The U.S. Housing Market Is Back

Includes: DHI, ITB, KBH, LEN, PHM, XHB
by: Valuentum

The housing market in the United States has regained its footing and looks poised to rebound even further. First, last Thursday, PulteGroup (PHM) reported better-than-expected second-quarter earnings, generated 15% revenue growth, and showed that its backlog grew 31% year-over-year on a unit basis. Then, on Friday, D.R. Horton's (DHI) fiscal third-quarter results revealed its backlog advanced 25% year-over-year. Plus, the firm reversed a tax-asset write-down, indicating the company expects increased profitability down the road. The strong performance from these two builders was preceded by solid results from other builders including KB Home (KBH) and Lennar (LEN). Though conventional wisdom may suggest a weak economic recovery would prevent a domestic housing rebound, we think several factors will continue to propel the housing market forward.

Low Interest Rates

Federal Reserve Bank Chairman Ben Bernanke has kept rates artificially low, thereby forcing investors out of bonds (and into riskier assets), whether intentionally or unintentionally. So where have all of these high-yield, income investors gone? The obvious choice is to junk bonds or to high-yielding dividend-growth stocks, but it also appears that rental properties have become an interesting avenue to fulfill investors' need for income. With incredibly low interest rates for buyers that have clean balance sheets, banks are willing to lend to these wealthy private investors. In turn, high-yield investors that now shun the paltry rates on bonds have access to better yield profiles via rental income -- and the chance at capital appreciation once the housing market recovers. This could help explain why new housing backlogs continue to grow even though overall home ownership sits at just 65.6%, near the lowest level since 1997 -- because the rate only includes owner-occupied homes (not investor-owned homes).

Additionally, traditional buyers with access to credit are also borrowing at extremely cheap rates. A 30-year fixed mortgage, for example, currently sits around 3.6%, so we feel traditional buyers with capital are eager to enter the new-home market, bolstering the backlogs at the builders. Creditworthy buyers may prefer purchasing new homes that need little work and/or updating. With a new home, buyers don't have to worry about "unknown" problems related to a house that's been on the market for years or a foreclosed home that has been neglected by previous owners.

Echo Boomer Household Formation

Perhaps the most powerful tailwind of all will be the Echo Boomer household formation. Eventually, the children of baby boomers will leave their parent's homes, whether by force or by choice. When this day comes, there will be tremendous demand for housing. Depending on the definition, Echo Boomers or Millennials, may be as much as 80 million or even one third of the US population.

This generation is currently struggling with finding post-education employment and is stricken by student loan debt. As a result, the Echo Boomers might not be able to afford to buy new homes. However, they will still need to acquire housing of some sort. In turn, rental prices may rise even higher, resulting in higher yields for investors or more capital appreciation (increased housing prices) as yields normalize. Therefore, in years ahead real-estate investors may continue to be a large source of demand rather than the Echo Boomers themselves. In either case, we think demand will materialize (and pricing improve) for almost all types of units, beginning with entry level.

Additionally, some of the traditional selling pressure in the housing market caused by Baby Boomers retiring may be alleviated by underfunded retirements and the need to work longer -- meaning there may be fewer Baby Boomers populating the coast of Florida (and more opting to remain in Cleveland and Detroit, for example). Societal trends, including medical advancements, could also make remaining in cold weather climates less restrictive in the years ahead. We think parents may choose to remain close to children and grandchildren rather than move to seclusion in the SunBelt. This could support the housing markets of some of the hardest hit regions of the country, though retirement destinations may still feel a pinch for some time to come.

Unless another financial catastrophe on the scale of the recent credit crisis arises, given these factors, residential real estate is starting to look like it has finally found a "bottom." Plus, certain evolving trends point to sustainable increases in both demand and price. Though we think constituents in the homebuilder space look fairly valued at this time (on the basis of our DCF process), we would not hesitate to open a position in a builder at the right price (below the lower end of its fair value range).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.