The Millionacres Hour: Homebuilder Spotlight
Transcript
Deidre Woollard: Hello, Fools. It is just past two o’clock on the East Coast. As Emily said, this is the Millionacres hour where we get to talk about all things real estate, my favorite subject. I’m Deidre Woollard, I’m an editor over at Millionacres which I’m sure you know is the Motley Fool’s real estate investing website. Here with Jason Hall who in addition to being The Wrap host, is also really knowledgeable about home builders which is what we want to talk about in this hour. Because I think it’s really interesting, 2020, not a great year for at least some of the REITS. I’d say a large part of the REITs didn’t do too well. Not a great year for this commercial side but man-o-man, residential side just popped, not all year, but certainly since April, and that’s been big for home builders, it’s been big for some of the real estate brokerage stocks. But today in specific, wanted to talk about home builders, what we think is going to happen and what to look out for. Because if there’s anything I think that any long-term investor knows it’s that what goes up eventually stabilizes or comes down.
Jason Hall: Reversion to the mean, that’s the thing, I guess.
Deidre Woollard: Yeah. [LAUGHTER] Exactly. It was such a strong year, it’s hard to imagine that 2021 is going to be as strong.
Jason Hall: I’m going to just tease everybody a little bit here. There’s a chart, I sent an image of it to Deidre half an hour or so ago on Slack. I’m going to tease, I’m not going to share it now but [LAUGHTER] I think the mean might be changing, maybe that’s the way to think about this. [LAUGHTER] Twenty twenty was a great year but the best part of 2020 to me wasn’t the final sales results, it was the order built. We’ll talk more about that, but let’s talk about, you’ve got a lot of great data here, I think, that really sets the stage for what happened last year and where things are.
Deidre Woollard: Yes. Where things are, wanted to look at a few of the numbers, I’ve talked about some of these before. There’s a series of numbers that come out every month that give you a little bit of a window into what’s happening. The one that comes out usually at the tail end of the month is always pending home sales from the National Association of Realtors. What they saw in November was a slight decrease from the previous month, but that’s totally normal, the slow season is always probably tail end of October through, used to be through March, but is now more like mid-January. But pending sales are still up year-over-year by about 16.4 percent. Even though things have started to slow which is the traditional cycle, there’s still way up over last year. The interesting thing is to hear what Lawrence Yun, who’s been the Chief Economist of the NAR for a long time.
Jason Hall: He’s great. He is really great.
Deidre Woollard: He is great. Yeah. He definitely thinks there’s still room in this market. He says existing home sales are probably going to go up by 10 percent in 2021, and new home sales by 20 percent.
Jason Hall: Yeah. [LAUGHTER] I think we should contextualize that. To see a sustained double-digit increase in home sales is like the stock market going up 30 percent. It is a very big number, it is an abnormal number because it is a very large, very mature market, and it takes a lot of very expensive items being sold to move the needle that much. It’s really a big deal.
Deidre Woollard: Another thing you and I have talked about before that I think is really changing the existing home versus new home picture is how close the median home prices are between new homes and existing homes. I’ve study real estate a long time, never seen them this close. The most recent existing home price from NAR, $310,800, which was up almost 15 percent from the year before. Really seeing prices of existing homes go up partly because inventory is so low. Then if you look at new home sales, their median home sales price in November was 390,000. Now, that’s a big difference but it’s not as big as it used to be. If they’re starting to become the situation where people are thinking, “Well, why buy an existing home if I can get a new home for a price that’s not too much higher and maybe not have to deal with some of the households that can come with an existing home, particularly a home that is older.” I think one of the things that I’ve been watching is the aging of housing stock in America in general. It’s interesting to me.
Jason Hall: We’re pushing 40 years now, right? It’s over 35 years now.
Deidre Woollard: We are. Yeah. What’s interesting is the old, old homes, I feel like they last forever, like pre-war homes. But homes that were built in, I’d say, from the 1950s and on, they have a little bit more built-in obsolescence in them, I see more problems happening and becomes harder and more expensive to fix them. I think that’s something that the people are starting to see is they’re starting to watch their friends buy a house and then they start to hear about the horror stories get out.
Jason Hall: There’s a history there that’s important too because the pre-war homes, they were a craft item. Then once you get into the post-war era, they became a manufactured good. That’s the way the federal government, in terms of the different buckets of economic activity, they’re manufactured. Even a custom, on the bottom line, is that they assemble houses. I mean, there is some custom work but for the most part, you think about the rafters, you think about even the wall panels, the studs, they’re taking sections and they assemble it. They’re manufactured in a facility. The benefits to consumers is that’s driven cost out. [LAUGHTER] It’s not necessarily reflected in the environment now because of the supply demand economics, but they’re manufactured goods. The bottom line is that for a lot of years, manufacturers, as they do, look to find ways to drive costs down using lower-cost materials. Materials is what has gotten smaller, every single piece of lumber has gotten smaller. A two by four hasn’t been a two by four in almost a century at this point. As a result, the quality has been affected. That’s your point, right?
Deidre Woollard: That is absolutely my point. There’s a lot of variation across the country, but my mother lives in one of those housing developments in Florida that was built during the ’80s.
Jason Hall: The worst. [LAUGHTER]
Deidre Woollard: Yeah. [LAUGHTER]. Exactly. The amount of problems with that house, as it’s gotten older, have been incredible. Really substantial plumbing problems that I found surprising. It’s not that old a house, it was built in the ’80s, but it’s certainly having problems, and I think there is that problem with some of that housing stock.
Jason Hall: Here’s the flip side. I think I had you and Tyler on The Wrap a month or so back. Tyler was talking about how some of that issue with the aging out of some of the newer properties. You think about those 80s, especially late 70s, early 80s. Especially a lot of composite materials came in that were junk, is a potential opportunity for the Home Depots of the world. Where they have good relationships with re-modeling contractors and that kind of thing. Where you have somebody that buys a house that’s an existing property, and then they [LAUGHTER] find out after the fact, I can’t do this little DIY project, I need to hire somebody. There’s interesting, compelling opportunities throughout the market that are going to play out as the trend of buying homes continues to grow. It’s a huge trend.
Deidre Woollard: Absolutely. I think the difference is for a home that is a couple of decades old, you start to think why not just get a new home because there’s not that difference in style or it being historic or something like that. That’s really one of the things that’s interesting too, is where homes are being built and the amount of permits. Some of t
he numbers that you and I have been looking at is we usually look at the building permits, which is the beginning start of the process. Then you have housing starts, which is actually the construction, and then you have housing completions. Those numbers come out every month from the government. These numbers are strong compared to where they were a year or two ago, but we’re still not building at the rate that we need and we’re still not building at the rates that were in place before the 2008, the great financial crisis. We’ve never gotten back to that point.
Jason Hall: We haven’t. Is this the part where I show that chart now? Should I do that now?
Deidre Woollard: Yeah, show that chart. That’s a great chart.
Jason Hall: I’m going to bring this up here and let’s see. I think it’s pretty good. Is that a good size?
Deidre Woollard: Yeah.
Jason Hall: Here’s what I’m showing. This is since 2010, and I’m showing this one first as a starting point. You look at the purple, that’s housing starts. That’s when the first process of building that property begins. Then you have US existing home sales. You look at that number and it’s like, wow. That’s on a percentage basis. What is this? They’re up huge over the past decade. Here’s the problem. The past decade is [LAUGHTER] not anywhere near enough context for what’s happening here. We take that back, and now look. Housing starts over the past 40 years. We’re usually pushing a couple of million. I’m going to pull existing home sales out of this and you’ll see one and a half to two million is more than normal healthy range. If you look, so right here, you see that curve, that’s like 2007, 2006. That was the peak, the pre-global financial crisis peak of the housing. All of this, this is a four year run of extreme overbuild that happened. Then the crash year. A lot of this was soaking up all of this excess inventory right here. But here’s the problem. Here’s the thing that there’s more context and I’m going to go even further out. I’m going to have to break this up because it pushes that down there to the bottom. You see here’s the thing that this doesn’t factor in. We spend a lot of time in this period soaking up excess inventory. But at the same time that all that was going on, the US population continues to grow and continue to grow. We’re talking about this period here where we’re pushing that one and a half to two million starts pretty consistently. Obviously, there were some recessionary periods that it fell a little bit. The US population continued to grow. Now, we have this scenario where Millennials, the most populous generation in American history, are actively and aggressively looking to own a home. We don’t have enough inventory. I’m going to throw these charts right on top of one another and you see that right here. This is the existing family home inventory. You see again from that peak, it came down as it should have because there was a massive oversupply. But again, if you look at where we are right now, a million existing single-family home inventory. In other words, that’s existing homes for sale. Come on people, look at this. [LAUGHTER] That’s historically low. We have also historically low interest rates, and the largest number of first-time homebuyers in American history.
Deidre Woollard: Yes. That’s another interesting thing to note is a lot of people have asked, with home prices being so high, has the amount of first-time homebuyers, did it gone down last year? It really didn’t. It’s usually around between 30 and 33 percent of existing home sales, and it stayed pretty consistent throughout the year. I mean, these prices are high, don’t get me wrong, affordability is strained. But because interest rates are so low, people are still feeling like this is possible for them and they are able to do that.
Jason Hall: The other thing important too is that real estate pricing in markets, it’s very geographically based. It’s very local.
Deidre Woollard: Of course.
Jason Hall: The area that I live in, pricing is much higher than like around Charlotte, North Carolina, or around different places in Georgia, than it is in Southern California, near LA. Or than it would be in San Francisco or DC metro area, that kind of thing. That’s another thing that affects it. There’s medium prices and average prices. What you see on a national level might be completely different in one market or the other based on access to land, local population, economic opportunities. All of those things come into play, but the big thing is supply and demand. There is no inventory. [LAUGHTER] I think that sets up the Homebuilders. We’ll talk about that in a few minutes.
Deidre Woollard: There’s limited inventory and there also, the other story that was part of 2020 was that work from home shift. That’s part of this, is that people were starting to think about suburbs again. We saw what they called the urban exodus. Although I still believe that’s mostly temporary and the data is starting to show that that is in fact true. As vaccines rollup, people are starting to be more interested in going back to cities, but we saw people move out to the suburbs. That’s always great news for the Homebuilders because the Homebuilders obviously, there’s very limited possibilities of building close to cities. They’re always having to be in the suburbs and exurbs. That worries me a little bit with Homebuilders is just based on what we saw in 2008, is that they built way too far out. They built way too far out, and then when the economy shifted and people want to be closer to jobs, those homes became less desirable. That’s something that I think is important to keep an eye on.
Jason Hall: I agree. I think that the greater context too is we really don’t know what the full implications are of how the coronavirus pandemic is going to change work in the broader scale. But I think there’s more and more evidence to your point that it’s not going to be as binary as maybe we think. For every Twitter that wants to have almost all of their employees working remotely, there’s going to be a 100 Netflixes. Reed Hastings was very [LAUGHTER] adamant that he wants his staff working in the office and working together. I think the reality is that probably the biggest group is going to be the hybrids. Where you have companies that want their employees in the office most of the time, but want to give them the flexibility to work from home a couple of days a week maybe, or maybe for an extended period of time. A week or two work remotely and then come back to the office. I think we’re going to see more of that model play out. But at the end of the day, I don’t think that those things are really going to affect the trajectory of the residential real estate market. I really don’t. I think the trajectory, especially for homebuyers, whether you’re buying a single-family home or you’re buying a condo or whatever, the demographics are [LAUGHTER] blatantly clear here. There’s millions and millions of people that want to buy a home. What those homes look like and exactly where they are, are they going to be affected. But the greater trajectory, I think is pretty clear.
Deidre Woollard: The other thing too is you also have some of the larger companies making some big moves. We’ve had a couple of different companies move their offices from California to Austin and Houston. We’ve had some of the New York companies that start thinking about what they call Miami, like Wall Street South. We start seeing that New York to Florida [inaudible 00:17:01]
Jason Hall: Was it Goldman Sachs that did something like that?
Deidre Woollard: Yeah, it’s Goldman Sachs. You’re starting to see these trends of these companies doing that. That’s an important thing to keep an eye on too, because money follows people and people follow jobs. If you’ve got the jobs in those areas, then that’s all the more incentive for Homebuilders. Certainly Texas, I think, is one of the biggest markets for Homebuilders. We’ve seen
some of the Homebuilders scale back a little bit in California, especially in Southern California.
Jason Hall: It costs.
Deidre Woollard: Yeah, land costs are just insane. We’ve seen them. Even before the pandemic, we saw a lot more activity in Houston and also in across the Sun Belt.
Jason Hall: I think that’s going to continue. There’s little doubt that’s going to continue. Number 1, because of affordability and also because I think a lot of companies have focused on growing in those areas because they’re going to have access to talent, and that’s important; and they know that costs are better there. A lot of those areas have implemented business friendly policies. I think a lot of big companies that are thinking about regulatory impact, thinking about taxes, and have the flexibility to move to outside of Charlotte or outside of Atlanta or Dallas or San Antonio or any of those places, or Florida. [LAUGHTER] They’re certainly more business friendly than California where I live now, where taxes are higher, and regulations are stiffer, and everything costs more. But I don’t think we should count California out. I think it’s a reminder that from this, if we’re talking about Homebuilders, especially if you’re looking to build entry-level housing, Southern California is very hard because the costs to build and the selling costs typically will push the price above where it will qualify. I just completely lost, drew a blank on the word here, confirming loan. When it comes to Fannie or Freddie all of a sudden you’re in a jumbo mortgage, which can cost a little bit more, less lenders want to do jumbo mortgages. It’s an extra level of complexity that a lot of Homebuilders, if they can avoid it, they will, and especially the smaller Homebuilders, Green Brick, we’re going to talk about, LGI Homes, Meritage, two of my favorites. They can still grow in other markets and not have to compete in California. It’s good for them. It’s not great for people that want to live here.
Deidre Woollard: Yeah, that is very true. Just to take a look at new home sales. The new home’s most recent data is from November, and new home sales were up 21 percent year over year. The interesting thing is there is more of a supply of new homes than there is existing homes right now. Existing home inventory is right around two months and you figure that what they call a balanced market is about six months of inventory. Now, existing home inventory hasn’t hit six months since the great financial crisis. It’s always been trending low. But, now it’s trending to the point where it’s just really, really low. I’m not sure if there’s going to be a big rush to have existing homes go on the market in the spring. Traditionally, March, April, that’s when people start to think about selling, you get that big push of homes on the market, I am not sure if we’re going to see that this year. Obviously we didn’t see it last year, so it’ll be interesting to watch. That’s one of the things to keep an eye on, especially if you’re invested in some of the Homebuilder stocks, keeping an eye on the existing home sales, it’s like watching your competition in some way.
Jason Hall: It is. Again, it’s very regional. You want to understand those matrix if you’re investing in these companies, you want to understand those matrix in the areas that they operate in. I think that’s a really important context to it. The good thing is that the National Association of Realtors, they break that data apart, and it’s free. They like it because it’s marketing and it’s great. They want as many people to see it as possible. Then the Fed does so much stuff that you can also get for free in terms of tracking that data and being able to peel it apart. But I think the point is that you want to understand those levers and how they affect the companies that you invest in.
Deidre Woollard: Right. When you’re looking at Homebuilders, you want to look at what their average prices and what they’re selling their homes for, how does it track against the market and how does it track against the average in the median, because that’s important too. Even before the pandemic, we did see some of these Homebuilders getting a lot smarter about this. Some of the biggies like Lennar and DR Horton, were already starting to know that their homes were getting a little bit too pricey for their market. Some of these Homebuilders are pretty smart about knowing what people are looking for and trying to find ways to make the flow plans still seem big enough, but, maybe make it just a tiny bit smaller or make the lot size smaller or anything that they can do in order to basically trim the cost of new homes. They’ve done pretty well in that.
Jason Hall: Well, and we saw the trend from probably 2011 or 2012 when things started to stabilize and the Homebuilders were really getting back into some semblance of closer to normal business, we saw for a number of years those average selling prices steadily increased and increased, obviously based on the supply and demand economics. But also they were focusing for the most part, on custom homes. Nobody was building entry-level homes, for the first five years after the global financial crisis, were very little I should say. But they were focusing on custom homes, because they were selling to people that had jobs and money, and we’re looking for something more, something nicer. That’s where they focused. An interesting thing that I saw with Meritage, I’ve followed for almost a decade now, is when Steve Hilton, the Founder and Former CEO, I think he’s retired at the end of the year, [NOISE] when he announced that the company was going to really focus on entry-level, was he pointed out that their average selling price was going to start trending down, and that that was going to be a positive indicator. Because it meant that the company’s focus was working and they were selling more of these entry-level houses. There are very few businesses that you ever want to see average selling prices fall, because if average prices are falling, usually it means they are selling something that has thinner margins, and they are not doing as well. It’s actually the opposite in the housing market, is that starter homes can be more profitable, you can have better margins because, you don’t have as much labor involved. It’s a format, you build one, you move to the next one, you build it, maybe have four or five floor plans. But that’s it. You’re not doing a bunch of custom work that cost more money and hits into your margin. It’s really interesting. I wanted to just stress that because as you are looking at these companies, if they say they are focusing on entry-level, then you probably want to see that metric if not staying flat, maybe coming down a little bit because it means that it’s working.
Deidre Woollard: Exactly. Yeah, that is a very important point. You also want to know, where they’re building, what types of forms of building, and you also want to know how they are holding the land. That’s something you and I have talked about a lot before, and that’s really, really important. Homebuilders have this problem, they have to have land available to build, but they have to not be caught holding the bag when the market shifts and they don’t need to build those homes anymore. A lot of Homebuilders, instead of owning the land outright, they’ll have options which basically gives them the right to use or not use the land, and so that’s one strategy that we’ve seen Homebuilders shift toward. A couple of the Homebuilder in the earnings reports recently, they talked about how they were trying to shift their ratio of land wholly owned versus options.
Jason Hall: Lennar in particular, that’s one of the biggest, is Lennar the biggest? They might be the biggest or one of the biggest Homebuilders, they talked about, I think they’re aiming for like 40, 45 percent of their land they want to hold in options. Just a little more detail on what exactly that means. If you look at Homebuilders, generally, on an earnings multiple PE
ratio, they tend to trade at a sharp discount to the market. They pretty much always trade for a modest discount. Like right now it’s crazy discount compared to the market. But there’s two main reasons why, and Deidre hit on it. But just to be really clear and specific, what it means is because historically, most of them have to buy this expensive land that they sit on for multiple years at a time they usually want to have like three-years plus inventory. They buy land that they sit on for three years and they use debt to buy that land. They’re paying interest on it. There’s a lot of leverage involved. Then the other side of it too, Deidre mentioned being, caught holding the bag when the market turns, it’s a cyclical industry. It can shift very quickly. 2020 was the most abnormal recessionary year than I’ve ever seen where housing sales went up and the steepest recession in history. That’s not normal. That doesn’t normally happen. Usually what happens is everybody circles a wagon or stops buying houses. These guys are left with a bunch of inventory that they’re having to pay debt to service, and all of a sudden they’re not selling new houses either. It’s like this worst double whammy. Moving to options means that they risk a little bit of capital that they might lose, but they can walk away without buying land, probably at a too high of a price that they have to figure out, well, do we offloaded at a discount or take a loss on it because, we need to lighten our balance sheet or do we just keep riding it out until the market gets better? All of these things creates a lot of risk for Homebuilders. That’s why Lennar, there shift to options makes sense. It’s following the NVR model, right?
Deidre Woollard: Absolutely. It’s also a way geographically to hedge your bets a little bit too. You can have options in different locations and then pull those into play if there becomes a geographic shift. The migration numbers for 2020, we don’t have the final ones yet, but so far from what I’ve seen there are stronger than usual. There was definitely more migration this year. I’ve mentioned before, Rich Barton the CEO of Zillow has talked about this before, that this year unlocked mobility in a lot of ways for people, and that he sees that as an ongoing trend. I’m not sure how big a trend it will be, even anecdotally, I just heard about more people moving around this year trying out new places to live. I think the millennial generation in general tends to be more open to that and more interested in moving different places. You also have this factor, especially the millennials, as they’re growing up in their 20s, they love travel. I’m noticing as the millennials hit their early to mid 30s, they are starting to scale back on travel and they’re starting to think about putting that money towards the down payment. 2020 put that in overdrive, because nobody could travel. It really was that reset for a lot of people. That’s the factor that I find interesting here, is that there just is this emotional factor that is always present in residential real estate. It’s important to keep that in mind as well, that there is that desire for home that really manifest itself in 2020.
Jason Hall: Well, we’ve put down roots. I think that’s what happens is first of all, the backdrop from coming out of the global financial crisis, you have an entire generation that was put economically and financially behind any prior-generation in the past 60 or 70 years. Job opportunities dried up. It was just a tough periods. But what we’re seeing is just, it’s the same thing that every other generation does. It’s been delayed because of the economic implications of the prior recession. But people get married, they have families, they start to put down roots in their community. They find a place that they want to stay and they want to make it their home and part of that is owning a home. Here we are, it’s just happening later. Then you factor in the implications for the Homebuilders, not building homes over that period because of the reality of, there was already way too much inventory, and then this somewhat of a perception that this is a generation that maybe they’re not ever going to really get into homeownership in the same way. Now, hey guess what? Reversion to the mean, [LAUGHTER] so here we are full circle.
Deidre Woollard: Yeah. Five-years ago, everybody was talking about the millennials are generation rent. They’re never going to buy houses. It’s just not in their DNA. It’s not what they want. That never made any sense to me because no generation is profoundly that different from the other generation in terms of that cycle of life. The millennials just had more to deal with. Student loan debt, I think, has been a big part of that. One thing that may be interesting for this year is some of President Biden’s plans for housing, planning that $15,000 first-time homebuyer tax credit. That could be a huge incentive because that could help with the whole down payment thing. That may be big. There’s been some talk about forgiving certain amounts of student loan debt. That could also impact first-time homebuyers as well. You’ve got these other factors too, where you’ve got an administration that is also going to be focused on affordable housing, but on increasing homeownership in general.
Jason Hall: I think it will be interesting to play out. There need to be some sort of incentives. I think largely this is just going to be an economic supply and demand thing. We’re just so far behind on supply build and demand. There’s going to be ups and downs. Economic things happen, interest rates, those things will happen. There will be cyclicality, but I think the greater trend is still just supply and demand. There’s not enough supply and there’s enormous demand. I see some stuff in Q&A here. Don’t know if we want to spend two minutes on Q&A?
Deidre Woollard: Yes. Lets talk about that. I wanted to address this question from Tony about what happened to Homebuilders in 2009 and what risks if the Fed tightens policy or if we see inflation. I think that’s important. There are things to watch out for. There are things to watch up for like if interest rates spike up, which I don’t think either of us is thinking is going to happen this year or even next year. I think it’s going to be when interest rates rise, I think it’s going to be a very slow and cautious process. But there are other things. If we see existing home prices suddenly drop or the existing home inventory that I talked about earlier that suddenly spikes, there’s a couple of things that could happen that seem unlikely now, but if there’s anything that we’ve learned from last year, it’s never rule anything out.
Jason Hall: That’s exactly right. Just reminder for anybody that’s new to Fool Live or just tuned in, be sure to hop into Slido to get those questions to us. Sli.do in your web browser and event code MF Live. I want to address Tory’s right here at the top. Talk about home affordability and talk about increased defaults in the future. Tory says people strain home affordability, could that cause increased defaults in the future? Tory mentioned potentially like a 40-year mortgage. I don’t know if there’s really any appetite for a 40-year mortgage. But maybe. People are living longer. If regulator approves it, maybe that’s part of the answer. But I think at the end of the day, home affordability is you have a number of factors that come into play here. The biggest two are the cost of the property and interest rates. Those are the two big things right now. The fact that interest rates have absolutely plummeted, and it seems like the Fed’s mandate. I don’t anticipate this will change under a Biden administration, [NOISE] and whatever happens in Georgia and how that affects Congress, whether we have a split legislative body or we have Democrats running the whole show. I don’t think that’s going to affect low interest rates for an extended period of time, but I think in terms of answering the default question, I think that’s going to come down to whatever
the next economic downturn looks like. Nobody saw this being what it was. Nobody anticipated a once in a century pandemic causing the next recession. It wasn’t on anybody’s radar anymore than the last financial crisis was on very many people’s radar. The other part of this that I think is important is we’ve never seen this sort of economic stimulus provided, and the bottom line is that we still don’t know how the lenders are going to have been affected, because there’s still so much money being pumped into the economy that’s offsetting people’s ability to continue to afford to pay a mortgage. We don’t know. It’s probably going to be another year before we really know. But here’s the biggest question to me is whatever the next economic downturn is, how does the government respond at that time to support the economy? Has this changed the expectations that the government’s role is now to pour trillions of dollars into the economy to prop it up, or is a more natural, normal economic cycle going to be allowed to occur? I think that’s the biggest unknown right now. I think at the end of the day that’s more of a risk for banks than it is for Homebuilders. Homebuilders just have a great opportunity if they manage their balance sheets in any sort of responsible way and make sure that they are operating in good markets, the next decade should be fantastic for Homebuilders.
Deidre Woollard: Well, I feel like the other factor is that this one is just going to run differently than the last one for a few reasons. Sure, you’ve got forbearance right now, you’ve got some eviction and foreclosure moratoriums in place, and that’s a factor. But the other thing that happened during the great financial crisis that I think may play out for Homebuilders is during the great financial crisis, you had the creation of things like Invitation Homes and other single-family rental giants that now own 50, 60,000 rental properties. I would suspect that if Homebuilders do run into trouble, if they do have a home sitting there, they will probably be able to find a bunch of different ways to turn those homes into rentals or something like that. I don’t think we’re going to see a situation in which we see a massive amount of foreclosures sitting around. We also we have iBuyers, it’s just something we didn’t have in the last cycle. However the next cycle plays out, it’s going to be a very different ballgame than it was before.
Jason Hall: Yes, because the biggest things is the supply, there was just so much excess inventory last time around that we don’t have. Even if we do see a spate of foreclosures to your point, the market’s already ready to absorb them. Completely ready. That changes the dynamics completely. I see you Mr. Ann, by the way. Mabel’s saying, do you think valuations of Homebuilders and related stocks have reflected the housing shortage and low interest environment. This is a good chance for me to show a chart I have here. This shows some PE ratios, this your four PE ratios. The top one in purple, so you see the four PE ratio for the S&P 500, so for the next 12 months, it’s projected to be 39 times earnings. That is a historically high rate, it’s not the highest ever but it’s incredibly, incredibly high. Now, you look down at the bottom and I put a collection of Homebuilders. We have Lennar, ticker LEN, the Green Brick Partners, GRBK, so these are two opposite ends of the spectrum, Lennar one of the biggest.
Deidre Woollard: Yes, they’re very big and very small. [LAUGHTER]
Jason Hall: Very small, right, then you have Toll Brothers ticker TOL, and they focus more on custom and luxury homes, that’s their thing. Then you have LGI Homes ticker, LGIH, and Meritage Homes, ticker MTH, who both focused very much on entry-level. Well, Meritage is top 10, LGI is pretty close to top 10 if they’re not there yet, and then you have NVR, that’s a ticker NVR that is more of a Mid-Atlantic, but they’re the gold standard in a lot of ways. They were profitable back during the financial crisis, they’re really good at managing their balance sheet because they’ve been the big innovator with using options to manage almost all of their inventory. Anyway, you see all of these, and you see NVR is the only one that trades for more than 10 times projected forward earnings rates for almost 13 times earnings, and then these other guys are way, way, way, way down, in terms of the forward PE ratios, and that’s even after they all just absolutely crushed it last year. There’s a couple of things happening here. Number one, the PE ratios are low because analysts are projecting record years, for all of these guys because you look at every single one of them and they grew their order books by, I don’t know, I think the lowest I saw was NVR grew their order book by 40 percent. Some of these small guys grew like 60, 70 percent, so just these massive order build, those are firm orders for a house, the people can walk away from them, but I think even you back out that average of 15 percent order cancellation, these guys are primed to have absolutely massive, massive years, so what’s happening here? Investors are always looking forward, so they are expecting sure, 2021 might be a great year for Homebuilders. What’s 2022 going to be? What’s 2023 going to be, what’s going to happen this summer when things do return to normal, and now, people are going on vacations, and they’re traveling again, and they’re deciding, “Well but maybe I really don’t need to buy a new house?” There’s a lot of looking past those order books and expecting maybe the best is already baked into the stock prices, but it’s also a factor, again, the leverage and all of those things that normally make them less valued in terms of the multiple premium you see. But to me, here’s what it comes back to, it comes back to this big chart right here where you have just the huge growth in the US population and you have the least amount of existing family, single-family home inventory in history, and the largest number of first-time home-buyers in history, that’s to me. So I think for a Foolish investor who’s looking at a 5-10-year investment or longer, I think it’s a good idea to be looking at Homebuilders with the understanding that they are cyclical, they are leveraged and you need to pay more attention to them that you might to say Berkshire Hathaway, for example.
Deidre Woollard: Yeah, they definitely are going to change and a lot of the Homebuilders that you mentioned did have hit record highs especially over the last couple of months. You talked about Green Brick. Green Brick has just had an incredible run and part of that is because they are so small, their stock is very low-priced, and they’re positioning themselves right now, I think for a bigger run. I know you’ve been following them, you turned me onto them and one thing about them I feel like what they’re doing is very smart with how they have their partnerships with different builders in the locations that they’re not centered in.
Jason Hall: I think it’s a smart approach, and your leverage relationships instead of building enemies, I think this is a business because it is so competitive. It’s a smart way to make sure your positions effectively in as many markets as you can. I think it’d be good if you could. [inaudible 00:42:27] question here, I know there’s a lot of interest in learning more about Millionacres. The two premium services, Real Estate Winner, was it Real Estate Winners?
Deidre Woollard: Real Estate Winners. Yeah.
Jason Hall: Real Estate Winners and Mogul are great services. You want to give a pitch and explain what they are?
Deidre Woollard: Yeah, sure. Real Estate Winners is meant for people who are just dipping their tells a little bit into real estate. It recommends real estate investment trust reads obviously, Homebuilders.
Jason Hall: Publicly-traded, that’s the key in stocks.
Deidre Woollard: Publicly traded, real estate-related stocks, and real estate investment trust. As so, it’s accessible for anyone. Mogul i
s it’s a mix of things, so it includes some REIT and real estate stock recommendations, but it also includes individual crowdfunded real estate deals. So for that reason, it maybe more suited to people who are accredited investors. So that’s a little bit of a hurdle there. Also for Mogul, a lot of those individual crowdfunded real estate deals have a minimum, usually of $10,000 or more per deal, usually 25,000. In order to get the best advantage out of Mogul, you probably want to have a larger amount of money that you want to build your real estate portfolio. Whereas Real Estate Winners, you can start with as little as 1,000 or $1500 and build yourself a nice little publicly traded real estate portfolio.
Jason Hall: Yeah, and the other part too I think neat with Winners is the fact that most brokers now, you can buy fractional shares, [LAUGHTER] you have no trading fees. If you have $1,000 and you want to diversify it across 10 different REITs and Homebuilders, and other real estate-related companies, you could do it. You can spend $100 and invested in each one and build up that portfolio. I think it’s a really valuable service, and I think we would be remiss if we didn’t tip our caps to Matthew Argersinger.
Deidre Woollard: Matt Frankel.
Jason Hall: Matt Frankel, who were the lead advisor on those two services, and the wonderful work they do, and how smart they are, and having them in your back pocket is why you will join those services. That’s the best pitch I can give. [LAUGHTER] I have immense respect for both of them and they’re both very, very good and they have a very good track records of picking winning investments.
Deidre Woollard: Exactly, and they deliver that top 10 in Real Estate Winners, that is just such a great way to get started with real estate, and you’re absolutely right there. They’re so smart about real estate that they’re both investors themselves in REITs, of course, but also, in rental properties and things like that so they just have so much wisdom that they share on those services.
Jason Hall: I’m going to give a little plug for Matt, I can’t name any names yet, we’re finalizing the details right after this call, but Matt has a range for really, really special guests to come on The Wrap on Friday. Hopefully, this afternoon, we’ll be announcing it on Twitter but stay tuned.
Deidre Woollard: I’m curious.
Jason Hall: Very big name, not in real estate and not even specifically in finance, so we’ve got a really potentially big name that we’re just working out the details on after this, so stay tuned for that, I’m pretty excited about it actually, pretty excited.
Deidre Woollard: Awesome.
Jason Hall: Let’s see here. Go through this. Do you see any other questions in the Q&A before we talk about our favorite stocks?
Deidre Woollard: I think this question from James is interesting of, what else would cause a real estate crash? Are we going to see a real estate crash? I don’t think we are on the residential side, but I am worried on the commercial side. I think I’ve said this on fool live before is that I’m just watching a lot of what’s happening with hotels and retail to some extent not as much office. I am getting a little nervous about some of the potential for not necessarily a crash in commercial because I think commercial operates a differently in terms of lending of structures and things like that. You wouldn’t see the same type of crash that you saw with residential in the great financial crisis, but there’s definitely some pain in that sector.
Jason Hall: The thing you have to remember is that real estate is a really big umbrella with a lot of specialized categories underneath it. We’re talking about residential real estate now and specifically a lot about Homebuilders. Within commercial you have 100 different things. You think about industrial properties. I think industrial properties also have a great path ahead with the growth of e-commerce with the global supply chain crunch because of the coronavirus, or we could see more local manufacturing happen. I think office to me is probably the biggest question mark because it wouldn’t take a lot of big companies saying, “We’re not going to go to remote, but we want to have a hybrid model.” Let’s say, a company that has 100,000 employees says, we’re going to go to a hybrid model, we expect we’ll have 20 percent less employees on-site every single day. They’d be 20 percent less offices. Just boom, just like that. If a lot of companies switched to that model, it could create a scenario where there over the next and it doesn’t happen overnight. This is the thing that takes a few years to play out, where there’s a lot of office space that needs to get repurposed. I think that’s the biggest thing is seeing how that transition happens and how that property is repurposed is probably the thing I’m most interested in. It’s just so hard to predict a straight-up crash. That you could say that every time. Then something unexpected happens, and there’s a crash, but I think it would be more nuanced and specialized in a specific area of real estate. We’ll see how that plays out.
Deidre Woollard: Wait, I think economists like to keep predicting it the same way certainly with real estate. For about four years I kept hearing, this is the end of the cycle. We’re extra innings, last innings. [LAUGHTER] Now, who knows?
Jason Hall: We saw the same thing with the stock market boom too. You go on record, decade bull-run. Before you finally have a down year, and then you have the worst recession in history and then market gains 18 percent. [LAUGHTER] Short-term bets are always risky. That’s the thing. Predictions are fun but they’re not investable.
Deidre Woollard: Exactly.
Jason Hall: We got about 10 minutes left. We should probably talk about some stocks we like, what do you think?
Deidre Woollard: Absolutely. I put some of the tickers in the chat for people because I know a lot of people were looking for those.
Jason Hall: Go ahead. I’ll let you go first here. Talk about what you like.
Deidre Woollard: Well, I just want to mention Green Brick again and explain a little bit about what they are doing. Because I think it’s really interesting. I believe they’re mostly centered. I think they’re based at Plano, Texas; is that right?
Jason Hall: Right.
Deidre Woollard: They started off with Texas and then Florida and Georgia. I believe they have a partner in Colorado. They are much smaller. The price of the stock is so much lower per-share than some of the other builders. But I really think that this is one that is under the radar. I hadn’t really heard about them until you started talking about them. But then the more I look at what they’re doing, the more I like It.
Jason Hall: Well, market cap is still less than a billion dollars, right?
Deidre Woollard: Yeah, there maybe.
Jason Hall: LGI Homes’ market cap is up about 2.1 billion, so it’s more than double. Wait a minute. That’s revenue. That makes sense. Did less than a billion dollars in revenue. Now, let me look at market cap here. It’s probably about the same. It did get over $1 billion. So it’s $1.1 billion market cap, still tiny. LGI, 2.7 billion. As a comparison, Lennar, is a $23 billion company. NVR is about 15 billion. It is tiny, and here’s the thing. I think investors should be careful. I just want to stress this real quick. Don’t automatically say, well, Green Brick is going to be a $20 billion company in 10 years. That’s not fair because Homebuilders don’t just scale up like that. This isn’t Zoom, [LAUGHTER] where it gets those incremental margins.
Deidre Woollard: It’s a lot more difficult to scale up that quickly as a Homebuilder?
Jason Hall: It’s literally a picks and shovels company. They are using picks and shovels and backhoes and all that kind of stuff. There’s a lot of operating expense. One of
Lennar’s strength is because they are so big, they do get leverage. They get buying leverage, they buy lots of land. They do get benefits from their scale. But they’re not as readily apparent as they are in other industries. But they can be more nimble. I think that’s one of the things that’s really interesting about these smaller companies. What else you do you have?
Deidre Woollard: Do you want to talk about Meritage? I believe you wanted to talk about losing their CEO and what that means for the future.
Jason Hall: I think it’s really important. Meritage Homes has been a stock advisor recommendation for a very long time. One of the theses behind the recommendation was that it was led by the Founder, the CEO Steve Hilton who led the company obviously since it’s founding. He just announced he was retiring a couple of months ago. There’s a little under the radar. He’s not a big flashy guy. But he announced he was going to retire and he’s retired. Its important whenever you have somebody who is so instrumental in really every phase of a company’s history and led the company to enormous returns for investors. When they leave, I think you just have to pay a little bit more attention. The good news is that the company has a really good stable of executives already in place. Its board has been pretty stable, he has a steadying hand on the company. My expectation is that this is going to be steady as he goes. This is a company that already has a very clear goal, a really clear trajectory to focus on that. I think this might have been the first of the top 10 Homebuilders to explicitly state we’re going after starter homes. It’s been almost five years ago since they stated that goal. Then they immediately started buying properties based on developing starter properties. So they already have a path. It’s just a matter of having a steady hand on that radar to keep the company moving in that direction. I’m going to pay more attention over the next few quarters to hear what their CEO has to say, if there’s any major changes in language or performance. That’s the big thing. Do they continue to deliver? Are their returns being good? Do their margins continue to improve? Does the order book continue to grow? As long as the business continues to perform, there you go. That tells you what you need to now. It’s worth watching.
Deidre Woollard: Their earnings is coming out tail end of January. We’re just starting to see who Homebuild earnings. Lennar’s came out end of last month. They tend to run earlier. One of the things that I found interesting about looking at Lennar’s earnings, and one of the things they talk about is I mentioned build to rent earlier. I see that as housing affordability, it gets tighter and tighter. There’s a lot of people that still want to have is a single-family home, even if they have to rent it. I think we saw that a lot in COVID 19. We’ve talked about residential prices going up. But one thing that it has been interesting is the condo market has not been going up at the same rate. Condos are significantly lower, especially larger buildings, partly because of COVID 19. You’re seeing a lot of available inventory actually in condos in buildings, and you’re also seeing prices not going up quite as much. Single-family build-to-rent is one of the reasons that I like Lennar. The other reason that I like them too is they’re doing some interesting things because they are the biggest, because they are doing thousands of homes every year, they have the ability to test out new ideas. They’ve been testing things out like multi-generational homes, which I feel is going to be interesting, especially as baby boomers continue to age. Are we going to see more families buying a home that then has like an in-lock apartment? I think that’s one thing that I find interesting that some of these Homebuilders are doing.
Jason Hall: What is old becomes new again. This is a transition to something that was very normal, 50, 60, 70 years ago, 100 years ago and doing it again. Maybe that’s part of the answer to affordability.
Deidre Woollard: It absolutely is.
Jason Hall: You have an aging family member, a parent who is ready to downsize. You have a young family. Affordability is an issue. Aging family member downsizes. All over sudden you have cash to buy a house and make it affordable. It will be interesting to see how that plays out. It really, really will. I think probably the one thing I just want to leave everybody with is, I want to highlight the bigger trend that we talked about. That to me I think it’s still really under the radar because there’s so much focus on affordability, which is a real problem. I think it’s a generational issue because there are so many people on the margins that buying a home is not even remotely possible. But as an investor, you look at that big trend, the convergence between existing home prices and new home prices that are squeezing together as that inventory of existing properties continues to fall. Then you have this massive generational shifts to the largest number of new home buyers in history with the least amount of inventory. It sets up Homebuilders that know how to operate and that have a track record of executing, to have a great decade. With the caveat that there will be bad years, there will be bad quarters. Every year is not going to look like 2020. You have to be prepared to ride that volatility out and think about how you want to invest and how you want to risk your capital.
