Don't Miss This Historic Opportunity in the Housing Sector

“Lack of resale inventory combined with strong consumer demand continues to boost single-family home building.”

- Chuck Fowke, National Association of Homebuilders (NAHB) Chairman

At the moment, there is a?historic opportunity?available in the homebuilding sector that you do not want to miss because the cycle will eventually change. Ever since around 2014, there has been a?large undersupply of housing, offering homebuilders a large chance for?profit?as they take advantage of the deficit, without much risk. As the shortage continues through the current, uncertain economy, this sector will see much?more safety and security?of investment than most others.

Housing Demand:

Historically, the United States population has grown constantly and consistently on an annual basis. According to Census data, the total number of households increases, on average, by about 1.2 million per year. Additionally, over the course of 2021, the most recent full year of Census data, total households increased by almost 1.5 million, or 1.15%, as the market recovered from the Covid-19 pandemic. This means that, in theory, there?must be 1.5 million more homes on the market?to ensure there is a place for everyone to live, representing the?demand in the housing market.

Housing Supply:

With the new needs of consumers in the housing market,?homebuilders simply cannot meet the demand?with housing starts. Inventory, the number of vacant housing units for sale on the market, hit an?all-time low?in November of 2021 as seen in the graph below. This means there are not many options for homebuyers to choose from,?increasing the need for new homes to be built. Annual privately-owned housing starts have broken above their historical average since 1959 of around 1.4 million. The current levels sit just above 1.7 million annual housing starts, yet homebuilders are still unable to meet demand.

Even with all of these new homes being started and added to the market, the?new supply and existing inventory still cannot handle the influx of demand. Since the credit crisis, housing inventory has steadily decreased while housing starts have steadily increased, further illustrating the fact that housing?demand has outpaced supply. This has left a?large gap to fill?for homebuilders as they work to build enough homes to keep up with the growing demand.

Additionally, it will be hard for homebuilders to bridge this gap. The construction industry is?short of 650,000 workers, according to a model that was developed by the Associated Builders and Contractors. Also stemming from the backlog caused by increased housing demand is a?material shortage. A statistic provided by the National Association of Homebuilders stated that 90% of homebuilders reported materials shortages as well as delays in sourcing the materials. Therefore, due to the mere cost and shortage of both materials and labor, the?timeframe for completing a new house has increased.

The Surge in Home Prices:

All of this has compounded into home prices increasing tremendously over the past few years. It is simply within the dynamics of supply and demand -?when supply is low and demand is high, price rises. Housing demand has reached a level where?buyers are competitive, additionally increasing the average home sale price due to bidding wars. The current median home price is?not far off from the all-time highs?of $411,200 recorded in the third quarter of 2021. With inventory at an all-time low and sales for both new and existing homes at levels only seen before the credit crisis,?the rising prices are bound to continue.

The Housing Cycle:

Just as the broader economy follows a business cycle with expansions and contractions, the housing market has its own cycle. The early?2010s marked the end of the recovery phase?for the housing market after the credit crisis and large housing bubble. This was the point where?new homes started to be constructed again?as the oversupply from the credit crisis was absorbed by the market.?

From that time until the present, there has been a?slow expansionary phase?as housing vacancies have declined and the construction of new homes has been steadily increasing. With the record low levels of inventory and the inability of housing starts to meet the increasing demand, it is?likely that the expansionary phase continues for the foreseeable future?before the next contraction. Especially with the added difficulties of the supply chain and inflation,?homebuilders still have a lot of work to do to catch up.

The Homebuilding Sector's Undervaluation:

As shown above, homebuilders are a crucial part of the current housing market. Houses are being bought at a rate where?new homes simply cannot be built fast enough. Even with all of this happening, however, the relative valuation of the homebuilder sector remains?very cheap compared to historical averages. The average homebuilder is only worth 6x earnings right now, well below the historical average since 2005 of the low teens.?

With the current high demand for housing and a 5-year projected earnings growth of the high teens, it is safe to say that there is a lot of room for the sector to grow over the next couple of years. In addition, the sector has a return on invested capital (ROIC) of the mid-to-high teens, which is essentially how well a firm allocates capital to generate profits. This is well above the broader market average of about 10-12%,?showing the high levels of profitability for homebuilders.

Possible Risk Factors to Homebuilder Growth:

Given the aforementioned statistics,?some are still worried?about the demand retreating due to rising rates. With most members of the Federal Open Market Committee expecting rates to stay below 2% in 2022,?it will take more than that to deter new mortgages. Especially since most buyers are aware of the anticipated rate hikes, they will?want to enter their mortgage sooner rather than later?as it is hard to predict where rates will be in the coming years. Rates are still low enough to comfortably buy a new home with a 30-year mortgage. As of right now, despite the rate hikes this year, the?demand in the housing sector has remained at its high levels.

Why We Think This is a Great Investment:

With all of these factors considered, it can be seen why the housing market is likely to?continue its boom. High demand remains constant as there are?very few homes left on the market?and homebuilders struggle to construct enough new homes. While the boom may not be as drastic as that seen in late 2020 and throughout 2021,?housing prices will continue to steadily rise. It is hard to predict by how much or for how long these conditions will continue. However, it is safe to say that the current environment still?offers a lot of room for profit in the real estate market, specifically in the undersupply of homes which will benefit homebuilders.

By: Siddharth Singhai and Cole Stephenson

Disclaimer

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. The views and strategies described may not be suitable for all investors. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.