Consolidated Home builders thread PHM, LEN, KBH, DHI, LGHI , TOL, NVR

[Spekulatius]

This thread is meant to consolidate thoughts on investing in homebuilders and housing related stocks. I have put some thoughts here:

 

[Gregmal]

FOR is an interesting name to go in there as well. A leveraged land bank controlled by DR Horton. Sole purpose of being public IMO is to transfer traditional homebuilder risks to public shareholders. Located in all the right spots but also probably the most sensitive to hiccups. 

[Spekulatius]

18 hours ago, Gregmal said:

FOR is an interesting name to go in there as well. A leveraged land bank controlled by DR Horton. Sole purpose of being public IMO is to transfer traditional homebuilder risks to public shareholders. Located in all the right spots but also probably the most sensitive to hiccups. 

My hunch is to stay away from controlled entities that are set up to lay of risk. For once, with controlled entities you can’t expect a buyout, except in a takeunder scenario and then there the general conflict of interest issue. it is interesting that DHI has been layi g of some risk, even though with a 63% majority, the assets and liabilities still remain on the consolidated balance sheet.

Edited April 11, 2022 by Spekulatius

[jouni1]

Well I've been looking at NVR solely on account of planning to invest in it on a dip for the past 10 years but always failing to do so. I have always thought of it as a best in class US homebuilder, do you guys agree?

[Gregmal]

Yes

[CorpRaider]

I bought back half my DFH position Friday (I previously lightened up at $19).  Great annual letter.

Edited April 11, 2022 by CorpRaider

[Spekulatius]

53 minutes ago, jouni1 said:

Well I've been looking at NVR solely on account of planning to invest in it on a dip for the past 10 years but always failing to do so. I have always thought of it as a best in class US homebuilder, do you guys agree?

Yes, NVR sticks out. They are run way more capital efficient than the rest. I looked at a few financial metrics (pulled from tikr.com so may need to be adjusted a bit). the key number in terms of capital efficiency I am looking at is inventory/revenues. and NVR on that end looks far better than the rest. This is because they don't speculate on land. Amazingly enough, even though they don't speculate on land, their gross margins aren't much lower than peers. Worst of the bunch seems to be KBH. Best after NVR are LGIH, PHM and DHI. DHI and PHM right now generate a substantial FCF, LGIH operates around FCF break even.

 

 

 

 

Edited April 11, 2022 by Spekulatius

[thepupil]

I don't think we're in a housing "bubble" in the 2005 sense of the word at all. I think we're in a period of elevated and rising housing prices. I want to be long homebuilders. 

 

I'll probably start w/ a low conviction basket approach 

XHB ETF calls ~1% (these are nice for me because i don't have to preclear ETF's) 

NVR #Neversell you can buy the dip all the way down, 1-2% to start

LEN/B Event driven/spin-off play, 3-4%

 

for now i'm thumbsucking. 

 

I think it's ridiculous that LEN/B is at 1.1x TVPS (0.9x book) vs its 10 yr average of 1.3x and 8/2021 valuation of 1.8x, the quarter before it spins off a decent portion of its asset base, after 2 years of tremendous deleveraging (2018 ND = ~$8.5B, now about $3.5B). I know this is the whole sector but I'm a sucker for that discounted supervoting share to capture a lot of the spin. 

 

On the whole "land bank vs non land bank", I actually don't mind a hefty land bank and like Lennar in that you are going from an asset intensive model to something less so, rather than NVR which is already asset lite / beloved. LEN has plans (albeit seemingly vague ones) to become more of an asset mgr and sell down/manage its land bank for a fee. this seems attractive. 

 

we're probably early and there's could be a knee jerk reaction to rates from home buyers that causes everyone to pause and potentially more of a panic. 

Edited April 11, 2022 by thepupil

[Dinar]

2 hours ago, jouni1 said:

Well I've been looking at NVR solely on account of planning to invest in it on a dip for the past 10 years but always failing to do so. I have always thought of it as a best in class US homebuilder, do you guys agree?

I think that their earnings are drastically overstated.  The company significantly understates its options expense.

[Spekulatius]

I think the bear case for SFH is all the institutional money piling in. Many here think it's bullish and maybe it was in the beginning, but institutional money become dumb money really quick. institutional money is also much more likely to sell once the tide turns than a homeowner living in his property. When the time comes, they may find that selling is not that easy because liquidity can disappear quickly in a housing market.

 

 I think that even the homebuilders buying their own product is a head scratcher.

 

Does anyone know how many SFH homes are owned by institutional investors and what percentage of the houses they buy currently?

Edited April 11, 2022 by Spekulatius

[thepupil]

17 minutes ago, Spekulatius said:

I think the bear case for SFH is all the institutional money piling in. Many here think it's bullish and maybe it was in the beginning, but institutional money become dumb money really quick. institutional money is also much more likely to sell once the tide turns than a homeowner living in his property. When the time comes, they may find that selling is not that easy because liquidity can disappear quickly in a housing market.

 

 I think that even the homebuilders buying their own product is a head scratcher.

 

Does anyone know how many SFH homes are owned by institutional investors and what percentage of the houses they buy currently?

 

It's extremely low still. INVH is the biggest and owns 80,000 homes. there are 84 million single family homes in the US. the largest institutional SFR landlord has 9 basis points of market share. this is not to dismiss your concern and there is a big "stock vs flow" dynamic here. Investors are a much larger percent of purchases. 

 

 

[Gregmal]

Institutional presence in SFH housing is still tiny. Tutes ain’t gonna be forced sellers of housing either. Demand there is still insatiable 
 

Part of my comfort in the thesis is that every Tom, Dick and Harry underwrites their bear thesis based on GFC but really, that was a once in a generation and maybe even a once in a lifetime event. And even there, it was what? 30% mark to market drawdowns? Things are nowhere close to that. But even that hardly sounds like such a big deal to me. Bring it. 

[thepupil]

5 minutes ago, Gregmal said:

Institutional presence in SFH housing is still tiny. Tutes ain’t gonna be forced sellers of housing either. Demand there is still insatiable 
 

Part of my comfort in the thesis is that every Tom, Dick and Harry underwrites their bear thesis based on GFC but really, that was a once in a generation and maybe even a once in a lifetime event. And even there, it was what? 30% mark to market drawdowns? Things are nowhere close to that. But even that hardly sounds like such a big deal to me. Bring it. 

 

umm if we're talking homebuilders it was a 90% peak to trough drawdown in the S&P 500 homebuilders GICS subsector and the 2005 peak was not reached until 2017. 

 

I am more bullishly inclined of the homebuilders than most, i like em. they're in far greater shape now than back then (several went BK and i don't see any major homebuilder coming close, they all have giant backlogs such that they may not even lose any $$$ even in a pretty big downturn), but 30% mark to market is not at all what the experience of the GFC was in homebuilding. 

 

if we're talking RE value declines, yea, it was about 30% asset level, but that's a huge % of equity. 

[valueseek]

Nice discussion. Just a quick point on NVR. I guess NVR changed their strategy after their bankruptcy more than a couple of decades ago. And also, current housing market is no where comparable in whole to 2006 GFC. Interesting fact for me was that NVR's EPS was $89 in 2005. And it took almost 10+ years for them to achieve $90 EPS in 2015. From 2005 to 2015 sales per share increased from $675 to $1120. Sales per share peaked in 2007 at $900, declined for 5 years until 2011, and took further 3 years to reach $900+ sales per share level. Basically if there is some guestimates on the next 3-5 years sales per share trajectory at NVR based on various macro conditions (house prices, sales of units, etc.), one can get a good approximation of the returns expected from here. Unless sales per share are negative for next 3+ years and they are able to maintain 5-10% growth per year, stock return over that period should be reasonable 10%+. Very crude analysis. 

[Spekulatius]

4 hours ago, thepupil said:

 

umm if we're talking homebuilders it was a 90% peak to trough drawdown in the S&P 500 homebuilders GICS subsector and the 2005 peak was not reached until 2017. 

 

I am more bullishly inclined of the homebuilders than most, i like em. they're in far greater shape now than back then (several went BK and i don't see any major homebuilder coming close, they all have giant backlogs such that they may not even lose any $$$ even in a pretty big downturn), but 30% mark to market is not at all what the experience of the GFC was in homebuilding. 

 

if we're talking RE value declines, yea, it was about 30% asset level, but that's a huge % of equity. 

Yes, homebuilder stocks lost 90%.

The  SFH decline was much dependent on location. East coat was probably ~30% from peak to trough, but others areas fared worse. My home went from $325K (2002 / purchase) to ~$550K ( Mid 2005) to ~300K in 2010, so a ~45% decline.  It would have taken me until 2012 to break even on my purchase price and until 2019 if bought at the peak. This was in the California North Bay area.

 

So stuff can happen.

 

I checked some old reports from DHI to see if the business model really has become more capital light and I don't think it did. In fact, based on my quick Inventory/ revenue metric, it has was asset lighter in 2004/2005 than it is now (DHI inventory / revenue ratio was 62% vs 67.4% now):

 

They do have less debt than they did back then, so the balance sheet has changed, but i don't think the business itself has changed.

Edited April 11, 2022 by Spekulatius

[Gregmal]

Generally, home building is a shitty business. We all thought airlines changed too and then they showed the same susceptibility to slowdowns. Just give me the asset owners not the builders, assuming they have good balance sheets and reasonable managers. 
 

in either event, using GFC for any sort of modeling today shows a general lack of awareness. There’s nothing remotely similar. Even probably the homebuilder balance sheets and business models. 

20 minutes ago, valueseek said:

And also, current housing market is no where comparable in whole to 2006 GFC.

Yup. When I see people making that baseline, I laugh. Get off the excel sheets and into the real world.

[ValueArb]

1 hour ago, Gregmal said:

Institutional presence in SFH housing is still tiny. Tutes ain’t gonna be forced sellers of housing either. Demand there is still insatiable 
 

Part of my comfort in the thesis is that every Tom, Dick and Harry underwrites their bear thesis based on GFC but really, that was a once in a generation and maybe even a once in a lifetime event. And even there, it was what? 30% mark to market drawdowns? Things are nowhere close to that. But even that hardly sounds like such a big deal to me. Bring it. 

 

You've been right at nearly every point so far, but I still have trouble getting anywhere near real estate in this market.

 

First, at current inflation rates (7.9%?) mortgage rates should be at least at 9% or 10%. But market is saying inflation is 100% temporary, and Yellen said last fall that it will tail off starting this fall.  We see this in current interest rates, which haven't increased remotely to the levels one would expect if you thought inflation was going to last years. So essentially interest rates have bumped a bit to help pay for this temporary inflation spike and probably will slowly decline as inflation declines. 

 

So lets assume that 85% of the time inflation is just a temporary issue that has already peaked.

 

But what happens that 15% of the time the Fed can't get handle on inflation. Lets not forget they really didn't see it coming, and maybe they really can't do what it takes in the short run (higher rates/unemployment?) to prevent it from continuing. If it was easy to kill inflation Jimmy Carter would have been a two term president.  So a year from now if inflation is still over 7%, what will bond investors think? What will they accept? Will anyone be buying ten years at 2.8% to lock in what could be 5% annual loss of purchasing power? What would any bond and debt investors think after nearly 2 years of "temporary" inflation still strongly persisting? We have to have much higher interest rates in this scenario, and mortgage rates are likely blowing past 7% on their way to 9%+.

 

In that case, if the person who bought a home when the rates were 3-4.5% wants to sell it, the buyer is going to have to pay two to three times as much a month in interest. That has to dramatically transform the market, reducing demand substantially, and hurting prices. We had 40 years of declining mortgage interest rates goosing Real Estate valuations, what happens when that tailwind turns into gale sized headwind?

 

Again, this is unlikely to happen. But some percentage of the time something like it will. If I have to take a 70% downswing in my home builders 15% of the time, that materially affects how much I value them at and how much risk I want to take with them.

Edited April 11, 2022 by ValueArb

[Gregmal]

The institutions own very little housing. And THEY DONT CARE about overpaying 10-20%. Nobody seems to realize this. Its a Pacman game. Look at the REITS. All they care about reporting is growth in owned units. Not mark to market. I only briefly did some housing related companies start mentioning their mark to market and most of the ones I saw got bought out. EVERYONE is about how many units. From there they do the finance thing. Play with rents, utilize leverage. Move shit around. These homes that they buy, for the most part, are gone for the foreseeable future. No one has touched on why you STILL have 3 caps going off despite the rate rise? Again, no supply. Insatiable demand. 

 

But on to Joe and Sally the individual home buyer. Its bad enough they have to compete with ibuying and the tutes. Yes, theyre idiots because they spent their 20s and 30s renting in Brooklyn or in the San Diego MSA instead of owning. Now they need to buy. Except, again, theres SOOOO much competition. The Excel guy plugs in a rate increase and says Sally and Joe cant afford the same amount of house as they could in 2021. In the real world, rates are rising because of inflation and a big part of this is the labor market. What the pocket protectors dont have in their spreadsheets is that Joe works remotely and can choose to take on more or less work and thus compensation and Sally has recruiters lining up to offer her 20% more. These are the inputs the are causing rates to rise. Further, Sally and Joe are getting priced out of their rental. They might be uncomfortable pushing their limits on a mortgage, but see the writing on the wall with renting and also would like to have kids and maybe get a dog. Is it inconceivable they push things a bit and take on some "paper risk" to still get into a house(assuming they even can because again, NO SUPPLY)? Even if they took on risk, if rates keep going up so will their salaries and their 30 year fixed looks even nicer. If rates come down they refinance. 

 

Lastly, what did the average home prices look like in the early 1970s? You know, the last days of low rates, right before they walked into the teeth of the highest rates the country has ever seen? What were they like two decades later, when the housing market "rolled over"? From 1970-1990, the average home price in America quadrupled. Yup. 

[Gregmal]

39 minutes ago, ValueArb said:

Again, this is unlikely to happen. But some percentage of the time something like it will. If I have to take a 70% downswing in my home builders 15% of the time, that materially affects how much I value them at and how much risk I want to take with them.

You just have to figure out what you want to deal with as an investor. Theyre attractive on metrics and the most likely of outcomes. I agree. Do I want to do nothing and sleep like a baby and make 15% or do I wanna have to be repositioning and actively trading to make 30%? To each their own. I know what im getting with certain companies. With homebuilders, you need to trust but verify, constantly. 

[thepupil]

1 hour ago, ValueArb said:

 

You've been right at nearly every point so far, but I still have trouble getting anywhere near real estate in this market.

 

First, at current inflation rates (7.9%?) mortgage rates should be at least at 9% or 10%. But market is saying inflation is 100% temporary, and Yellen said last fall that it will tail off starting this fall.  We see this in current interest rates, which haven't increased remotely to the levels one would expect if you thought inflation was going to last years. So essentially interest rates have bumped a bit to help pay for this temporary inflation spike and probably will slowly decline as inflation declines. 

 

So lets assume that 85% of the time inflation is just a temporary issue that has already peaked.

 

But what happens that 15% of the time the Fed can't get handle on inflation. Lets not forget they really didn't see it coming, and maybe they really can't do what it takes in the short run (higher rates/unemployment?) to prevent it from continuing. If it was easy to kill inflation Jimmy Carter would have been a two term president.  So a year from now if inflation is still over 7%, what will bond investors think? What will they accept? Will anyone be buying ten years at 2.8% to lock in what could be 5% annual loss of purchasing power? What would any bond and debt investors think after nearly 2 years of "temporary" inflation still strongly persisting? We have to have much higher interest rates in this scenario, and mortgage rates are likely blowing past 7% on their way to 9%+.

 

In that case, if the person who bought a home when the rates were 3-4.5% wants to sell it, the buyer is going to have to pay two to three times as much a month in interest. That has to dramatically transform the market, reducing demand substantially, and hurting prices. We had 40 years of declining mortgage interest rates goosing Real Estate valuations, what happens when that tailwind turns into gale sized headwind?

 

Again, this is unlikely to happen. But some percentage of the time something like it will. If I have to take a 70% downswing in my home builders 15% of the time, that materially affects how much I value them at and how much risk I want to take with them.

If you think mtg rates should be that high you’re effectively saying where the 10yshould trade(5-7% to get mtg’s of 7-9%) and taking a  low probability view thereon. 

id recommend futures options or bond etf options to express this view.

 

I’m not trying to dismiss the risk just saying that mtg’s and tsy’s are inextricably linked and that fixed income investors are not entitled to a real return 
 

 

Edited April 11, 2022 by thepupil

[Viking]

Podcast Odd Lots just released an episode on housing... ping pongs around but a decent listen for those interested in housing / home builders.

 

This Is What 5% Mortgage Rates Mean Now for the Housing Market

- https://www.bloomberg.com/news/articles/2022-04-11/this-is-what-5-mortgage-rates-mean-now-for-the-housing-market?srnd=oddlots-podcast

[Broeb22]

12 hours ago, CorpRaider said:

I bought back half my DFH position Friday (I previously lightened up at $19).  Great annual letter.

+1

 

[Broeb22]

I do believe the homebuilders are healthier now than they were for a lot of the reasons Spek mentioned, healthier balance sheets, actual free cash flow, etc. 

 

One important point to make is that the % of optioned lots today is not significantly different than pre-GFC for many homebuilders. Like I said, I think they are generally healthier than pre-GFC, but I was surprised to learn that the land option strategy for some builders has not really changed as much as some people think.

 

 

From PHM 2005 10-K:

Land acquisition and development We select locations for development of homebuilding communities after completing extensive market research, enabling us to match the location and product offering with our targeted consumer group. We consider factors such as proximity to developed areas, population and job growth patterns and, if applicable, estimated development costs. We historically have managed the risk of controlling our land positions through use of option contracts and outright acquisition. We typically control land with the intent to complete sales of housing units within 24 to 36 months from the date of opening a community, except in the case of certain Del Webb active adult developments and other selected large projects for which the completion of community build out requires a longer time period due to typically larger project sizes. As a result, land is generally purchased after it is properly zoned and developed or is ready for development. In addition, we dispose of owned land not required in the business through sales to appropriate end users. Where we develop land, we engage directly in many phases of the development process, including land and site planning, obtaining environmental and other regulatory approvals, as well as constructing roads, sewers, water and drainage facilities and other amenities. We use our staff and the services of independent engineers and consultants for land development activities. Land development work is performed primarily by independent contractors and local government authorities who construct sewer and water systems in some areas. At December 31, 2005, we controlled approximately 363,000 lots, of which 174,000 were owned and 189,000 were under option agreements. 

 

From DHI 2005 10-K:

 

 

[Spekulatius]

@Broeb22 I believe it is correct that the home owners business model has not changed in the last 15 years. My favorite metric - Inventories/ revenues ( a measure of capital intensity) is actually worse now than it was in 2005 for DHI (to my own surprise). For me, it's clear that home builders likely would lose a lot of money in a severe housing decline.

 

However, keep in mind that DHI always was a quite well and efficiently managed builder, so all this may not apply to the entire industry.

[thepupil]

i'll am i the only nut job who likes the idea of owning all this land?  at least to start. like I'd rather go from land rich , asset heavy to asset lite than to buy the asset lite. 

 

Lennar had $8.1 billion of Land and Land Under Development as of 11/2019. They've since sold a bunch of homes and added some and now have $7.5 billion, but the point is a good bit of that $7.5 billion is from pre-covid. they were also a buyer of whole companies (Cal Atlantic $5.7 billion in 2017)  and WCI 2017 ($640 million). t

 

o summarize, most of the land on the balance sheet (and in unconsolidated entities) is likely well before the covid housing boom and underwritten under pre-covid assumptions. 

 

If you could go back in time, knowing that housing prices have mooned and buy billions of dollars of land (not to mention even more billions of finished inventory) at pre-covid prices, would you? I would. and have in very small tiptoe-ish size. tha'ts big picture why i find the idea of buying homebuilders <book right now interesting...I don't have time/bandwidth to llook at all of em though