“Lack of resale inventory combined with strong consumer demand continues to boost single-family home building.”
- Chuck Fowke, National Association of Homebuilders (NAHB) Chairman
At the moment, there is a historic opportunity available in the homebuilding sector, since 2014, there has been a significant undersupply of housing, offering homebuilders a great opportunity for profit as they take advantage of this deficit. As the shortage continues through the current, uncertain economy, this sector will see much more safety and security of investment than most others.
Historically, the United States population has grown constantly and consistently on an annual basis. According to Census data, the total number of households increases, on average, by about 1.2 million per year. Additionally, over the course of 2021, the most recent full year of Census data, total households increased by almost 1.5 million, or 1.15%, as the market recovered from the Covid-19 pandemic. This means that, in theory, there must be 1.5 million more homes on the market to ensure a place for everyone to live, representing the demand in the housing market.
With the new needs of consumers in the housing market, homebuilders cannot meet the demand with housing starts. Inventory, the number of vacant housing units for sale on the market, hit an all-time low in November of 2021, as seen in the graph below. This means there are few options for homebuyers to choose from, increasing the need for new homes. Annual privately-owned housing starts have exceeded their historical average since 1959 of around 1.4 million. The current levels sit just above 1.7 million annual housing starts, yet homebuilders still can not meet demand.
Even with all of these new homes being started and added to the market, the new supply and existing inventory still cannot handle the influx of demand. Since the credit crisis, housing inventory has steadily decreased. In contrast, housing starts have steadily increased, illustrating that housing demand has outpaced supply. This has left a large gap to fill for homebuilders as they work to build enough homes to keep up with the growing demand.
Additionally, it will be hard for homebuilders to bridge this gap. The construction industry is short of 650,000 workers, according to a model that the Associated Builders and Contractors developed. Also stemming from the backlog caused by increased housing demand is a material shortage. A statistic provided by the National Association of Homebuilders stated that 90% of homebuilders reported materials shortages and delays in sourcing the materials. Therefore, due to the mere cost and shortage of both materials and labor, the timeframe for completing a new house has increased.
Surge in Home Prices:
Lack of supply has compounded into home prices increasing tremendously over the past few years. It is simply within the dynamics of supply and demand - prices rise when supply is low, and demand is high. Housing demand has reached a level where buyers are competitive, increasing the average home sale price due to bidding wars. The current median home price is not far off from the all-time highs of $411,200 recorded in the third quarter of 2021. With inventory at an all-time low and sales for new and existing homes at levels only seen before the credit crisis. The rising prices are bound to continue till we reach a normalized housing supply.
The Housing Cycle:
Just as the broader economy follows a business cycle with expansions and contractions, the housing market has its own cycle. The early 2010s marked the start of the recovery phase for the housing market after the credit crisis and giant housing bubble. New home construction slowed down in this period as the market absorbed the oversupply from the credit crisis.
From that time until the present, there has been a slow expansionary phase as housing vacancies have declined and the construction of new homes has been steadily increasing. With the record low levels of inventory and the inability of housing starts to meet the increasing demand, the expansionary phase likely continues for the foreseeable future. Especially with the added difficulties of the supply chain and inflation, homebuilders still have much work to do to catch up.
The Homebuilding Sector's Undervaluation:
Houses are being bought at a rate where new homes cannot be built fast enough. Even with all of this happening, the relative valuation of the homebuilder sector remains very cheap compared to historical averages. The average homebuilder is only worth 6x earnings right now, well below the historical average since 2005 of the low teens.
With the current high demand for housing and a 5-year projected earnings growth of the high teens, it is safe to say that there is much room for the sector to grow over the next couple of years. In addition, the industry has a return on invested capital (ROIC) of the mid-to-high teens, which is how well a firm allocates capital to generate profits. This is well above the broader market average of about 10-12%, showing homebuilders' high levels of profitability.
Possible Risk Factors to Homebuilder Growth:
Given the aforementioned statistics, some are still worried about the demand retreating due to rising rates. With most Federal Open Market Committee members expecting rates to stay below 2% in 2022, it will take more than that to deter new mortgages. Rates are still low enough to buy a new home with a 30-year mortgage comfortably. Despite the rate hikes this year, the demand in the housing sector stays strong.
Why We Think This is a Great Opportunity:
With all of these factors considered, it can be seen why the housing market is likely to continue its boom. High demand remains constant as very few homes are left on the market, and homebuilders struggle to construct enough new homes. While the boom may not be as drastic as in late 2020 and 2021, housing prices will continue to rise steadily. It is hard to predict by how much or for how long these conditions will continue, and supply-demand dynamics should always be considered locally on a state-to-state basis. However, it is safe to say that the current environment still offers much room for profit in the real estate market at large; Another 2-3 years of solid home prices makes the homebuilding sector a very attractive place to be for investors.
By: Siddharth Singhai
This White Paper expresses the views of the author as of the date indicated and such views are subject to change without notice. Ironhold Capital has no duty or obligation to update the information contained herein. Further, Ironhold makes no representation, and it should not be assumed that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.
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