Through the Roof: Revisiting Our Case for Homebuilders
In our 2019 publication, “Still Climbing: The Case for Homebuilders,” we argued that the housing market was not peaking, but instead building toward a multi-year period of robust demand and tight inventory. Underpinning this growth are demographic tailwinds, which we would expect to power housing through possible recessions, unlike 2007. Additionally, we maintained that younger homebuyers are not that different from previous generations and would likely follow previous patterns of household formation and subsequent suburbanization. With an ongoing global pandemic and a year of additional data to test our expectations, we revisit our stance from 2019.
“The housing market was approaching mid-cycle, not peaking.”
So far this has proven true. Housing starts, or the number of new residential construction projects begun over a specific period, skyrocketed after the publication of our paper, but have fallen more recently. While lower starts usually mean lower demand, as in 2007, today lower starts simply reflect the difficulty of permitting and building new homes; demand is stronger than ever. Homebuilders reported almost universal order growth in June and real-estate services companies are reporting record home search volume. Inventory is incredibly tight, with listings down over 20% according to Redfin. Mortgage rates are near all-time lows. Prices are steady, but this reflects a shift away from high-priced metro areas to more family-friendly suburban locales. Like-for-like, prices are largely up.
That said, the National Association of Realtors continues to predict deep year-over-year declines in starts for each remaining quarter this year due to coronavirus-related constraints, though they are beginning to soften that view. While the housing market has powered past staggering job-losses so far, the economy may still negatively impact the housing market. It is unclear which will be stronger: secular real estate demand or the gravity of tens of millions of lost jobs and lack of supply.
“Demographic tailwinds would power housing through recessions, unlike 2007.”
This has proven true as well. Homebuilding has been one of the best performing consumer discretionary categories since the beginning of March, and within that, relatively affordable housing appears to be a robust sub-category. While it will be several months until we can confirm that this activity is driven by the first-time buyers whom we expected to power the market, it certainly appears supportive of our thesis.
“Younger homebuyers aren’t that different and would likely largely follow previous generations’ patterns of household formation and suburbanization.”
Last year, we could not imagine that the office towers and vibrant streetscapes which once drew high-income millennials to urban cores would close indefinitely. Real estate services companies are reporting double-digit increases of buyer interest in suburbs and historically second-tier metro areas. At this point, it is too early to confidently forecast whether the drivers of the last decade’s urban economic boom are temporarily or permanently impaired. However, we have conviction that if the top 15 cities no longer offer the perceived utility premium they once did due to work-from-anywhere or because their cultural institutions do not recover, the magnitude of demand for new homes elsewhere could dwarf even our bullish pre-COVID-19 estimates.
As helpful as these forecasts have been, the fallout from COVID-19 has offered up a fresh set of questions. To what extent will the cultural and economic agglomeration effects of America’s top cities diminish as a result of changing work habits and social distancing? It also remains to be seen how consumer confidence and purchase patterns will change as the initial COVID-19 shock diminishes and a new economic “normal” emerges. While we believe the role of interest rates in determining long-run supply and demand in the housing market is overstated, it is worth asking whether historically low mortgage rates will risk overheating an already supply-constrained housing market in the immediate future.
Even without answering these questions, there is an easy playbook for investors. We believe in investing in homebuilders when the implied fundamentals are “like 2007” or “worse than other discretionary categories.” Although forecasting the macroeconomy is currently difficult, the tailwinds to housing demand are such that we believe it should outperform other categories while the constraints on housing supply mean asset impairments like those in the global financial crisis are very unlikely. We also find opportunities to invest in companies that are reducing frictions for younger homebuyers as we expect the importance of these homebuyers to increase materially in the coming years.
1 Redfin, Home Sellers’ Asking Prices up 13% from Last Year as Demand Keeps Soaring, July 23, 2020, https://www.redfin.com/blog/home-sales-and-prices-keep-climbing/
2 Pre-COVID is defined by February 28, 2020.
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