Safe to invest in “New Home Builders” stocks yet?

The answer to this question may lie in an analysis of basic economics. Property prices, much like any other asset class do not operate in a vacuum, and as the old saying goes, a rising tide lifts all ships.

If we understand what drives behaviour, then one should be able to evaluate demand for property with a bit more clarity. Adding in a good healthy dose of reality, one can accept the fact that not all geographical areas will experience the same level of recovery, let alone growth!

So what affects the demand for housing?

• Affordability
• Ratio of house prices to income
• Availability of mortgages
• Price expectations and confidence levels
• Level of interest rates
• Cost of renting
• General economic growth
• Employment

In the aftermath of the global crisis, everyone is quite familiar with the notion of lower interest rates. Yet not all of us are on the receiving end of money being thrown at us from financial institutions standing in line to lend us money.  As such, though more affordable, access to funding is still tricky, often requiring large down payments and stricter demand for a healthy credit score before loans are to be extended.

This process resulted in many would-be-buyers being forced into the rental market, and have been there for a while now. During the midst of the crisis many families opted to sit tight, and wait out the economic cycle of doom.

Slowly but surely the tide is turning, with the economy doing better, more jobs are being created, funding is still relatively cheap, and hopefully for most, no new debt was added to the pot. With rentals on the increase due to historical demand, coupled with a desire to improve their own financial situation, many households are now starting to shake off the recession cob webs, and are willing to make longer term decisions.  Economic amnesia may prove beneficial at times like these after all.

THE ANSWER TO THE MILLION DOLLAR QUESTION:

This brings us to the answer to the question… IS IT SAFE TO BUY NEW HOME BUILDERS STOCKS YET?

In order to answer this and in an effort to avoid a repeat of the past we need to pay attention to a few details:

• Regional Winners
• Choice of vehicle to access the market

REGIONAL WINNERS

When one consider the cost of renting and (regional) employment levels, we can make the following assumptions:

• Regional job growth attracts people
• People need to stay somewhere
• If the people have confidence in the economy and their future, then why rent if you can buy

One can deduct that in regions and cities where industry is booming, the demand for labor will at minimum remain stable, if not rising, and as such the housing market in that region should improve.

Let’s take the state of Texas for example. There has been a lot of sombre talks about its economic health especially with regards to the state of oil prices, yet all the while some of its major cities are experiencing an increase in population growth driven by job creation and investment. It is estimated that 110 people move to Austin every day , and that Austin is expected to grow by more than 30% over the next 15 years!

Not too far from Austin lies San Antonio which is expected to grow by 28% in 15 Years as well.

Looking at these numbers, and expecting similar results from other major cities in Texas, one could argue that the lone star state may in fact be a regional winner and even though not all new movers will require new homes, it does not take a lot to realise that current inventory and availability of housing will not accommodate the anticipated demand. A new job or an increase in spendable income drives not only the move from rent to buy, but also a desire to improve, a bigger house, or closer to work for example. The by-product of this should bode well for New Home Builders.

Builder Magazine quotes, “An important driver for new home demand is the extremely tight inventory of resale homes available on the market. Historically low resale inventory levels seem to be pushing would-be resale buyers into the new home market.”

Thus, stating the obvious then, considering New Home Builders with a reasonable exposures to Texas, may in fact turn out to be a great way to capitalise on this economic momentum. One can repeat this process by looking at other growth regions in the country, and similarly evaluate the builders in those areas, or even better still, New Home Builders that are diversified across numerous high growth regions nationally.

NOT ALL NEW HOME BUILDERS ARE CREATED EQUAL

The market for New Home Builders is extremely competitive and as such, even though one may choose the correct regional exposure, choosing the wrong builder could still result in disaster, much like the concept of gold doing well overall, but one particular miner filing for bankruptcy due to poor operational concerns and inadequate management.

One selection process used to find a suitable investment candidate could entail looking for companies who are not only exposed to key-growth regions, but also maintain a reputation of solid management and strong and constant earnings.

One such company that comes to mind is LGI Homes Inc. (LGIH)

In keeping with our example of Texas being a region with sizable economic growth potential, it comes as no surprise that LGI Homes has a core focus in cities such as Houston, San Antonio, Dallas/Fort Worth and Austin.

Also, as eluded to earlier, LGIH is exposed to other key growth areas such as Phoenix, Tucson, Tampa, Orlando, Fort Myers, Atlanta, Albuquerque, Charlotte and Denver, making it a solid contender for reaping a share of the growing demand in retail housing as the labor migrates to these vibrant economies.

BLOOMBERG PRICE GRAPH: http://www.bloomberg.com/quote/LGIH:US/chart

LGIH has been building and selling homes for over a decade and has managed to successfully navigate the property crisis due to their strong business fundamentals, corporate culture and management team. Keeping a laser-like focus on their key target market they have somehow avoided the fate so many other competitors in this space had to endure, and one of the few companies reporting closing and revenue growth during arguably some of the toughest housing markets of 2006 – 2008. 

CONCLUSION:

Though improvement of the overall economic conditions and business cycle have been slow to say the least, there are some clear signs of a pulse emerging in the economy. This coupled with the fact that certain regions are poised for solid growth expectations on the back of consistent migration of labor, the notion of increasing exposure to New Home Builders may in fact be far more realistic than one would originally have thought.

The key however remains to choose a company that can successfully weather the storm and navigate the many obstacles which arguably still lies ahead. Having said that, investing in New Home Builders may still be a process reserved for the early-adopters, and choosing a company with sizable exposures to economically active regions, coupled with a solid financial history remains the key to investment success.