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JakilaTheHun (99.93)

Time to Get Bullish on Homebuilders: A Look at Pulte

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December 16, 2010 – Comments (25) | RELATED TICKERS: PHM , DHI , TOL

There’s no sector that people have remained more terrified of over the past few years than homebuilders. In fact, even if you bought in at the March ’09 market lows, you would still have a negative return on Pulte (-11%) (PHM) and a mere 4% return on MDC Holdings (MDC). While some other homebuilders have fared a bit better, much of those gains can be attributed to the market realization that certain builders were solvent and could survive, rather than bullish prospects on the general housing market. Yet, I believe that the sector is now attractive for long-term investors.

In early ’09, I was bullish on palladium/platinum miners North American Palladium (PAL) and Stillwater Mining (SWC). My rationale for buying was that the prices were so absurdly low, that even if it took the industry an entire decade to rebound, it would still be worthwhile to buy in. Over the past 2 years, the stocks have returned about 300% - 500%, depending on when you bought in and which of the two you chose to buy. That’s a very spectacular return for 2 years, but even if it had taken 10 years, a 400% return over 10 years would have yielded a very respectable annualized return of 17.5%!

Make no mistake about it - homebuilders in late ’10 are not as attractive as palladium miners in early ’09. In fact, the opportunities that came along in ’09 will likely be rare in the future. All the same, the risk/reward balance for the homebuilder stocks is very favorable. My own estimations suggest that in a normalized environment, many of the homebuilders should be selling at prices 100% - 400% higher than they currently sell.

Things have looked dismal for homebuilders over past few years and the housing market is not going to dramatically rebound in a year or two the way the palladium miners did. But given the current state of the market, I feel that even if I have to wait 5 years for a homebuilder stock to pay off, that this may very well be worthwhile. My favorite homebuilder over the past month has been Pulte; but before I look at that, let's explore the more generalized thesis in favor of the homebuilders. 

 

The Case for Public Homebuilders

The biggest problem for the public homebuilders right now is fixed costs. There are economies of scale involved with the large homebuilding operations and all the large builders need a certain amount of volume in order to break-even. As housing starts improve, we will see homebuilders start to profit again. Of course, the big question is “when will housing starts improve?” 2 years? 5 years? 10 years? No one really knows.

The figure below examines housing starts, population growth, and “housing starts per person” over the past 31 years:

View Seeking Alpha version for larger figures

The first thing that should immediately stand out is that aside from the past three years, we have never even come close to being at the low levels we are right now. The low-points before the current crisis were 1981 (1.8 M starts), 1982 (1.06 M starts), and 1991 (1.01 M starts). In spite of the US population base being approximately 25% higher than it was in 1991, we now have about half as many housing starts as we did in those depressed environments. That should tell you just how extremely depressed the housing market is right now.

The next interesting thing on this table is the average housing starts. Average housing starts were about 1.450 million. That’s about a 170% increase over the current levels. This figure should theoretically be weighted down by the lower population levels in the earlier years, as well.

Finally, the last column is the most interesting one to me. That column represents “starts per person.” The 31-year average is 0.0056 starts per person. Over the past two years, we have been around 0.0017 starts per person. We would need to see the number increase about 230% to reach the average. If you apply the average ratio to the current population, we come up with an expected “normalized” starts of about 1.725 million, well above the current level of 540,000 starts.

While we undoubtedly have a lot of excess supply in the market and there are still numerous foreclosures working their way through the system, the basic takeaways from this data is that we are far, far away from normalized production and once we reach more “normalized” levels, the number of houses needed is going to be dramatically higher.

It’s based on this premise that I believe the public homebuilders may be a very good long-term investment. Even if housing starts were merely to double over the next three years (still leaving us at semi-depressed levels), the public homebuilders could reap major benefits.

The pain of the private homebuilders could also mean major gains for the public homebuilders. The public homebuilders have certainly suffered significantly over the past few years, but by and large, the group has remained solvent. Contrast that to private builders, where we’ve seen huge numbers of bankruptcies. For this reason, the publics could see major market share gains over the decade, meaning that prior levels of profitability in the boom are not necessarily out of reach even in an average market.

It’s for all these reasons that I am so intrigued by the public homebuilders. While I believe numerous builders will see significant gains over the next half decade, I have particularly liked Pulte over the past month.

Pulte

Pulte is the US’s largest homebuilder. In 2009, Pulte completed the acquisition of competing public homebuilder, Centex. Pulte also has a small financial services arm that engages in mortgage lending.

Pulte participates in a diverse mix of building activities. Like most homebuilders, it does build single-family homes with a primarily suburban emphasis. It also constructs condominium and townhouse communities. Recently, Pulte has started a few interesting projects with more mixed use and New Urban designs; we can see examples of this with new communities like Potomac Yard in Alexandria, VA, and Metro West in Fairfax, VA.

The primary reasons why I have favored Pulte recently are that I like its focus (less oriented toward deep suburban areas than competitors), recent New Urban projects, and valuation. The last part is very key, though, because Pulte, in particular, has been punished over the past two months. After PHM's earnings release in mid-October, the stock dropped from $8.20 to about $6.15 (a 25% decline), before pushing back up to $7.00. The drop came on no major news, aside from a major goodwill write-down in the earnings release. This should have been a non-event for investors.

With that basic thesis out of the way, let’s take a look at the financials for Pulte.

Balance Sheet

First off, I should note that all my data relating to Pulte is from after the 2nd Quarter results. While 3rd Quarter results have been released, I originally conducted my analysis in late September and have become more bullish as I saw the prices drop further. The 3rd Quarter data would not appear to significantly change any of my information.

 

With that said, Pulte’s simplified balance sheet is posted below:

View Seeking Alpha version for larger figures

About 28% of Pulte’s total assets are in cash, which tells you that this company has a major amount of dough to pump into the market if its business picks up. Net tangible assets (NTA) for Pulte were about $5.75 per share after the 2nd Quarter. I view NTA as a “floor” for PHM, because its competitive position within the homebuilding industry should always give it a premium. If the price for PHM’s stock were to fall below the NTAs, I would be extremely bullish. Note that it came fairly close, as it dipped all the way down to $6.15 very recently.

Geographical Distribution

With the acquisition of Centex, there’s no doubt that Pulte is a national brand. The following table gives Pulte’s geographic breakdown of revenues for the past three years.

View Seeking Alpha version for larger figures

 

Income Statements

It’s very rare for me to give more than a cursory glance over 10-year-old income statements. However, due to the extraordinarily depressed levels of the current housing market, combined with the housing bubble that preceded this period, I wanted to look back as far as I could in order to try to get a greater sense of normalized production and margins. Here are income statements and ratios for the past 16 ½ years.

View Seeking Alpha version for larger figures

Note that PHM changed the structure of its income statement during this period, which is why my gross margin calculations might seem a bit confusing. The margins are calculated two different ways for all years after 1999. Pulte originally calculated SG&A with “cost of revenues,” but moved it down the income statement into operating costs after 2007. Therefore, I calculate gross margins both with and without SG&A post 1999.

Revenues, Margins, Units Sold, and Average Price

Finally, the chart below attempts to piece together revenues, margins, average prices, and units sold.

View Seeking Alpha version for larger figures

Keep in mind, once again, that margin figures might not be analogous.

Piecing Together the Earnings Picture

With all the data above, I have tried to piece together the earnings picture for Pulte in a less depressed environment. I have used gross margins (w/o SG&A) as my starting point and looked at how the potential earnings picture would change with a specified margin level given a changing number of units sold for Pulte. For instance, in the first chart, I use a 10% gross margin. If you look at the first row, you can see that if Pulte sells 25,000 units, it loses 33 cents per share. If it sells 35,000 units, it will earn 7 cents per share.

All the figures for these projections are annual. I examine gross margins all the way from 10% - 20%. While I have included a 10%, 12%, and 14%, I view these as somewhat unlikely projections outside of a depressed environment, and view gross margins from 16% - 20% as more realistic.

Here are all the scenarios:

View Seeking Alpha version for larger figures

 

Analysis

Currently, Pulte is selling about 15,000 – 17,000 units annually. Based on the historic housing starts figure, it seems likely that starts will at least increase to 1.0 million again at some point in the next five years. So even if we assume a 16% gross margin and 27,500 units sold for PHM that gives us potential earnings of 85 cents per share. Even with a low earnings multiple of 12, that could suggest that PHM would be worth $10.20, or a bit more than 40% above where it’s trading at now. This seems like a fairly conservative scenario.

Moving up to an 18% gross margin and 30,000 units sold, we come up with earnings of about $1.44 per share. With a P/E multiple of 14, that gives us a valuation of about $20, which is about a 190% increase over the current share price.

While my tables only go up to 40,000 units sold for PHM, if we get even more aggressive and assume that my normalized production figure from earlier is correct, that would imply that housing starts need to triple. If PHM also saw its units sold triple to about 45,000 units and was able to make an 18% margin, that could imply earnings upwards of $2.75 per share! With a P/E multiple of 15, it would be possible for PHM to be selling as high as $40.

Even going back to the more conservative 16% gross margins and 30,000 units, PHM could potentially earn around $1.00 per share. That’s still fairly conservative and could imply that the company could trade at around $15 at some point.

While I do believe that PHM has significant odds of earning over $2 per share again sometime in the next decade, for now, I will go with the semi-conservative outlook of 18% margins and 30,000 units sold, yielding an expected valuation of $20. If we see the housing market rebound faster than expected, this would be an added bonus. Even if the housing market stalls for another 5-10 years, I still believe that this investment could see some decent (but more subdued) gains of around 50% - 75%.

Conclusion

I like investing with a margin of safety. Pulte does not meet my traditional definition of “margin of safety,” which is a company selling below NTAs minus write-downs to susceptible asset accounts. However, with PHM, you really have to consider its competitive position in the market and cash flow potential based on that. Based on that, I believe that at $7, PHM has a reasonable margin of safety for long-term investors.

Pulte (and many other builders) might be very undervalued right now if you believe that housing will even semi-rebound over the next half decade. Even if housing starts were to double, we would still be at relatively depressed levels, and PHM could be earning $0.50 - $1.00+ per share in that environment. If we were to see normalized levels again, PHM could be earning $1.50 - $3.00 per share.

Given this, I believe it's worthwhile strategy to buy into the builders and sit and wait. For long-term investors with patience, the builders could turn out to be quite a good buy.

I initiated a position in Pulte under $8.50 and accelerated my buying as it dipped below $6.75. It is now one of my larger positions.

Disclosure: Author long PHM, TOL and DHI

25 Comments – Post Your Own

#1) On December 16, 2010 at 6:47 PM, JakilaTheHun (99.93) wrote:

P.S. Shout out to FB, who knows vastly more about the homebuilders than I ever will, and could probably even pinpoint some flaws in my reasoning!  But even if I'm not an expert on the industry, I do like the valuations and future outlook for the homebuilders, all the same.

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#2) On December 16, 2010 at 8:35 PM, MKArch (99.72) wrote:

Outstanding Jakila and I swear I didn't see this until after I posted my LEN pitch. You obviously put more time in than I did and make a more articulate argument. Maybe I'm missing something but I think I'm a little more bullish on potential market share gains for the public builders than you are. LEN's revenues were up ~350% from 00-06 while home starts in general were only up ~33%. LEN's current revenues are about 50% of their 00 revenues while home starts are ~33% of what they were in 00. 

Home price appreciation from 00-06 could explain some of the difference between starts and LEN as well as the other large public builders revenue increases but it seems to me market share is what was the major driver. With the public builders buying up land now and financing in the next cycle flowing more to the survivers I think they will continue taking big time market share as the new home market normalizes and probably beyond that as well. I think the public builders only had mid teen market share in the bubble years.

 Mike

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#3) On December 16, 2010 at 10:03 PM, checklist34 (99.69) wrote:

rec, interesting, and I just posted related thoughts. 

your rating has well exceeded my own, I am pyoonished for over-a-year of laziness and sloth.  nice to see you so highly rated.

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#4) On December 17, 2010 at 3:11 AM, JakilaTheHun (99.93) wrote:

Checklist,


Of all the people here at CAPS, your opinion on investments is definitely near the top, alongside anticitrade and streetflame.  In all fairness, there really hasn't been much money to be made in the past 8 months. 

 

My rating has actually fallen for most of the year.   The main issue is that I continue to make gutsy calls, whereas most of the rest of the top 50 make cheap shot calls in order to game accuracy.  C'est la vie. 

I'd rather make calls that people can actually invest in and focus on absolute returns.  And maybe one of these days, I'll get a shot at being an Analyst at a hedge fund.  (Or maybe I have to go the David Einhorn route and find a way to fund my own firm for a few years.) 

 

In terms of absolute returns, I did very well from Nov '08 to May '10, then I started underperforming from May '10 till Nov '10; mostly due to my high concentration in bank stocks.  I'm OK with that, though, because I didn't lose much, I kept around quite a bit of cash, and lower prices mean I can jack up the returns more in the future.  I'd also say I'm happier with my portfolio now than I have been at any time this year; which I hope is a good sign. 

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#5) On December 17, 2010 at 4:33 AM, TMFRosetint (98.77) wrote:

Very nice post, Jakila. Pulte's not really my cup of tea when it comes to what I like to invest in (unfollowed companies with hidden assets + a catalyst) but this was a very well thought out pitch. There is a reason you're one of the top players in the game.

 Best wishes,

Scott

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#6) On December 17, 2010 at 6:07 AM, dwot (43.46) wrote:

Interesting post.  One of the things that I saw that I did not like is if you look home demographics what you find over the period that you are describing is a shrinking home size, the number of people per home is constantly declining.  So, that tells us that some of that "normalized" level of sales over that period is for something that isn't sustainable.  One thing that I am not sure about is how vacation homes get calculated/handled into that declining household size.

Then you also have population demographics to consider.  What is a reasonable age for people to have bought homes?  You have your baby boom ending in 64, and if you consider say age 30 having most people that are going to be home owners into a starter home, and certainly that was probably true before the massive housing bubbles, then you should see a decline in homeownership and the need for need homes starting in the 90s based on the age where people normally make a first home purchase.  I am make the assumption that a new home start is only necessary when a new person comes to the housing market.  

The other thing is that population is up about 20%, not 25% in the past 30 years.

One of the things that I found interesting about school demographics is that you have an explosion of children when a new suburb or development is built.  You have a lot of people of child bearing age moving into new housing developments.  Schools have a rough time keeping up with the population increases.  Then the school populations decline.  The parents do not move away, but they do stop having children, so then the school population tends to become stable at a much lower population then through the boom of the new housing developments.  This is true for any suburb in any big city where developers have tended to build.

The same kind of thing has to be happening in the need for new housing, although the population overall is up, I suspect the relative population to spur new housing is down because of the aging demographic population stats.  I am not so sure that the increase population is enough to outweigh this.

The other thing that I think will compete big time for housing is people increasing their home size population through the economic hard times by opening their homes to renters either through renting a room in their home or somehow putting in a suite, and that can drive prices for rents down, which also means that the cost for housing would need to decline to compete.  After the housing bubble I don't think people hold the same value for home ownership so affordability will be a stronger determinate to home ownership then in the past.

And then, if you are a deflationist, as I am, declining wages are going to affect people's ability to afford homes and it seems to me that that would squeeze margins.

 Just my thoughts...

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#7) On December 17, 2010 at 7:27 AM, JakilaTheHun (99.93) wrote:

One of the things that I saw that I did not like is if you look home demographics what you find over the period that you are describing is a shrinking home size, the number of people per home is constantly declining.  So, that tells us that some of that "normalized" level of sales over that period is for something that isn't sustainable.

Only if you assume that technological and productivity gains aren't resulting in increases in wealth.  I'm sure the average frontier home in the 1840s had some ridiculous number of occupants (more typical of third world countries today), but that doesn't mean we're going to revert back to 1840s frontier style households.

 

The other thing is that population is up about 20%, not 25% in the past 30 years.

Population is up 36% over the past 30 years.  It's up about 25% over the past 20 years.  This is fairly simple to calculate. 

1980 pop = 228.3

2010 pop =  310.9

You take the 2010 pop and divide it by the 1980 pop, then subtract 1 from the total, so ...

310.9 / 228.3 = 1.364 - 1 = .364 or 36.4%

The US population growth rate averages about 1% so the shortcut method is if you have a period of 20 years, it's probably something slightly above 20%.  For 30 years, slightly above 30%.  

 

 

Actually, for me, the bigger issue with these figures would be the Federal subsidies that might be driving a chunk of the housing sales.  That's the part that I question the sustainability of.  The economics behind smaller household sizes and greater demand make perfect sense; but Federal subsidies might artificially up the demand.  Still, even if this is the case, it doesn't necessarily mean we won't need many more homes 5 years from now than we are currently producing. 

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#8) On December 17, 2010 at 8:11 AM, portefeuille (99.61) wrote:

In all fairness, there really hasn't been much money to be made in the past 8 months.

My "fund" (see this post) is up by around 42% since March 8, 2010 (I am in the green by a little more (EMC call options helped "quite a bit". Some my current positions are shown here.). It has not been all that hard, hehe ...

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#9) On December 17, 2010 at 8:14 AM, Valyooo (99.35) wrote:

I know this is probably stupid and irrelevant...but how many homes can we build? With the whole green movement people are trying to get smaller housing, there's only so many houses you can build given the population and finite land, there's alread a lot of vacation houses, and timber prices are rising dramatically

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#10) On December 17, 2010 at 8:32 AM, JakilaTheHun (99.93) wrote:

My "fund" (see this post) is up by around 42% since March 8, 2010 (I am in the green by a little more (EMC call options helped "quite a bit". Some my current positions are shown here.). It has not been all that hard, hehe ...

About 50% of your portfolio is in one company, so of course it's not hard to outperform that way.  It's also not hard to lose a crapload of money that way, either.  That's the issue with that sort of strategy; it's extremely high risk.

Though, if you had to bet on only one company, EMC isn't a bad choice.  

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#11) On December 17, 2010 at 8:33 AM, JakilaTheHun (99.93) wrote:

I know this is probably stupid and irrelevant...but how many homes can we build? With the whole green movement people are trying to get smaller housing, there's only so many houses you can build given the population and finite land, there's alread a lot of vacation houses, and timber prices are rising dramatically

I'd say from a green perspective, we need more homes.  It's just that they need to be build in dense urban areas connected to mass transit systems, rather than deep suburbs.  Our inner cities are actually woefully underdeveloped in the US. 

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#12) On December 17, 2010 at 8:36 AM, portefeuille (99.61) wrote:

About 50% of your portfolio is in one company

It was for a very short time period very concentrated. A recent list of the larger positions is shown in comment #68 here. My "fund" (see this post) has always been "well diversified".

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#13) On December 17, 2010 at 1:56 PM, JaysRage (88.99) wrote:

I generally disagree that this housing is a buy low opportunity.   Here's why. 

1)  I think roughly 120% of the people that can afford a home currently have one.  

2)  Interest rates were recently at all-time lows, and they will only go up from here.  People that were able to afford houses had a great opportunity to do so.   The market is totally saturated.  

3)  When housing does recover, we're not going to be talking about the large houses that were being built at the peak of the market.   The same number of houses may be built, but they are going to be of the smaller and less profitable variety.   This, coupled with the high fixed costs of commodity wood...etc, is going to pinch profits for the foreseeable future. 

I do not think we will see a housing environment like the pre-boom for at least another 20 years.  

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#14) On December 17, 2010 at 2:06 PM, JaysRage (88.99) wrote:

Actually, for me, the bigger issue with these figures would be the Federal subsidies that might be driving a chunk of the housing sales.  That's the part that I question the sustainability of.  The economics behind smaller household sizes and greater demand make perfect sense; but Federal subsidies might artificially up the demand.  Still, even if this is the case, it doesn't necessarily mean we won't need many more homes 5 years from now than we are currently producing. 

Yep.   Fannie Mae and Freddie Mac are artificially keeping mortgate rates deflated currently.   If these two demons ever get privatized, interest rates will pop several percentage points in order for banks to take on the risk at normalized risk/reward profitability ratios, taking the air out of any recovery that could have happened.  Any bet on housing is betting that the government can continue to subsidize indefinitely by continually taking the housing losses public.   I don't like being dependent on such a situation. 

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#15) On December 17, 2010 at 2:08 PM, JaysRage (88.99) wrote:

By the way -- this is a great thread.   Just because I disagree, doesn't mean that I don't appreciate the analysis that went into the discussion.  

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#16) On December 17, 2010 at 3:28 PM, TheDumbMoney (37.82) wrote:

Wonderful thread with so many smart people, I'm embarrassed even to post on it.  I'm responding to this from the original post:

"While we undoubtedly have a lot of excess supply in the market and there are still numerous foreclosures working their way through the system, the basic takeaways from this data is that we are far, far away from normalized production and once we reach more “normalized” levels, the number of houses needed is going to be dramatically higher."

Other than that paragraph, this is an excellent post.  I think the thought is probably correct, but if this is such a large real money position you really should quantify this as rigorously as you quantified everything else in this post.  The true housing bears look only at the huge foreclosure/supply overhand.  The true bulls look only at depressed construction and demographics.   Here are some of the questions I'm asking myself:

Exactly how many homes are in the banks' foreclosed-upon shadow inventory?  How many are in the process of foreclosure?  How many more are likely expected to go into foreclosure in the next year, two years, three years, etc.?  If you add all of that to the negative by which we are below average historical housing starts, how does that stack up to the historical level of housing starts and other supply?  I.e., what's the total available "house potential" per person, compared to historical levels?

Then there are the various unknowns.  For example, off the top of my head, what is the shadow-shadow inventory of homes people want to sell but are unwilling to sell given the market? (potentially bad)  What is the number of homes that would go into foreclosure if there is another major leg down in the housing market?  (potentially bad)  The Fannie/Freddie thing was already mentioned.  (potentially bad)  Is the thirty-year period too short, since much of it coincides with the prime house-buying years of America's largest generation?  (potentially bad)  Did we get an answer to the number of vacation and second homes question (which is related, too, to my immediately prior question)? (potentially bad)  Will Congress pass immigration reform and/or potentially allow more immigration?  (potentially good for housing)  How many people have put off forming households not out of real economic need but out of fear during this period?  (potentially very good -- worth looking at household formation figures historically)

Or, would you take the position that my prior questions do not matter, because we assume that the low level of starts is basically compensating for the amount of supply overhang, and after that supply clears, the mere fact of returning so some sort of historical average for starts will cause a huge pop for the homebuildings?  That's actually a fair point if so.  Basically I've just been thinking aloud through this whole thing and typing as I do.

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#17) On December 17, 2010 at 4:02 PM, Valyooo (99.35) wrote:

Why would interest rates go up if demand goes down? I know rates are artificially low, but interest rates cant be "too high"...if they were "too high" they would go lower until demand picked up wouldn't they?  They can be "too low" because of the fed, but they cant be "too high" because they cant sell a bunch of mortgage

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#18) On December 17, 2010 at 4:32 PM, MKArch (99.72) wrote:

Dumberthanafool,

In my LEN post just after Jakila's I made a long winded argument for LEN and the large home builders in general. The second link I included in my post made the case for new home construction a lot better than I did. The author pointed out that home starts have averaged about 1.5M year over the 50 years of recorded history or about 15M per decade. This is due to population growth both organic and immigrant as well as replacement homes for lost stock. In the bubble years of the last decade or first half of the decade we built ~10M homes. For the rest of the decade we built ~5M homes for ~15M or the long term average and about the same as we built in the decade of the 90's.

Right now home starts are on a pace for ~5M total over the next decade or about 33% of the long term average and the numbers built in each of the last two decades. Foreclosures are certainly the culprit behind the new home builders sitting on the side lines right now *BUT* a foreclosure sale adds no new homes to the U.S. stock. We will need ~15M new homes over the coming decade to keep up with population growth and replacement stock and what ever we don't build early in the decade due to the foreclosures will have to be added later. As I pointed out in my LEN post, LEN and other large builders are already selling smaller homes with land bought at better prices for a profit right now albeit not many. Building townhouses and low rise apartments for a rental market if demand shifts that way is not much different than single family home construction and I think most of the large builders already do build some multi family structures anyway.

At some point housing starts over all are going to go from the current level of ~0.5M/ year to ~1.5M to get back to normal and take care of natural demand for new stock. That will be a triple for the sector in general. I made the argument for LEN that if you look at the large builders numbers over the last decade they were taking large market share from the traditional smaller regional builders. I would expect them to take even greater share in the coming cycle. You can boil the case for new home construction down to this: The long term 50 year average new home starts is ~15M/ decade. We are currently on a pace to build ~5M homes in the coming decade. At some point that will correct itself and we end the decade having built on the order of 15M new homes.

Mike

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#19) On December 17, 2010 at 4:50 PM, TheDumbMoney (37.82) wrote:

Hi Mike, yes that's essentially what I was getting at in my last paragraph, though less articulately or specifically than you put it.  The actual numbers on the supply side would still interest me though.

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#20) On December 17, 2010 at 5:14 PM, MKArch (99.72) wrote:

http://news.morningstar.com/articlenet/article.aspx?id=281220

http://seekingalpha.com/article/241088-homebuilders-perhaps-one-of-the-best-buys-of-the-decade?source=yahoo

I'm not sure what supply numbers you are looking for DTAF but I'm reposting the two articles I linked in my own thread to put the market in context. The first article from M* does an outstanding job explaining natural demand although they come up with a number that's a little higher than the long term average and what most seem to be using (~1.5M starts per year). The chart at the end of the article detailing 50 years of housing starts is particularly interesting but it ends in 2008. 2009 and 2010 come in at ~0.5M starts each and you have to mentally picture them added to that chart to really appreciate where the new home industry is right now.

The second article does a great job explaining starts over the last couple of decades and also pointing out that while foreclosure sales are certainly hurting new home sales right now they don't add new stock and don't affect the long term demand for new stock. What ever we don't build right now due to foreclosures will need to be built eventually to meet new stock demand.

 

Mike

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#21) On December 17, 2010 at 9:13 PM, TheDumbMoney (37.82) wrote:

Thanks, I'll take a look.

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#22) On December 20, 2010 at 11:59 AM, JaysRage (88.99) wrote:

Why would interest rates go up if demand goes down? I know rates are artificially low, but interest rates cant be "too high"...if they were "too high" they would go lower until demand picked up wouldn't they?  They can be "too low" because of the fed, but they cant be "too high" because they cant sell a bunch of mortgage

Not sure if you're asking in response to my post, but the whole point is that the current rates are not based on supply and demand of loans at all.   There is very little BANK demand for home loans right now.   The demand is mostly all from Fannie and Freddie, who eat all the mortgages and get subsidized from the government keeping rates artificially depressed.   They are insolvent because the interest rates and down payments required for Fannie and Freddie mortgages do not match the risk of writing the business.   If these two ever get privatized, the real risk of writing the business will drive rates and down payments dramatically higher, making the demand from BANKS (which you might call supply) for loans drop, because their supply of loans was never really there in the first place.   The demand came from government-subsidized Fannie and Freddie.

A couple of readings from "experts" (take that for what it's worth) estimated that an environment that is free of this subsidizing would result in down payments of 20% and interest rates in excess of 8%.   These additional capital requirements would further depress the housing market, because credit is an important part of the purchasing equation.    

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#23) On December 20, 2010 at 1:18 PM, JaysRage (88.99) wrote:

There is a compounding issue that would drive up rates if Freddie and Fannie were removed.   That issues is the depressed Fed borrowing rate.   Right now, it is low enough that banks can carry Fed funds for a profit.   Borrow from the Fed at .5% and buy treasury bonds at 4%.   3.5% free money.   Or they can invest it in the stock market for higher returns.   There is no need for mortgages at all when the government is giving you profit for free.   Lovely system that we have, isn't it?   Until all of this free money gets unwound and bank profits are derived from traditional sources, such as mortgages and personal loans, we are a long way from being able to analyze the current situation based on historical averages or risk portfolios or supply and demand.   

With the renewed focus from the government on budget restraint, how long will it be before they pull the plug on Freddie and Fannie?......if that plug is pulled, you can forget about a near-term housing recovery.  

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#24) On December 21, 2010 at 10:42 AM, MKArch (99.72) wrote:

Jay,

It looks like my last response got booted for some reason so I'll try again. The over all housing market is broken down into existing homes which traditionally account for ~85% of sales and new homes which traditionally account for ~15% of sales. Existing home sales were a little above average while the tax credit was in effect and fell a little below average since it has expired. New home sales have fallen off a cliff over the last two years at 1/3 of their long term average. Total home sales were about average while the credit was in effect but have fallen a little below average since the credit expired. Lending has not been the problem in fact existing home sales have held up fairly well. New home sales are at an all time unprecedented low as home builders sit on the sidelines waiting for the motivated seller to clear out so that they can compete in a rational market.

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#25) On December 28, 2010 at 6:25 PM, diditbad100 (< 20) wrote:

My concern about the homebuilders is that there are too many other problems with our economy. I can not see a recovery even in the next 10 years. Call me a pessimist!

Where are the new jobs going to come from for the purchasing power?

1. high unemployment  2. declining middle class 3. record deficits 4. aging of our population which leads to a strain on Medicare, Medicaid, S.S., pension plans etc.

I live in Va. and the State employee pension plan is underfunded by over a BILLION dollars.

With our States and our Country in such a financial mess I can not see any upside for many, many years.

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