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Home Construction's Hot, But Is This the Right Time to Invest?

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A slew of numbers/reports has been released in the last few weeks, so first, let’s go through them quickly-

On Tuesday, the U.S. Census Bureau and the Department of Housing and Urban Development released numbers for housing permits and starts. Accordingly, we now know that permits in April increased a marginal 0.3% from March, which was however 60.9% above the pandemic-hit April of 2020.

Similarly, starts, which were down 9.5% from March, were up 67.3% from a year ago. There’s a wide margin of error in the starts number (21.6%). Housing completions were 4.4% above March levels and 21.7% from last year (again a wide margin of error of 15.8!).

Bottom line: more completions is good news for inventory but slow starts are indicative of supply-side issues.

So much for new homes.

As far as the existing home sales inventory is concerned, this has been declining in recent months. Based on data from the National Association of Realtors, the existing home inventory is the lowest it has been in five years. Bottom line: this means escalating prices.

The monthly supply of houses (ratio of houses for sale to houses sold) fell to its lowest level since the 1960s based on data from the U.S. Census Bureau. Bottom line: there is continued pressure on inventory, so it doesn’t look like prices are coming down soon.

The NAHB/Wells Fargo Housing Opportunity Index (HOI), which is a gauge of housing affordability, being the percentage of homes sold to people earning local median income, was 63.1% in the first quarter, down slightly from 63.3% in the fourth quarter of 2020. The HOI has been above and around 63% since the third quarter of 2019 although it jumped much higher in the first two quarters of 2020.

Bottom line: affordability hasn’t worsened noticeably, so buyers are likely to remain in pursuit.

The Zillow Market Pulse from May 21 says, “The combination of rising prices and limited inventory may be starting to weigh on buyers, particularly lower-income households and first-time home shoppers who have a more difficult time saving increasingly lofty down payments.

"A report released last week showed that more people thought it was a bad time to buy a home than a good one – the first time since 2010 in which that’s been the case. But while buyer sentiment may be starting to waver, sellers appear to be growing more confident — a key development on the road back to a more balanced market that may be somewhat easier on buyers.”

There are multiple issues on the supply side.

According to National Association of Homebuilders (NAHB and the Bureau of Labor Statistics, the Producer Price Index (PPI) increased 0.6% in April and 6.2% in the 12 months to April. The index for steel mill products increased 18.4%, and was a big piece of this. Steel mill prices are up 55.6% year-to-date with price volatility being greater than it has been at any time since the Great Recession.

Similar is the case with softwood lumber. Prices increased 88.5% from April 2020 to September 2020, then dropped 22.9% by November-end. Since then, the softwood lumber PPI increased 52.0%. The 13.1% depreciation in the dollar over the past 12 months isn’t helping Canadian lumber imports either.

Gypsum product prices increased 4.4% in March. The PPI for all gypsum products increased 12.5% over the past 12 months and for gypsum building materials (e.g., drywall) increased 13.3%.

Ready-mix concrete prices climbed 1.1% (seasonally adjusted).

Material price increase isn’t the only problem. Robert Dietz, SVP and chief economist at the NAHB said earlier that “we lost about 1.5 million workers, who either lost their job or quit during the great recession. These were tradesmen, electricians and carpenters.

"We’ve added back about 900,000 over the last decade, but we still need more people in the pipeline.” So skilled labor is a big issue. The slowdown in immigration and lack of women in construction work are other factors impacting labor availability, plus the fact that it is seasonal, physical labor that many don’t like.

Then there’s the question of lot availability. Builders have been seeing a dearth of lots for development.  There are many factors at play here, including the fact that single-family home owners often oppose multi-family development in the neighborhood.

President Biden’s sweeping executive order on climate change reinstates the 2015 Federal Flood Risk Management Standard (FFRMS) from the Obama-era that was later revoked by the Trump administration. This will increase regulated floodplain areas for development that might be particularly helpful given that the work from home model has already proved successful.

NAHB opposed the reinstatement on technical grounds and also because the integration of climate-related financial risk into underwriting standards, loan terms and conditions could make FHA, VA and USDA-rural development mortgages difficult to obtain and also more expensive.

Okay, so the housing market is really hot despite the supply-side issues. While material prices may remain elevated and labor supply wont suddenly increase, the strong demand and relatively low mortgage rates (still at 3.00% for the 30-year fixed in the week ending May 20, down 24 basis points from last year) are likely to remain tailwinds. And as we’ve seen above, affordability hasn’t deteriorated much either.

A quick look at valuations across the sector show that the supply-side problems have really hit prices, making the shares attractive for any longer-term player.

So let’s consider the Zacks Building Products - Home Builders industry first (top 12% of Zacks-classified industries). #1 (Strong Buy) ranked Beazer Homes USA, Inc. (BZH - Free Report) , Century Communities, Inc. (CCS - Free Report) , M.D.C. Holdings, Inc. (MDC - Free Report) , MI Homes, Inc. (MHO - Free Report) and PulteGroup, Inc. (PHM - Free Report) all promise strong double-digit growth in revenue and profit this year. And they’re all going cheap.

Next, consider the Building Products – Wood industry (top 7%). Analyst estimates for #1 ranked stocks Potlach Corp. (PCH - Free Report) , UFP Industries, Inc. (UFPI - Free Report) , Weyerhaeuser Co. (WY - Free Report) indicate double/triple-digit increases in revenue and profits this year. And valuations are attractive.

The Building Products – Miscellaneous industry (top 36%) is another attractive segment with many buy-ranked stocks. Of them, #1 ranked James Hardie Industries PLC. (JHX - Free Report) and Owens Corning Inc. (OC - Free Report) offer double-digit growth in revenue and earnings at a cheap valuation.

Time to buy!

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