Riding the uptrend in housing construction

PHOTO: KB Home residential buildings stand under construction in the Glencroft neighborhood of Cary, N.C., Jan. 6, 2017. Luke Sharrett/Bloomberg via Getty Images
KB Home residential buildings stand under construction in the Glencroft neighborhood of Cary, N.C., Jan. 6, 2017.

After 10 years of under-building, the home construction industry has turned brisk and is gaining momentum as consumers of various ages, motivated by high consumer confidence, seek new places to live.

Various indicators show uptrends in different segments of the industry. These include a big increase in sales of new single-family houses in March: a whopping 15.6 percent over March of 2016, according to estimates released jointly last week by the U.S. Census Bureau and the U.S. Department of Housing and Urban Development. The median national price paid for new homes has been rising steeply, ascending from about $230,000 in 2012 to about $311,000 currently.

Less dramatic but still robust increases are being posted for existing home sales, which rose 4.4 percent in March, well above consensus estimates. This has propelled median price increases upward, to about $236,000. This surge, experienced in all regions except the West, is “the fastest pace in more than a decade,” according to Brian Westbury, chief economist for First Trust Advisors. The faster existing homes are gobbled up, the better things are for remodeling suppliers and housing construction companies.

The strength of these trends bodes well for the prospects of continued growth, despite a month-to-month dip in housing starts in March that analysts attribute to abnormally warm weather that “moved” March’s normal starts to February. The early building season also affected construction spending figures in March. The Census Bureau said on Monday there was a 4.9 percent increase in construction spending in the first quarter of this year versus the same period in 2016.

In the big-picture department, the nation needs an estimated 1.5 million new homes of various types annually to meet the demand, but there haven’t been that many since 2007. Since then, the scenario has been one of pronounced under-building. After the housing bubble popped in 2008, home sales plummeted, bottoming out in 2013-14. But it started picking up markedly in late 2015/early 2016. The slack in the market has since played out, and the supply is being pulled taut by demand from most demographic groups:

• Millennials, many of whom have been living with their parents, getting jobs and apartments in the improving economy.

• Gen-Xers with growing families seeking more space in single-family homes.

• Late baby-boomers downsizing from single- to multi-family housing to save money and reduce maintenance burdens after their kids move into their own places or leave for college.

• Early baby-boomers seeking smaller footprints in retirement developments of multi-family structures or single-family homes in 55-and-over communities.

Historically economic confidence is motivating all of these groups, led by 35-40-something Gen-Xers and then 35- to 54-year-olds, as both groups experience wage growth, and then the 54-plus crowd—all spurred by historically low yet rising mortgage interest rates. If you’re confident and need housing now, goes the thinking, better buy soon and lock in a reasonable rate while you still can.

Aberdeen Investment Management projects that this confident, pent-up demand will propel industry growth well into the 2020s. While single-family homes are expected to do better than multi-family, which got a spurt from the Great Recession’s displacing broke homeowners, multi-family is also projected to enjoy growth.

Investors seeking to tap into the steep growth in single-family construction can research the relative health and positions of the familiar company names in this industry segment: Toll Brothers, K. Hovnanian Homes, CalAtlantic Homes and Centex Home Builders. For funds rather than individual stocks, various investment houses offer exchange-traded funds (ETF) that track the industry.

Another way to get in on the growth is to invest in residential real estate investment trusts (REITs) that buy up shares of multi-family and apartment construction companies. History shows that these investments tend to do well during times of rising interest rates.

In addition to this strategy—or instead of it—investors could capture overall growth by investing in suppliers to home builders that have broad builder distribution bases. Key suppliers include those that manufacture carpet or flooring, appliances, lumber, insulation, prefab building panels and plumbing fixtures. Another play is self-storage facilities — businesses with low overhead and regular income from packrats or people who must find temporary space for furniture and belongings when moving, especially as a result of downsizing.

Doubting Thomases would react by citing an undeniable market maximum: With all of this growth, aren’t most stocks in these sectors getting pricey, precluding good share-price growth? The happy answer is that these sectors are still so beaten up by the housing crisis that they still haven’t recovered to their previous glory-days level, even though glory-days demand is here again today.

The industry’s image of being pummeled by crisis continues to linger for those slow to wake up and smell the new numbers. In terms of market perception, anything to do with housing carries a taint, and recent mortgage rate increases are freaking out investors who get agita whenever Fed Chairman Janet Yellen says the word “increase.”

Yet, the Fed is increasing rates because of an improving economy in which rising demand more than compensates for the higher cost of money in benefiting the industry. Even if mortgage rates went up by two full points—which would only come gradually—rates would still be historically quite low. Many investors lack historical perspective, especially if they’re too young to remember the double-digit mortgage rates of the late 1980s. And because of this short view, they lack any consciousness that the economy can work just fine with 6 percent mortgages, especially if those rates reflect a healthy economy with high employment.

The window of price-value disconnection in housing and related industries will close. And as always, gains for the informed will be greater before this starts to happen.

If you’re already invested before these shares price up, you should probably start looking for an exit after the rate of construction exceeds an annualized rate of 1.5 million new homes for several months, or certainly for a year. Until then, those coming to the party late will be buying your drinks.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry.

The author does not own shares of any of the companies mentioned in this column.

Any opinions expressed in this column are solely those of the author.