Buy a Home and a Homebuilder

By: Chad Hudson | Thu, May 29, 2003
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The S&P Homebuilding index is up almost 45% year-to-date and several homebuilders are trading at all-time highs. It is far and away the best performing non-technology related group so far this year. Business cannot be better for the industry and there very few signs that the environment will be changing. This week, the Bureau of Census reported that new home sales increased 1.7% in April to a 1.028 million annualized rate. While April sales were a little below the record rate of 1.056 million homes set in September, this was the eighth month out of the nine previous months that sales of new homes eclipsed the one million annual rate. The median price of new homes declined 1.1% to $185,400 and has been range bound for over a year between $180,000 and $190,000 with a few outliers.

Existing homes are also running near record levels. Sales of existing homes increased 5.6% in April to a 5.84 million annual rate. This was the largest increase since last October and was the first increase this year. Since January 2001, there has only been five months that existing homes have sold higher than a 5.8 million annual rate. Four of those months have been since December 2002.

The Mortgage Bankers Association purchase application index continues to hover near record highs. While it dropped 0.1 points to 395.7 this week, it is 11% higher than last year. The record was set earlier this month at 416. There has been only six weeks that the index has been above 400 since it was created, everyone happening within the past year. Two of those weeks have happened this month. Additionally, the refinance index is surging back to new highs after a brief and minor pull back. Incidentally, the low point of the recent pullback, 5,092, was higher than all but three weeks for the period before August 2002. The Mortgage Bankers Association should think about a 2-for-1 or even a 3-for-1 split.

This week's survey from the Conference Board showed consumers increasing appetite for yard-work. It found that 3.6% plan to purchase a home in the next six months, up from 3.4% last month. It also found that the new round of auto incentives might be working, 7.6% anticipate buying a car within the next six-months which is a huge jump from 6.0% in April. Consumers plan on going appliance shopping as well. Those planning of buying a major appliance increased to 31.0% from 29.7% last month.

The strength in new home sales is not only evident in the government data, but the homebuilders continue to report record results as well. Today, Toll Brothers reported record earnings for both the second quarter and for the six-month period ending April 30, 2003. Second quarter earnings per share rose 4% to $0.72, beating analysts forecasts by three pennies. Homebuilding revenue increased 10%, with a 2% increase in the number of homes delivered. Similarly, the dollar volume of contracts increased 3%, but the number of contracts declined by 2%. More impressive was Toll Brothers backlog increasing 25% to $2.21 billion on a 20% increase in the number of homes in backlog. Both were records. Toll Brothers mentioned that the war and inclement weather "delayed the start of the selling season." This delay led to "strong demand in April and May." In fact, in its press release the company said, "The past four weeks have been among the best in our history for traffic and reservation deposits." During the conference call this was expanded upon by the company: "Last week was the highest reservation deposit per community count we have ever had. The week before last was the highest reservation deposit per community count that we have ever had. The week before that was the highest reservation deposit per community that we have ever had. The week before that was just terrific, but didn't set the record, the record for that week was set back in 1999."

Homebuilders have benefited greatly from housing inflation. Since housing prices have been climbing at very high rates and homebuilders costs are much more fixed, a substantial amount of the higher selling price drops to the bottom line. Additionally, since many builders purchase land prior to development and land costs have not escalated enough to hamper margins yet. It appears the benefit of rising prices is staring to wane. The average price on homes that were closed during the second quarter increased 9.3%, but average price for contract homes increased only 5.1%. This is similar to the monthly new home sales reports have been revealing as well. According to the Bureau of Census, the median new home price fell 1% from a year ago compared to the 6.8% year-over-year increase last year. While all major metrics were at record levels, there are a few cracks surfacing. Growth rates are slowing and the number of new contracts declined by 2.2% in the second quarter from the year ago period. This is similar to what happened with Hovnanian as well. Hovnanian also announced earnings on Wednesday. Its average price for contract homes increased 3%. For homes that were closed during the quarter the average price jumped 8.2% from last year. However, while the average price inflation is moderating, business is far from falling off a cliff. The number of contracts signed leaped 16% from last year. Additionally, Hovnanian has more than 90% of its expected deliveries for 2003 either delivered or in backlog. The company also raised its earnings guidance for the year to a range of $6.50 to $6.75 per share from $5.25 to $5.50 per share.

I hate including long quotes, but I'll leave you with the response from Robert Toll, Chairman and CEO of Toll Brothers, to a question about government deficits leading to higher interest rates and the sensitivity the homebuilding industry is to higher interest rates:

Yes, I am concerned about the macro economic picture, the budget deficits that are being run by all governments. We, in the short run, will find this to be stimulating to the economy. Money will be pumped in. In the long run, these deficits have to be paid off. And I think we are going to be forcing -- we will be forced to view some very major decisions and will be forced to, at some crossroads in the future -- now, I don't think it will be within a year but within two or three years, this is going to come home to us. And surely if we keep on as a government, local and federal, borrowing, more and more, that there is going to be a higher interest rate. That's what demand will do.

Right now, supply is keeping up with that demand for borrowing, but at a certain point if it just keeps up without any road map, to borrow a foreign policy phrase, as to how we get out of it, then the dollar would be, you know, less in demand and the interest rates would go up. And how do I believe the current markets would be impacted by interest rate increases? We did tremendous business at 8% and we did tremendous business at 10%. But coming from, I think a seven-one arm today on a jumbo is four and seven-eighths, on a conforming is four and five-eighths. If you bump that up, which I can see happening easily to seven or eight, I think it's going to take a bunch of people out of the market that would otherwise have been in the market.

And I do think that when you have interest rate increases that significant, you'll have a slowdown in the home-building business. Were it not for the fact that demand so far exceeds supply, that it appears as though all that would happen is you might have a slow down in the increase in prices of homes. In general, I think what will happen, and this is just one man raving, is that the economy will definitely be stimulated by the current tax program, and by the fed. I think that stimulation will go through to the economy, I think you will have the pick up in demand in business, I think the consumer confidence will continue to increase, and you ain't see nothing yet, as Al Jolson used to say.

I think you're going to see tremendous price increase in housing in the short run in the next year or two because the supply is so constrained. Then when the macro economic picture starts to slow us down again, as surely it will unless we correct these budget deficits, I don't think you're going to see a slowdown in housing, you'll see a slowdown in house appreciation, you won't get as rapid an increase but you will still have strong demand vis-a-vis the supply because the supply is so constrained.

Your housing delivery that was spoken of on Friday that you got that write up in the Times about and the Journal, remember, they're focusing on 1% or 2% increases. We went up 2% over the last month. We are selling at a rate that hasn't been seen since December. Well, December isn't a decade ago. Big deal. If you take a look at housing starts, they're basically flat. But they are bumping up against tremendous population increase and the increase is in immigration not in babies. So I think the prognosis for the housing market is a very positive one.

Now, we at the higher prices being a luxury home builder, are going to be less impacted, but -- than those who are selling less expensive homes to people who are more constrained by their budgets. But still it would have some impact because it's got to impact the daisy chain. Because if you sell a little home to buy a big home, then you are impacted by the smaller, less expensive home market. I'm sorry for giving you typical economist kind of evaluation there on the one hand. On the other hand, but there it is.


Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis

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