Buy the Homebuilders in a Hurry! (LEN, DHI, PHM)

The great stock market worries this summer about China, interest rates, the strong dollar and falling oil prices did a number on homebuilders’ stocks.


All of them saw declines from 52-week highs turn into precipitous tumbles. Losses of 20% or higher across just a few months were the rule, not the exception.

But homebuilders’ shares now appear to have bottomed, and, despite all market turmoil of late, look solid for the next six to 12 months.

Heaps of Good News for Homebuilders

Homebuilders have been rallying since the end of September after the Federal Reserve decided not to raise interest rates and the panic about China’s economic health subsided.

The Philadelphia Housing Sector Index is up almost 8% since bottoming on Sept. 29 and is up roughly the same amount for the year. Shares of Lennar (LEN) and D.R. Horton (DHI) are up a couple percent near-term bottom and are sporting double-digit gains for the year. NVR (NVR) is also up 27% for 2015.

Compare that with the Dow Jones Industrial Average, still down 3% on the year, or the S&P 500, down 1%.

If mortgage rates remain stable — they’re currently just under 4% — and the economy holds steady, homebuilders could have a decent end to this year and 2016. In fact, homebuilders’ optimism is running at the highest levels since October 2005, according to the National Association Builders/Wells Fargo Housing Market Index.

Unlike 2005 when the housing bust was about to blow wide open, homebuilders have four big factors in their favor:

  • Growing demand in many markets, particularly the West Coast, Dallas-Fort Worth and Denver. Millennials are forming families and entering their 30s, a prime time for home buying, Lennar CEO Stuart Miller said during the company’s August conference call.
  • Tight land supplies. Miller and others have said this is the biggest problem that their companies face. But tight land supplies means new competitors would have a hard time breaking into a market.
  • Tight inventories of homes for sale — new or existing. New-home sales should reach 500,000 units this year. That would be up 15% from 2014.
  • The Fed. Even if the central bank starts to raise short-term rates this year or early in 2016 (which now seems more likely), the changes will be modest at worst and probably be slow in frequency. A rapid rate run-up would slow the domestic economy, push the U.S. dollar higher and cause problems for global markets.

The stocks to buy and hold are probably those of the big homebuilders like LEN and DHI, as well as shares of PulteGroup (PHM) and Toll Brothers (TOL). They bring geographic diversity, not a lot of debt on their balance sheets and decent inventories of buildable lots — four-to-six years’ worth. And we’ll add one more point: They survived the housing bust.

NVR stock is worth considering as well because of years of consistent performance building along the Atlantic seaboard.

A subset to consider are companies that could be takeover candidates, such as Meritage Homes (MTH), based in Scottsdale, Ariz., and M/I Homes (MHO), a Columbus, Ohio, company with operations in the Midwest and Southeast.

Many of the largest builders have been acquiring smaller, privately held competitors in recent years. In 2014, William Lyon Homes (WLH), a Southern California builder with operations in California, Arizona, Nevada and Colorado, bought Bellevue, Wash.-based Polygon Northwest and instantly became the No. 2 player in Seattle and Portland.

The homebuilders looked just about dead in the depths of the recession. Building permits fell more than 70% between a 2005 peak of 2.16 million units and 583,000 units in 2009. New-home sales fell 73% between 2005’s peak of 1.28 million units and the 2011 bottom of 306,000 units.

However, as the economic recovery has emerged, employment and consumer confidence have slowly improved. 2015 looks like it will produce about 1.2 million permits, up 14% from 2014 along with those 500,000 new-home sales.

Those numbers are still way off from the 2005 peak, but that’s not a bad thing. The housing bubble was in full roar in 2005, and way too many houses were built and way too many buyers couldn’t handle the financial responsibility.

It appears that the larger builders like the current slow-and-steady pace. Witness Douglas Yearly, Toll Brothers CEO, which concentrates on move-up, second-home and affluent markets. On his company’s Aug. 25 conference call, he said, “We believe that the slow but steady acceleration we and the industry are experiencing bodes well for the long-term health of the housing market.”

There are areas of concern that could affect builders’ shares, but they don’t blow up my thesis. These include:

  • Softness in oil-patch markets like Houston, a concern cited by many companies in their August conference calls.
  • The ability to qualify for a mortgage under current rules remains a problem for many buyers. The offset is that it makes overbuilding exceedingly difficult.
  • Labor shortages means it takes longer to build homes. But the supply of labor should not affect demand.
  • How fast the Fed raises interest rates. Online real-estate marketing firm Zillow (Z, ZG) sees rates topping 7% by 2018. For the next year or so, rates may move above 4% but should have little impact on homebuilders and home sales, the study by senior economist Aaron Terrazas says.

Separately, watch the charts for an entry point. During the big selloff in August and September, many homebuilding stocks fell below their 50-day moving averages, often looked as a gauge of investor confidence. Most are still trading below the indicator, although the gaps for all have been narrowing. That gives the shares of the better-managed builders better value.

Bottom Line: Buy Homebuilders

If you have a longer-term investing horizon — a year, anyway, and maybe two — the homebuilders offer a pretty good proposition. Interest rates won’t be a problem. The demographics are definitely in your favor. The level of construction is not even close to being out of control, and, in many markets, rents are rising so fast that owning a home is a compelling idea because the after-tax costs are lower.

As of this writing, Charley Blaine did not hold a position in any of the aforementioned securities.

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