Barron's Streetwise - Home Prices Jumped 19% Last Year. The Outlook for Buyers and Builders

Episode Date: March 2, 2022

Jack launches a midweek edition with a look at a double-upgrade for two homebuilder stocks, plus tailwinds for home improvement chains. Learn more about your ad choices. Visit megaphone.fm/adchoices

Calling all sellers, Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. Welcome to the Barron Streetwise podcast. I'm Jack Howe. U.S. house prices soared 19% last year, and that's not normal.

It's the fastest run-up in more than 70 years. Is it a bubble or a buying opportunity in shares of homebuilders or both? And what does it mean for home improvement chains like Home Depot and Lowe's? That's next. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. Obviously, our thoughts are with the people of Ukraine at this moment. We discussed the Russian invasion and the impact on investors in our last

episode, and there will be more to say. But we focus here on U.S. housing, and we're experimenting with something different, adding a short midweek episode to the podcast. Just a few thoughts on an evolving trend or investable idea. Jackson, did we decide to brand this the Barron Streetwise Quickie? We did take a vote. Yes. And you were the only yes. I got you. So it's more of a working title for now. Time to get this quickie started. I'm not sure that's the best.

There's a house price benchmark that used to be called the K. Schiller Index, named for a pair of economists. The name has inflated over the years. Now it's called the S&P CoreLogic K. Schiller National Home Price Index. It rose 18.8% last year. last year. Now, we've been talking about huge price gains for houses for many months now, including in an episode of this podcast with the CEO of Invitation Homes in December. But it doesn't make the final yearly number any less shocking. It's faster than any of the yearly price gains that led up to the massive housing bubble and bust around 15 years ago. In fact, it's the fastest in the data series.

Deutsche Bank has stitched together a few different sources for historical U.S. house prices, and it reckons that last year's gain was the fastest since right after World War II, when Americans returning from the battlefield snapped up houses and started families. That wasn't a bubble. Price growth moderated back then, but prices didn't fall. 15 years ago, on the other hand, we saw a price plunge that rivaled what houses did during the Great Depression. So where do things stand now? One way to judge how expensive houses have gotten is to compare them with incomes,

and another is to compare them with rents. A third is to track overall affordability of monthly payments after factoring in mortgage rates. Rates are up, albeit from exceptionally low levels. A year ago, the typical 30-year mortgage came with an interest rate below 3%. Today, it's around 4%. Here are a few facts to put things in perspective. There's a severe housing shortage brought on in part by sluggish construction in the wake of the last bubble. One study last year found that more than 12 million new households had been formed since 2012, but only 7 million houses had been built,

creating a shortage of more than 5 million houses. The U.S. homeownership rate peaked at over 69% in 2004, a couple of years before house prices peaked. Last year, the homeownership rate fell. It's still more than 3.5 percentage points below its peak. Bank of America Securities expects housing demand to continue to outstrip supply this year due to short supply and in part to strong demand by institutional buyers, corporations that buy single-family homes to rent out.

It says that affordability has worsened, but not by much more than rental affordability. For example, B of A says that median monthly rent has increased by $240 year over year, compared with a little bit more, an increase of $250 to $300 for the typical monthly mortgage payment. And as it wrote in a recent note to investors, inflation is more painful to a renter than a homeowner. In that note, B of A double upgraded shares of two home builders, Toll Brothers, ticker T-O-L, and Pulte Group, ticker P-H-M. And when I say double upgraded, I mean it took them straight from underperformed to buy without stopping at neutral.

Both stocks were recently down by double digit percentages year to date, and both have price to earnings ratios in the mid single digits using this year's earnings forecasts, making them appear dramatically cheaper than the overall stock market. For home builders, investors often discuss stock valuations using another measure, the price-to-book ratio, which factors in the accounting value of company assets, including land. Using that measure, Toll Brothers was recently trading well below historical levels and Pulte a little above them. B of A makes the case that Pulte deserves a higher valuation because of the high profit it earns on the money

it puts to work. For Toll Brothers, it notes that three quarters of its land was bought before the pandemic, which should provide a long runway for healthy profit margins. We'll see. Rising mortgage rates are a risk, although that risk may be reflected in share prices. For both companies and home builders in general, B of A says that there are factors that can offset higher mortgage rates, like the supply and demand dynamics I've mentioned, and the fact that the tailwind of millennials buying houses appears to be in its early stages. One more thing. Goldman Sachs recently hosted a

discussion with Harvard University's Joint Center for Housing Studies, which predicts double-digit growth this year in the amount we spend on home renovations and remodelings. Goldman is bullish too, although it expects supply chain constraints to continue to play a role, so it's forecasting 6% growth. The factors cited include the aging of the existing supply of houses and the shift to more working from home even as the pandemic passes. It makes sense. Goldman has buy ratings on several companies with home improvement exposure, including Home Depot, ticker HD, and Lowe's, ticker LOW, plus three makers of building supplies, AZEK, ticker AZEK, Fortune Brands Home Security, that's FBHS, and Mohawk Industries, MHK. BHS, and Mohawk Industries, MHK, and also the appliance maker Whirlpool, ticker WHR. I would just add one thing on the subject of the outlook for home improvement spending.

If you're an investor with a diversified portfolio, it's much easier to find answers for the stock side of the portfolio than the bond side, with the 10-year treasury recently yielding 1.7% and the latest reading on inflation 7.5%. It's enough to make an investor look outside of traditional asset classes for creative solutions to protecting against inflation without taking on equity risk. They might, for example, replace an old oil heating system with something more efficient, like a geothermal system, or add solar panels to reduce electricity purchases, or upgrade a traditional open fireplace to a high-efficiency closed one, or upgrade their insulation, or do all of these things. These jobs are different from, say, remodeling a kitchen because they reduce or replace known future expenses, like the cost of heating oil and electricity.

And that means they have an ongoing rate of return that's effectively indexed to inflation. And for the ones I just mentioned, the federal government is offering tax credits to reduce the upfront cost. is offering tax credits to reduce the upfront cost. My recent investment was putting a piece of plastic over one of the single-pane windows in my apartment. What was the principal invested? $29. I got a good feeling about this one.

I'll let you know when my heating bill comes in. My point is not that projects like these are right for everyone. It's that writing checks for them becomes a heck of a lot easier when you think of them as fixed income alternatives at a time when yields on safe bonds appear punishingly low. And that, as much as anything, bodes well for spending on home improvement. And that, as much as anything, bodes well for spending on home improvement. We will surely take another look at housing and related investments as the year goes on. If you have a question on that or another subject and you'd like to ask it on the podcast, just record it using the voice memo app on your phone and email it to jack.howe at barons.com.

Thank you for listening. Jackson Cantrell is our producer. Subscribe to the podcast. Follow me on Twitter. That's at Jack Howe, H-O-U-G-H. What do you think of the quickie? Tweet me or email me to let me know. See you next week.