I can’t be sure, but I might have bought at the top of the housing market cycle. Not the very top, mind you, but close enough.
It’s not what I was aiming for, obviously. But an opportunity on a new townhome came up in January, and – after doing my due diligence – I decided it was worth the buy.
I still do, for the record, but I’ll be the first to acknowledge charts like this one:
Obviously, I could have done worse. But it also could have been a whole lot better, especially when you take mortgage rates into perspective.
Source: FRED
Yet here’s why I don’t regret the decision, even with those rates about to fall…
I have my personal reasons, of course. My family has “downsized” over the past several years, with two of my children now married and running their own households. So as much as I love the old house, I simply don’t need that much room anymore.
But the real appeal of this townhome is the area it’s in – which is ripe for development. So, while I might have bought at the top of the short- or even mid-term housing market, there’s longer-term value I can’t ignore.
There’s one particular plot of land nearby that immediately captured my attention. It’s perfect for further residential expansion.
At first, I considered buying it up and building an apartment complex to rent out. But I’ve since changed my mind.
I’m still raising funds to purchase the plot. However, my new intent is to make it the perfect property for some intrepid homebuilder to buy.
The profit could be substantial that way and with far less hassle.
The Past Decade-Plus Put Us in This Housing Situation
The housing market is insane right now. Absolutely insane.
And it’s all due to the crisis.
Not just the shutdowns with their work-from-home mandates. I’ll get to that in a minute. First, though, we have to acknowledge the previous crisis – the one that came to light 12 years prior.
Older investors easily remember the economic pain and political chaos of the 2008 crash. The banks collapsing (or being bought up before they could collapse)… the big bailouts… the layoffs…
It wasn’t a pretty time, to say the least. And it took years for the economy to fully recover.
The official recession might have been relatively short, all things considered. But the effects? They were enormous.
This was particularly true of homebuilding. That once-booming industry was simply no longer the place to be since people were losing their homes, not buying them.
On top of that, financial institutions became a lot more cautious about signing mortgages, further depressing demand. So, it only makes sense that homebuilders stopped making as many houses – a trend that continued even while the U.S. population grew and grew and grew some more.
As such, when the 2020 shutdowns did hit, spurring a surge of renters wanting to buy their own homes and existing homeowners wanting to buy bigger accommodations… the disparity came into stark focus.
With demand so high and supply so low, prices skyrocketed, as visualized by that earlier chart. Add in home-flippers and institutional investors, along with rock-bottom mortgage rates, and prices skyrocketed even more.
Despite some dips, they’ve stayed up ever since, no matter that mortgage rates have since climbed to often unsustainable levels. The combination has taken many a would-be buyer out of the market altogether.
They simply can’t afford it.
Then again, they can’t afford to rent either. The monthly cost of leasing an apartment is severe, jumping 30.4% between 2019 and 2023 whereas wages grew just 20.2%, according to data from Zillow and StreetEasy. And while that surge has since quieted down, it’s not like prices have actually dropped.
All these otherwise negative factors combined make now the perfect time to start considering the benefits of investing in homebuilders.
U.S. Homebuilders on Display
Last week, the Federal Reserve all but announced a September rate cut. And that likely won’t be the last of them this year or in the year ahead.
Ipso facto, borrowing rates will start falling too – both for businesses and homeowners, making for a double-win for homebuilders. Not only will they spend less to borrow money (as all businesses do), their customer base will be in a better position to take out affordable mortgages as well.
Most people don’t grasp how big this opportunity is. But it’s huge. Just consider how Reuters reported last week that the U.S. is short 4.5 million homes.
Now take a moment to let that sink in.
That’s a lot of business to go around – and for years to come! This makes now an excellent time to educate yourself about publicly traded U.S. homebuilders.
I’m not hitting the buy button just yet, but I am studying these companies very, very closely. And I know I’m not the only one intrigued.
One of the perks of doing what I do is the amazing people I get to interact with, including experts in varying fields. One of those experts is Alex Petee, president and director of research and ETFs at Hoya Capital.
He very kindly provided me with this chart the other day:
As you can see, it lists homebuilder names, preceded by their ticker symbols and followed by importance balance sheet measures. Obviously, we want to pay close attention to their debt and debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratios.
My regular readers also know I prefer companies with higher marks from ratings agencies like Fitch and Moody’s. For Fitch, anything BBB and above is considered investment-grade and therefore the least likely to experience financial difficulties. And for Moody’s, Baa is the cutoff, with Ba and lower falling into the “junk” category.
This doesn’t mean there can’t be worthwhile opportunities in lesser or even unrated homebuilders. Just understand that you’ll likely be working with a higher amount of risk.
You’ll want to consider this chart as well, also courtesy of Alex:
Price-to-earnings-per share and earnings-per-share growth can also help guide you to make the right investment decisions.
Now, again, I’m not currently recommending any of these companies in my Wide Moat Research portfolios. There are still other factors to consider, and I’m working hard to consider them all.
However, I do have several on my watchlist that I see so much potential in. So, give it another few months… or maybe even a few more weeks.
I expect this category to look better than ever before too long.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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Source: Wide Moat Research