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Bullish on Home Builders

By Linda McDonough on September 28, 2016

With several home builder-related stocks in the Profit Catalyst Alert and Growth Stock Strategist portfolios, my heart sank with the latest release of housing data from the Census Bureau.

The data for August showed declines across the board. Existing home sales, new home starts and building permits all dropped below July estimates. After mopping the sweat from my brow, I started digging through the details.

Buried in the press releases from the government agencies were positive trends for single-family homes. Construction on single units generates much higher profits for the stocks that I follow. As I connected the dots in these press releases, the picture that emerged mirrored my bullish thesis on homebuilder suppliers.

Home-building stocks initially sold off on the dramatic headline, but making money in the stock market requires more than a cursory glance at the headlines, which rarely tell the whole story. This month’s data on home-building trends was no different. Those devilish details delivered some positive news for home builders and the companies that supply them.

Most companies that supply parts to home builders note that sales of products destined for single-family homes carry higher profits than those for apartment or multiple-unit buildings. This makes sense. Most buyers of single-family homes plan on living there for some time and are willing to pay more for higher-quality doors, windows and fixtures. Landlords building apartments for rent are more interested in keeping their construction costs as low as possible by using commodity parts.

Singles Shine

Building permits pulled for single-family homes rose 3.7% from the previous month, in contrast to the headline report of a 0.4% overall decline, which included a dramatic drop in multiple-unit dwellings.  Single-family permits are up 8% for the first eight months of the year. Pulling a permit is the first step to building a home and a strong indicator of future homebuilder demand.

Another disappointing headline was the one describing a 5.8% drop in August building starts. The single-family number was slightly worse than the group but was primarily due to a dramatic 15% decline for home starts in the South, a region plagued recently by flooding. The home starts number is notoriously volatile and quite sensitive to weather patterns. It is likely the August decline is just a pause before housing starts catch up to permits pulled. Year-to-date, starts on new single-family homes are up 9%, a sign of robust demand for housing parts.

Supply Tightens

Existing home sales data requires more detective work to decipher the underlying trends for homes. The headline announced a 1% drop in the annualized number of existing homes sold. One might wonder how the housing market can be so strong if the number of units sold is not increasing. The issue is low inventory of existing homes, leaving frustrated buyers empty-handed. Home builders will continue to expand the number of units they are building to satisfy this unfulfilled demand.

The inventory of homes on the market is 10% lower than last year and has declined every month for over a year. The average property was on the market for just 36 days, down from 47 days in 2015. Prices rose 5% as frustrated buyers quickly snapped up homes just after they were listed.

Ralph McLaughlin, an economist at real estate website Trulia, thinks the trend “reflects a healthy combination of home builder confidence and sustained demand for homes during a time of solid job and income growth.” Although the building boom is a welcome relief for home buyers stymied by low inventory, McLaughlin says, “home builders still have a long way to go to meet historical norms.”

That’s music to my ears. As home builders sharpen their shovels, I’ll be doing my own digging, pulling apart the details buried beneath the headlines to make sure my picks are on track for growth.

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