The Big Housing Migration And How It Affects The Homebuilding Industry

Homebuilding Industry

Housing starts for December 2020, reported in late January, hit a level not seen since 2006.

A confluence of several factors is driving this trend which we’ll explain in this article. 

Translation: the housing market is booming once again. Is the boom here to stay, and how does this fare for the homebuilding industry?

Quick Rundown on Homebuilders

It’s in the name: home builders build and sell homes.

They buy plots of land in neighborhoods poised for growth and use construction crews to build houses on the land. Once the house is built, they typically use their own team of realtors to sell the house.

Some home builders build speculatively–meaning they build before they have a buyer, and list the home on the Multiple Listing Service hoping to get a good price.

On the other hand, many require a customer order and deposit before they start developing. Each model has their own benefits drawbacks, but the speculative builders are more likely to get caught out when the housing market cools down. 

To build houses, you need land.

The two primary land acquisition strategies that homebuilders utilize are outright purchases of raw land from landowners, and buying call options on land–giving them the right (not the obligation) to buy that land in the future if they want to build on it.

The options strategy of course reduces leverage and increases return on invested capital (ROIC). Some firms, like NVR, will go a step further and buy options to acquire build-ready lots from local builders, instead of raw land.

The options strategy also allows companies to control much more land, because they’re only paying option premium for each lot until they decide that it’s time to develop. 

Homebuilding is a difficult, low-margin business that is a victim of the cyclical nature of the housing market.

Further, because the large publicly-traded homebuilders operate in several regions, their competition are typically small operators who are experts in their local markets.

The advantage the big homebuilders have over their local competition is the ability to easily attain financing.  Many builders choose to close the gap between their limited knowledge of any specific regional market by acquiring or partnering with the local experts.

They offer financing and leverage, and their local partners assist in development.

Because homebuilders acquire a great deal of property throughout a cycle, they’re often left “holding the bag” when the music stops. Their balance sheets will be bloated with the land they can’t offload near their purchase prices because nobody else is building either.

This problem is compounded if the business is saddled with debt, as the leverage could wipe them out completely. 

The profitability of homebuilding depends on both regional and macro factors. On a regional basis, population growth, local employment trends, and demographics play a key role in the demand for homes.

At a macro level, mortgage interest rates, national unemployment, and wage growth have direct impacts. 

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Disclosure: Nothing written in this article is intended to be a buy or sell ...

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