By Dave Gilreath
After taking a beating in 2018, housing industry equities are showing early signs of a comeback, arguably signaling potential value opportunities. But convincing bubble-scarred clients of this can be a tough sell.
This year, relative performance is generally up for the category, whose current tracking is reminiscent of early 1995, when it rebounded impressively from weak performance in 1994.
New home sales, in a downward trend since March 2018, turned around at year’s end, rising nearly 17 percent in November—the largest one-month gain since 1992, according the National Association of Homebuilders. The sector has been up and down since, demonstrating the halting nature of what is basically an overall upturn.
The market continues to be affected by the remainder of the monstrous surplus of homes built during the housing bubble. This slack is still playing out in some regions because of caution among some would-be buyers and limited resources among others. Despite strong employment, some consumers are saving their powder out of reservations about the economy. These doubts have been fueled by the recent, now-subsiding hysteria over the flattening long-term yield curve, wrought by obsessively looking at what was actually the wrong curve. (Notice that the sky hasn’t fallen yet.)
Based on early 2018 signals, the short-term outlook for housing construction may be less than gangbusters, but for various demographic and market reasons, healthy returns over the next few years seem likely for those who judiciously invest now. Receding interest rates would normally be expected to get more home buyers off their couches, but lingering economic doubts, along with the cautious limitation of volumes by some builders apparently concerned about over-extension, may be creating a window of market inefficiency.
Many clients won’t be able to see this, at least initially. These investors have had a bad taste in their mouths for the sector since the housing crisis and market meltdown of 2008, and the associated Great Recession.
However, there are some ways to overcome this resistance with relatable points. Perhaps the most compelling among these involve demographics.
To get a realistic grasp of the sector’s demographic destiny, all baby boomer clients need do is think about their grown children. Odds are, many of them have kids living at home. Other clients may have been in this position until recently, before seeing their kids get a job—or a better job—and move into an apartment. Still others may have recently seen the financial fortunes of their more successful children improve to the point where they’ve purchased their first homes. Thus, they’re personally witnessing the gradual, early signs of the release of pent-up consumer demand enabled by a strengthening economy.
Moreover, the market of working people of home-buying age is growing apace. Millennials (ages 20 to 35) are now poised to outnumber baby boomers (ages 52 to 70) this year. Generation X, which tops out at 51, is projected to outnumber boomers by 2028. And among major nations, the U.S. is about the only one with a rising working-age population.
All these people need a place to live, and effects of the housing-crisis surplus won’t last long. Various research shows that the nation—which now has about 122 million households, needs roughly a million new homes a year. Though demand has been at this level for the last few years, pre-housing-bubble models project near-term inventory growth at only about 820,000 homes annually.
Single-family homes are clearly the greater area of growth, and all indications are that it will remain so. Demand will increase as apartment-dwelling late millennials moving from cities to the suburbs to start families buy their first homes and Gen-Xers look to move into larger homes for their growing families. (Sales of new homes in general are hurting those of existing homes, which are down 8.5 percent versus a year ago. Existing home sales declined in January in every region but the Northeast.)
Demographics aside, the case for the sector can be compelling if clearly presented. Key points include:
- Promise shown this year by related industries, which suffered along with construction in 2018. These include construction materials, building products, home furnishing and household appliances. Basically, performance in these industries has begun to improve, with earnings-projection misses and negative economic headlines apparently priced in.
- The significant early-2018 performance of key investment vehicles. State Street’s homebuilder ETF, SPDR S&P Homebuilders ETF (XHB), which comprises homebuilder and supplier stocks, is a good proxy for the industry. Last year, shares were down about 15 percent from the peak but they’ve recovered nicely this year, gaining about 18 percent as of late February—a healthy rebound since the market selloff in December. Since the recession, this group has been generally out of favor. Yet reversion-to-mean adherents will likely be attracted to its recent strength, indicating continued sector recovery. Building companies owned by this fund include M/I Homes, Lennar Corp., D.R. Horton, Beazer Homes USA and PulteGroup.
- New-home volume is being crimped by a relative shortage of skilled tradesman. But this shortage will be short-lived. Many plumbers, carpenters and other tradesman dropped out of the market during the no-build days of the housing crisis. As more buyers come forward, this will create more demand for trade skills, boosting wages and attracting more people to acquire them. The result will be greater capacity and rising volume. To the extent that mid-market builders have full control over their production, the brisk volumes of D.R. Horton and Lennar Corp. will doubtless spur their ilk to ramp up volumes to keep from falling too far behind.
- Opportunities for owning rental houses as an alternative asset. A Millennium Trust Company survey in December showed a growing interest in alternative investments, including real estate and, particularly, single-family home rentals. Projections anticipate significant demand for single-family homes and changing renter profile that includes people seeking short-term flexibility because of job relocations.
Yet investors don’t have to buy houses to tap the single-family rental market. Spurred by indicators, REITs are springing up to buy and manage single family home rentals. This new breed of REIT offers desired exposure without the expense of buying homes and hiring property managers.
If these points fall on resistant client ears, well, you can only lead a horse to water. But for horses inclined to drink, these and other signs of value would suggest seeking the right opportunities in the sector, consistent with clients’ individual goals.
Dave Sheaff Gilreath, a 36-year veteran of the financial service industry, established Sheaff Brock Investment Advisors LLC, a retail portfolio management company based in Indianapolis, with partner Ron Brock in 2001.