battered emerging market economies. Much Commercial, Industrial, Multi-Family and to a lesser extent Residential Real Estate has arguably hit what could be called "fair market value", or is even entering "overheated" territory. With many commercial properties in Tier 1 markets trading at 3.5-4.5% cap rates, is there really that much more room for cap rate compression?
Land, however, is an often overlooked asset class that may be both less susceptible to global economic volatility as well as currently available at attractive historical valuations.
In the run-up to the 2008 crash, land prices were driven up by 3 demand-side market participants, all of which were fueled by loose credit markets. At the base of the market, there were the consumers who had easy access to capital and were eager to enjoy the benefits of home ownership, including the capital gains then commonly associated with it. Acting as a middle man, there were individual investors who were engaged in land investment, land banking and "pre-development". At the top of the market, homebuilders competed with one another to rapidly acquire land for their soon-to-be-built communities. After the 2008 financial crisis, each of these market participants packed their bags and went away. The consumers suffered from foreclosures and massive financial losses, and were left with their credit in tatters. Aside from the substantial toll that the crash took on their finances and their employment, it has taken many buyers over 7 years for their credit to recover so that they can finally qualify for a mortgage once again. For their part, land investors faced tremendous losses, as the value of their land plummeted to in many cases less than 10 cents on the dollar. Many investors gave back their land to lenders or tried to "hang on" until prices recovered (which they still haven't...). The largest players in the market, large homebuilders, faced drastic losses as their core business all but dried up. Along with the banks who took back property secured by bad debt, the homebuilders wrote off unprecedented losses and ditched their assets at fire sale prices. All 3 market participants (the consumer, the land investor, and the large homebuilder) have still not returned to "normalcy". Normalcy is by no means the 2005-2007 run-up to the Financial Crisis, but it is also not this ho-hum market that we are seeing today.
Despite the painfully slow recovery that we have experienced thus far, there are signs that we are slowly marching towards "normalcy". The market participant that is out in front of the rest is the U.S. consumer. The stabilization of home ownership rates and the rise of housing prices are a testament to the resurgence of the U.S. consumer. Despite the recent global economic turmoil, the gains in the housing market have been largely sustained and resilient. It is great news that the U.S. consumer is leading the charge, since in a healthy market the U.S. consumer serves as the cornerstone for housing growth. The land investor has been wary of reentering the market. Many land investors who were burned during the financial crisis, and there were many, have "sworn off" land either out of necessity or based on bad prior experiences. Other would-be land investors are unable to invest in more land since they are still holding onto land that they have owned since before the crisis. Meanwhile, the large homebuilder is slowly dipping their toe back in the water to meet rising consumer demand. However, they are still highly conservative (arguably over-conservative) with their land investments and entitlements for new developments. The corporate objective of most builders in today's market is to have just enough supply to meet their projected demand, which is likely underestimated. With the U.S. consumer driving sustained gains in the U.S. housing market, builders may soon need to step up their land acquisitions to meet this rising demand. In response to the strength of the U.S. consumer and the return of the large homebuilder, land investors will also likely take note of attractive investment opportunities and re-enter the market.
In certain parts of the Valley, raw land prices are currently at an estimated 20% to 50% of their pre-crisis peaks (although this varies widely). While we do not anticipate quickly returning to the inflated land prices seen in the frenzy leading up to the crash (nor do we hope to see such frenzied activity again), today we believe that may be substantial room for land price appreciation. With few attractive investment alternatives to chose from, long-term investors should consider adding some land to their portfolios.
Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content shall not be construed as a recommendation to buy or sell any asset, or to participate in any particular investment strategy. All material presented herein is believed to be reliable, but we cannot attest to its accuracy.
Analysts maintain that we are still in the early stages of the housing cycle. For those who experienced the "normal" housing market from 1992-2000 and then from 2002 - 2006, it may seem apparent that we are still below the mid-point of the cycle. The local real estate market is certainly not as strong as it used to be. However, after nearly 8 years of an anemic market, many mistake the first few indications of growth as a sign that we have returned to "normal" -- just as after a long winter one is overly-eager to stash away their winter coat at the first signs of Spring. With that being said, I think very few people expect the market to return to the over-exuberance of 2006-2007. For a reminder that we are still in the early stages of the real estate cycle, we turn to analyst reports, market data and local market sentiment.
Morningstar believes that the mid-point in the real estate cycle (halfway from trough to peak) will be reached in 2019. Between 2014 and the mid-point of the cycle in 2019, they expect annual new home sales to rise by an impressive 61% - at which point they will at long last reach the 40-year historical average.
JP Morgan noted that on KB Home's latest earnings call, KB Home revealed that they were "'very encouraged' with early indications of the Spring selling seaons." Additionally, they noted that "Phoenix has stabilized and is improving." It is key to note that while builders are "encouraged," they do not claim to be back to business-as-usual (e.g. most of the 1990's or early to mid 2000's).
Goldman Sachs believes that the recent decline in homeownership rates is actually a sign of growing strength in the housing market. A decline in homeownership rates can be caused by either a decline in the numerator (the number of homeowners) or a faster rise in the denominator (the number of households). In this case, Goldman Sachs believes that both renters and homeowners are growing, but renters are growing at a faster rate. Their view is that years of delayed household formation , a result of the economic recession and demographic trends, will be followed by a sharp increase in household formation. Most importantly, this in turn will drive the housing sector (both multi-family and single-family residential) back toward normalcy.
Homeownership rates hit historic highs in the run-up to the 2007-2008 housing crisis. In 2006 the homeownership rate (the % of households that own their own home) reached 69%. As a result of excessive sub-prime lending, many new homeowners in the run-up to the crisis were arguably not financially equipped to purchase their homes. The pendulum had shifted too far towards high homeownership rates. Since 2006, homeownership rates have steadily declined. In Q4 of last year they reached 64% - an historically low level not seen since before 1995. Today, one could make the case that the pendulum has shifted too far towards low homeownership rates due to tight lending standards, lack of consumer confidence and low household formation rates. However, local market data suggests that the homeownership rates are stabilizing back toward their long-term historical average of 66% - 68%. In March 2015, the number of residential rental closings was 23% less than one year ago and 29% less than two years ago. Rising rents is one of the main reasons why many people are moving out of their rental units and into new homes. This trend is expected to continue for the next several years and should be a source of sustained demand for both new and existing single family housing.
Local Market Sentiment:
The local market sentiment is currently mixed. While few real estate investors, brokers or market observers would claim that we are in a "strong" market, most would note that the market outlook continues to gradually improve due to employment growth and economic growth. We believe that this recovery still has legs to run since the signs of that improvement are inconsistent and concentrated in certain areas. For example, the higher-end of the market for single family residential homes has taken the lead. Several new high-end subdivisions in North Scottsdale & Cave Creek have sold out or have only limited inventory remaining. Additionally, the mid to upper-end subdivisions in NW Peoria have seen relatively robust sales over most of the past year. However, in many sub-markets (such as Maricopa, Buckeye and Glendale, to name a few) the housing market has yet to gain momentum. We expect to see the entry-level to mid-level single family housing market rebound over the next several years.
Arizona Regional Multiple Listing Service (ARMLS® COPYRIGHT 2015).
Goldman Sachs Research.
Krapfel, James. Lennar Report. Morningstar Equity Research. March 19, 2015.
Rehaut, Michael. KB Home Report. JP Morgan Research. March 20, 2015.
United States Census.
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