Every spring, the same headline flashes across the screen: "The housing sector is perking up and it's time to buy." As time passed, the newfound momentum invariably petered out, leading to the follow-up refrain "wait 'til next year."
Make no mistake: it's still a sickly sector. The fact that shares of many major players are already up solidly from their lows means that housing stocks hold little appeal to value investors. But for growth-oriented investors, these stocks may be shaping up to be one of the better opportunities of the next 24-36 months.
Such a bargain
Many Americans have opted to rent rather than own their homes, but that could change quickly if the economy gets a bit stronger in the next year or two. That's because homes have not been this good a deal since 1970. That's the last time the National Association of Realtors' Housing Affordability Index surged above 200. In the first quarter of 2012, it hit 205.9.
Low inventories create scarcity
One thing is for sure: there are a lot fewer existing homes for sale in almost every major market. According to housingtracker.com, the number of listings in the country's 20 largest metropolitan areas fell roughly 25% in the 12 months ended March, led by drops of 40% or more in Phoenix, Sacramento, Calif., and Tampa, Fla. Meanwhile, falling inventories appear to be spurring consumers into action: the markets that have had the greatest glut of unsold existing homes in the past are now showing some of the greatest gains. From March 2011 to March 2012, sales of existing homes shot up 35% in Phoenix, 16% in Denver, 15% in Miami and 11% in Dallas. On a nationwide basis, home sales rose another 3.4% sequentially in April, on a seasonally-adjusted basis.
As the supply of existing homes falls, home builders are in a better position to lure in buyers to get a closer look at newly-built homes. It helps that home builders have shown a lot of restraint in the past few years, keeping construction activity at a low boil. Even as demand for new homes has been weak, the supply has been even weaker. From March, 2011 to March 2012, the supply of new homes for sale by the nation's 25 largest homebuilders fell 28%. And the low inventory has finally helped spur price increases in certain markets.
For example, on recent conference calls, Ryland Group (NYSEW: RYL) said that prices have been boosted in 25% of the 200 housing communities it serves. PulteGroup (NYSE: PHM) said it has stopped discounting homes to expedite sales, and Meritage Homes (NYSE: MTH) has pushed through price increases on roughly two-thirds of its available homes.
The long climb back for prices
Housing prices have fallen so sharply in the last half-decade that it could take many years to return to previous peaks (and even longer to return to inflation-adjusted levels). If history is any guide, then housing prices will only slowly creep up during the next few years, and it will be the middle of the decade before more robust pricing gains will be seen. Analysts at Guggenheim Partners expect home prices to rise just 3% this year and again in 2013.
Yet even that modest figure can help profit margins for home builders. Coupled with forecasts of 15% more new homes being sold this year, analysts at Guggenheim anticipate revenue for publicly-traded home builders to rise nearly 20% this year -- and in many instances, even greater profit growth.
Lastly, it's unclear how the glut of foreclosed homes will affect the market once banks have worked through their current set of legal challenges and put homes up for sale. Currently, banks appear to be working more closely with homeowners, adjusting loans to keep them in their homes, which may limit any future foreclosure-related glut. Importantly, the number of homes going into foreclosure is now falling rapidly, as April 2012 figures represent a five-year low.
Valuations: taking it on faith
For investors, waiting around to value plays in housing stocks may be futile. These stocks are up sharply from their 52-week lows and won't look like bargains based on near-term results. Instead, investors will need to believe that 2012 and 2013 results are just the start of even better days to come as we head into the middle of the decade.
Guggenheim Partners, for example, recently upgraded many stocks with new price targets that reflect P/E (price-to-earnings) ratios of around 25 times projected 2013 profits. They see shares of D.R. Horton (NYSE: DHI) rising from a recent $17 to $27 by that math. They also say Lennar (NYSE: LEN) could rise from the current $28 to $37, and predict Ryland Group could rise from $23 to $34.
Goldman Sachs recommends MDC Holdings (NYSE: MDC), which has 30% upside to its $36 price target. It notes MDC is seeing solid demand in its markets, sports a very strong balance sheet, and offers an attractive 3.5% dividend yield.
Analysts at UBS prefer Beazer Homes (NYSE: BZH), spotting more than 100% upside to their $5.50 price target. They say Beazer has the makings of a solid turnaround under new CEO Allan Merrill, who took the reins a year ago. Their target price implies a move up to just 1.1 times book value.
Risks to Consider: Further gains in housing will be tied to employment trends. The economy likely needs to create an average of 150,000 jobs a month in order to provide a tailwind to housing. This Friday's monthly employment report should be closely watched by investors who are interested in home building stocks.
Action to Take --> These stocks are best pursued with 1-2 year time horizons because their outperformance relative to the S&P 500 thus far in 2012 makes them vulnerable to profit-taking if the market slumps further. Despite recent gains, sector share prices don't begin to reflect the profit potential of these companies if housing demand is truly solid by mid-decade. The housing stocks I mentioned earlier should all be on your watchlist.