There Just Aren't Enough Homes Being Built

U.S. home builders are on pace to begin construction on more than a million new single-family houses this year. That would be a big increase from the annual average of less than 750,000 housing starts over the past decade.

But even a million housing starts this year is still well below the 1.6 million annual starts during the peak of the U.S. housing bubble from 2004 to 2006.

The outcome of that decelerated pace of building has been a persistent shortage of housing in the U.S. that has built up over the past decade. It has been met by surge of demand for homes during the past 18 months, as the pandemic spurred people to move and millennials age into their home buying years. Ultralow interest rates on mortgages have added fuel to the fire.

Low inventory of properties for sale and soaring home prices have been the result. 

“This market is primarily driven by a lack of supply, not excess demand,” Stephen Kim, a housing analyst at Evercore, told Barron's Andrew Bary. “The supply shortage built up over 10 years, and it won’t go away quickly.”

Kim estimates that it would take a decade of two million housing starts a year for the U.S. to shake off its current underbuilt situation.

In the meantime, the big U.S. home builders including D.R. Horton, Lennar, PulteGroup, and Toll Brothers are poised to benefit from the millennial demographic tailwind and an improved industry structure.

Here's Andrew, writing in Barron's latest cover story:

'The industry is completely different than it used to be,' says Bill Smead, a manager of the Smead Value fund, which holds D.R. Horton and Lennar. 'It’s going from being fragmented to being aggregated in a relatively small number of publicly traded hands, and there is a secular growth story due to demographics that mutes a lot of the normal cyclicality.'

Nineteen publicly traded builders now command more than 30% of the new-home market, against 21% a decade ago. The builders have strong balance sheets and less land inventory, and are poised to ramp up capital returns to investors in the coming years. Dividends, now averaging just 1% across the industry, should rise along with share repurchases.

In the past, home builders plowed profits into land purchases to enable future construction. That kept a lid on valuations, as investors worried that land-heavy balance sheets would become liabilities in a downturn.

Home builders are now reaching deals with land developers that give them the option to purchase home-building lots rather than buying and holding land. At Horton, the percentage of owned lots has fallen to 24% from 43% since 2018.

'It’s not like the top of the last cycle, when home builders owned a ton of lots purchased with borrowed money,' Smead says. The companies, he says, have gone from being 'land developers' to 'home manufacturers'—increasing returns and lowering risk. Pulte has scarcely any net debt, and Horton has little net debt at its core home-building business.

Less cyclicality and higher shareholder returns in a sustainably strong housing market should help boost valuations of home builders. Their stocks are certainly cheap today: The big four trade for an average of just seven times next year's estimated earnings, compared with over 20 times for the S&P 500.

Find six stock picks and two exchange-traded funds to play a continued housing boom in Andrew's cover story here. And also check out our latest Sizing Up Small Caps column here, in which Carleton English makes the case for shares of UMH Properties, an owner and operator of manufactured-home communities.