The real estate market, like any other market, is a numbers game. Demand versus Supply. If one is greater than the other, it tips the balance and creates a turn in the market. Did we turn? Let's look at the numbers.
Demand can be tracked simply by population growth. Using 2010 US census numbers, we can track back 50 years of population growth and get an average compound growth of 1.4% growth per year. Factors such as birthrate and immigration make this demand stable and consistent through the last 50 years.
Secondly, let's look at Supply. New supply comes onto the market in terms of new homes built each year. The best way to track this is through housings starts. Let's track back 50 years of housing starts to see our levels of new supply to the market.
From the graph, the average cyclical real estate market is plotted through 10 year cycles. It's rather clear that the 10 year cycles have been pretty predictable the last 50 years up to 1997. Instead of the cyclical downturn we should had expected in 1997, we accelerate upward mainly due to the dot-com bubble. This continued to after 2001 when the dot-com bubble popped, and was followed upward with historically low interest rates from the Federal Reserve. It's no wonder why we had a dramatic downturn in 2006, followed by historically low starts the next 5 years to clear the supply. Excluding the bubble period, if you break down these 10 year averages from the last 60 years, the average new housing starts are close to 14M per decade. There are decades where the homebuilders either overbuilt or under-built, but the demand over time remains consistent to level out this supply. More dramatically though, in the last 4 years, the total cumulative housing starts combined to a number barely over 2.2M homes. To reach the historic 14M decade average, there will need to be 2M housing starts per year or a sum of 11.8M starts in the next 6 years.
If we are able to meet 2M homes per year, the homebuilders would need a dramatic spike in housing starts the next 6 years.
From the latest housing report this month, the homebuilders are currently on pace to reach only 894k (revised, Oct 2012) (seasonally adjusted) new starts this year. It is no wonder why new homebuilders are in "catch-up" mode buying any large developed parcel of land to meet the supply shortage. Furthermore, to support this data, inventory in many local markets are experiencing 50 year historic lows. So in principle, the increased demand due to consistent population growth, combined with decreased supply shortage from the last 4 years, will equal price appreciation in the next 6 years. Do you think we hit a bottom now?
Who are the best homebuilders that are position to take advantage of this shortage?
Any homebuilders that survive the downtown of the last 5 years are all in a great position to take advantage of the next 5 years. More specifically, homebuilders with the largest and key coastal land position will benefit the most. I like KB Home (KBH) as my top pick due to its heavy land position in California. They own more than 60% of their total land holdinsg in California, with the majority of the remainder in other hot markets like Texas. Fundamentally, their balance sheet and cash position is solid with moving a large part of their short-term bond holdings ($585M) well out to 2020 and beyond. In addition, they have a meaningful deferred tax asset of $883M that could be used to potentially offset $2.2B future taxable income. All of this combined will just provide them with a significantly large cash position to fill the shortage the next 5 years in housing.
Disclosure: I am long KBH.
Additional disclosure: John Chiem is a realtor in the SF Bay Area real estate market.