For the past six months the SP 500 Homebuilders Index (XHB) has significantly outperformed the S&P 500 (SPY). The thesis of this article will be to examine the reasons for the outperformance and examine whether this outperformance will continue into the foreseeable future.
Chart courtesy of Big Charts.com
As we can see from the above chart the XHB has returned roughly 35%+ since the beginning of November while the SPY has returned roughly 10%. While a 10% gain in six months in a major diversified index such as SPY it pales in comparison to what the XHB has returned. What are the conditions that have led to this outperformance?
The homebuilders have seen a small uptick in their business and are starting to sell more completed homes. The following excerpts from DR Horton's (DHI) recent analyst conference call will illustrate this point.
"The spring selling season did arrive this year and it is still in full swing. Our net sales orders were up 55% sequentially from the December quarter and up 19% from our second quarter last year. Our average sales price increased to $222,700 during the quarter and the value of our net sales orders increased 28% compared to the year-ago quarter.
We've also seen continued sales strength into April. Our sales this quarter resulted in a 17% year-over-year increase in our backlog units, which puts us in a strong position for increased revenue and profitability in the second half of fiscal 2012.
In response to our improving sales, we have increased our homes under construction while reducing our spec percentage to 50%, which is the lowest level in recent history. We are also evaluating and selectively investing in land acquisition and development."
(Transcripts courtesy of Seeking Alpha, person quoted is Donald Tomnitz CEO and President of DHI
The negatives mentioned by the bears are that real estate prices are continuing to fall and that foreclosures are being sold at prices far below what a new house can be constructed for. As for prices continuing to fall The Trulia Price Monitor - which claims to be a leading index by tracking home asking prices - rose 0.5% in April, the 3rd consecutive increase. Prices rose 0.2% Y/Y. Beaten-down towns like Miami (+16.1%) and Phoenix (+15.8%) led the way. Rents nationally in April are up 5.6% Y/Y. (Source Seeking Alpha).
Granted three months is a small sample size, but the heartening signs are the significant increases in Miami and Phoenix. Both these markets were significantly overbuilt during the boom and contracted mightily once it ended. For them to show significant an increase leads me to believe the bottom is in for them and prices should begin to climb.
As for the continuing overhang of foreclosed home affecting home prices the following quote from Donald Tomnitz CEO of DHI sums up the dilemma. "I noticed a lot of media coverage around foreclosures. And frankly, one of the things that we think is that the foreclosures that are available to our buyers today are in typically poor condition requiring quite a bit of cash out of pocket to make them livable. And I think that's one of the reasons why you're consistently seeing over 1/3 or equivalent to 1/3 of existing home sales go to all-cash buyers, which means that the investors who have the money to take out of their pocket to put -- to improve those homes. But our buyers are typically looking for a new home, obviously, with a good warranty to behind it and frankly, something that they don't have to take cash out of their pocket. So I think we're in a very, very strong position notwithstanding the fact that banks are supposedly going to increase the number of foreclosures they're putting on the market. But again, I think these are tertiary buys compared to what the new home buy is for our customers."
The price that is being paid for the foreclosed home doesn't accurately reflect the amount of money required to renovate and bring the house up to proper standards again. I am confident going forward that the banks will continue to bring foreclosed homes to market again. They will be a great deal for an investor that is handy and has the time, knowledge and skill to rehab the residence however the vast majority of homebuyers are not interested in renovations. They are more concerned with getting the features they are looking for and will continue to flock to the homebuilders.
For an investor going forward what is a reasonable expectation for XHB. In my opinion, XHB outperformance is only beginning and can continue for a significant period of time. New home sales are still at depressed levels and have yet to recover to the normal levels seen before the boom. As the economy improves and interest rates stay at these low levels buying a home is a great investment. As Warren Buffet recently mentioned "It's a terrific deal." I would look to purchase XHB on any pullback and consider it a long term hold. As the housing market returns to equilibrium significant capital gains will be earned.
Additional disclosure: Thanks for reading. This article is for informational purposes only. I look forward to your comments.