US House Prices: Are Homebuilder Stocks (ETF: XHB) Still A Buy?!
Against expectations, the US is building fewer new homes than expected this year. This deficit is occurring despite the housing market being red hot from coast to coast.
Why is this happening? And does it change our thesis around owning US homebuilders?
(Answer: no)
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It has been awhile since we have written on US housing. Likely too long.
We made a series of arguments this summer that high demand, a serious housing deficit (2-3 million homes) from a decade of under-building and historically and unusually low interest rates were fueling an epic new rise in the US residential property market.
You can find them here and here if you are a new subscriber.
Recently, we have had some pretty important data around US housing recently and it seems like an opportune time for an update.
Two big data points:
US house prices continued to rise in August. The Case-Shiller Index for 20 large cities rose 19.7% on annual basis, though there are finally signs that the pace of price appreciation may be cooling.
Meanwhile US housing starts fell 1.6% last month, dropping to a 12-month low.
So, demand may be moderating but it continues to outstrip supply and supply is not rising to meet the hot market for homes.
This suggests that prices will stay elevated for longer.
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But it is also very unusual.
This lack of new supply isn't how markets should work. Homebuilders should be furiously trying to capture these high prices with new builds and strike while the market is hot etc.
What gives?
The short answer, and it is tiresomely familiar, is that home builders are struggling to construct more homes because they are unable to find the raw materials and labor force necessary to meet the demand.
If you can't find the wood and granite and tile to say nothing of skilled workers, then there can be no new houses.
So supply is down not because of a lack of will but because of supply constraints.
What does this mean for homebuilders and homebuilding ETFs like XHB?
Well, fewer housing starts will mean fewer sales and revenues.
But it also means that they will be selling those homes for higher prices due to the serious lack of supply.
As a result, XHB continues to do well. It is up 35% this year, easily outpacing the S&P 500 and is just short of its high for the year.
The reason?
Well those that are successfully completing new houses are making more profit per house.
So, fewer sales but more profit per sale.
The constrained supply, though unintentional perhaps, is helping US home builder profit margins.
We see a similar dynamic in the US oil exploration and production companies. The large amount of demand is not being met with increased supply of crude.
In the case of the oil companies, the financial markets are enforcing discipline and keep additional supply muted. In the case of the homebuilders, it is labor market and lack of materials holding them back.
It all adds up to a whole lot of people looking at not enough homes. I believe this is what real estate agents call a seller's market.
What to watch?
The big trend to monitor here is US mortgage rates.
The rate for the average 30-year fixed rate reached 3.14% this week and it has been steadily rising for the last few months as the Fed indicates it will be pulling back its support and getting ready to raise rates.
If these rates continue to rise at a quick clip then they will start to hamper demand sooner rather than later. More and more people will simply be unable to afford a house at a far higher level.
For now, rates are barely above historic all-time lows. When we last wrote about housing in July the rate had just crept above 3% and it has stayed suppressed even though inflation has been high and the Fed has clearly signaled it is changing its policies.
Longer term, there are other interesting developments that could eventually make US housing more innovative and productive.
For instance, it is cool to watch the housing industry start to respond to the lack of workers by coming up with new directions to save on labor costs and supply. There have been plenty of headlines recently around plans for 3D printed homes being built by gigantic 3D printers in places like Austin, Texas which is just flat out cool.
Could this be the solution for the long term US housing structural deficit and affordability problem? Maybe not in 2021 or even 2022 but the remainder of the decade?
Some charts:
US Housing starts falling steadily:
US Housing starts falling month over month:
US Case Shiller 20 city home prices. Some slight (very slight!) moderation:
3D Home "printed" in Austin by Icon:
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