U.S. home prices, as measured by the S&P/Case-Shiller 20-City Composite Home Price Index, increased 1.8% on a sequential basis from June to July and 12.4% year-over-year. The top 5 cities in terms of one-year growth: Las Vegas, San Francisco, Los Angeles, San Diego and Phoenix. The average price in those cities was 22.5% — almost double the top 20.
There are two ways to look at this. Either you see some sort of apocalyptic housing bubble or an opportunity to invest in some of the hottest housing markets and homebuilders in the country. I see the latter. And before you get all hot and bothered about a housing bubble, just remember that current housing prices are still 22% below their peak in July 2006 — when the prime rate was almost 8%.
I’m going where the growth is. To do that, I’ve got to find homebuilders with strong businesses in all five of these markets. Here’s a look at my best housing bets.
According to Trulia (TRLA), the top homebuilder in Vegas based on new home sales in 2012 was Richmond American Homes, the operating subsidiary of M.D.C. Holdings (MDC), the nation’s 13th largest builder by revenue. Based in Denver, the company generates about 77% of its homebuilding revenue in Colorado and westward. In the six months ended June 30, it delivered 294 new homes, an increase of 13% over the same period in 2012. Thanks to a 32% increase in the average price, it was able to grow revenues by 49%.
The Bay area experienced a 24.8% year-over-year gain in home prices in July. The median sale price in the city was $850,000 in August, compared to the national median of $204,000. Somehow I doubt San Franciscans are paid four times as much as the rest of us, so you’ve really got to love it in order to live there.
According to the most recent data from the San Francisco Business Times, KB Homes is the biggest publicly traded homebuilder in the Bay area, followed by Pulte Group (PHM) and Toll Brothers (TOL). In fact, KB Homes is the biggest builder in all of California (based on new homes delivered), where it generates 52% of its revenues. What happens in San Francisco, Los Angeles and San Diego is very important to the company’s future success. On Tuesday PHM announced Q3 revenues that were 29% higher at $549 million with net income up seven-fold to $27.3 million.
The median sales price for homes in LA in August was $450,000. That’s not quite the nosebleed section like San Francisco, but it’s still more than twice the country’s median price. Standard Pacific Homes (SPF) was founded in Southern California in 1965 and currently generates more than 50% of its revenue from the California market. Unfortunately, most of its other revenue comes from Texas, Florida and the Carolinas. While it might make a good investment, it doesn’t necessarily apply for the purposes of this article because it has little or no business in Arizona and Nevada.
An interesting possibility not readily apparent to the average investor is Weyerhaeuser (WY). The Seattle-based real estate investment trust that has its hands in virtually everything to do with forests — including the development of real estate. The Weyerhaeuser Real Estate Company generated $870 million in 2012 from the sale of 2,659 homes at an average price of $376,000. In terms of future development, it has 17,844 lots in California, 1,477 in Arizona and another 1,683 in Nevada. Operating through Maracay Homes, Pardee Homes, and others, it has all five cities covered. Due to WY’s diversified businesses, it’s a great long-term hold.
Like San Francisco, Toll Brothers is one of the top home builders in the area. A luxury builder, its average home price in 2012 was $573,000 — at least $200,000 more than any of the other builders mentioned in this article. It doesn’t need to sell nearly as many homes to qualify for the Builder 100. With just 3,286 closings in 2012, it managed to generate $1.9 billion in revenue, placing it fifth among the country’s top builders.
In the second half of 2013 Toll Brothers is experiencing a slowdown in new home sales as its customers digest the mortgage rate increase from 3.5% to 4.75%. Long-term, it feels the new home market is going through a slight pause but business will ultimately begin to pick up once more. InvestorPlace contributor Ian Harvey provides a good overview of why the company’s attractive. If you’re a luxury home builder, you have to be in this market.
Of the three, Meritage is most interesting because it has been in the Phoenix market since 1985 and is headquartered there. Having said that, MTH lacks both a Los Angeles and San Diego presence, which disqualifies it for the purposes of this article.
My first pick is Toll Brothers. It’s in all five markets, along with many more across the country. With higher selling prices, it’s serving a wealthier clientele that can more easily absorb any increases in mortgage rates.
My second is KB Homes, which has a big presence in both San Francisco and Las Vegas. Of the two, I like Toll Brothers’ higher price point. But they’re both going to continue to do well in the next 12-24 months.
Oh, and don’t forget Weyerhaeuser, which is a great investment all around.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.