David Evanson and Oliver Pursche
Minyanville.com, Winter, 2013
Tuesday’s October New Home Sales report generally confirmed that the housing market is improving. October sales followed a sharp rise in September (Sept. = up 5.7% to 389,000). The September and October reports also show that supply is very tight and actually is limiting sales. The improvements in the housing data, coupled with the delay of implementation of the Basel III rules – which would lower the value of real estate assets as bank capital – is good news for the sector. Home prices and home sales are now at a two-year high.
But investors are wise to be cautious, especially when it comes to investing in homebuilder stocks, which as a group, have already gained over 60% in the past 12 months. DR Horton (NYSE:DHI) underwhelmed investors with its latest earnings report. Toll Brothers (NYSE:TOL) warned of “bumps” ahead.
According to Bloomberg, as of September, foreclosure inventories continue to remain near record highs, with almost 4.1% of all active mortgages delinquent, although serious delinquencies (over 90 days) have been dropping. Moreover, Corelogic (NYSE:CLGX), a provider of consumer, financial and property information, reported that “the reduction in foreclosure volumes is to some degree being facilitated by the rising popularity of alternative resolution methods, such as short sales and loan modification,” said CoreLogic CEO Anand Nallathambi.
Politics will also play a role in housing. As senators and congresspeople negotiate a compromise deal on the fiscal cliff that will (somehow) cut spending and raise taxes, formerly sacrosanct deductions could be at risk, specifically, the allowable mortgage interest deduction. The Romney/Ryan team suggested just that: a $25,000 cap on mortgage interest deduction. At 4.5% interest, mortgages over $550,000 could be at risk, a big number, yes, but the inclusion of home equity lines of credit, and interest paid on second homes, could reduce it quickly, and could provide quite a headwind to the real estate market.
From my point of view and against all odds, the homebuilders have had their run, and there are better opportunities to be found.
One of the cardinal rules of successful investing is to focus on facts and not on how you feel. Accordingly, I can’t ignore the improving housing and broader economic data. There’s an opportunity there, it’s just not among the homebuilders, but rather, in my view, the home improvement sector. Specifically, Lowes Corp (NYSE:LOW) and Home Depot (NYSE:HD) — the latter of which just reported better-than-expected earnings — are growing at an impressive rate, pay a 1.8% dividend each, and in the current politically muddled environment, could be the most direct beneficiaries of continued improvement in the housing market.
The consensus forecast on compound annual earnings per share growth for Lowes, starting in 2013 and forecasting to 2016 is 20.5%. For Home Depot, the consensus forecast for the same period is 14.5%. Interestingly, and germane to my point, there are no three year forecasts (to 2016) for any of the major homebuilders.
(Sources: Case Shiller Home Index, Basel III Capital Rules Requirements, Basel III Timeline Implementation, Housing foreclosure info / CoreLogic.)