Housing: What Inning Are We in?

Housing innings apartments interest rates

Investors are always asking the question what inning are we in when it comes to where we are in a particular cycle. It’s a pertinent question related to housing as it has had a tremendous run in terms of home price appreciation, equity build-up among homeowners, and tremendous profits for builders and investors. Now that interest rates have risen fairly sharply (prior to a pullback late last week) which has led to mortgage rates shooting up, it’s understandable to ask if this is the beginning of the end or just the end of the beginning? Or somewhere in between?

FRED 30-Year Fixed Rate Mortgage Average in the United States 2-2021 - 1-2022

The stock price of U.S. homebuilders has been negatively impacted by the run-up in mortgage rates as the following chart shows.

January 20, 2022 - Since Jan 12th SYP S&P 500 Jan 13th - Jan 21st

Part of the concern among investors is that homes, which have already appreciated tremendously, will become even less affordable in the wake of higher interest rates as this chart is already starting to show.

12-Month Cost of Purchasing Median Home 1975 - 2020

D.R. Horton is the largest U.S. homebuilder. It has had a remarkable run since bottoming during the Covid carnage in March 2020 when it hit approximately $32 per share. It recovered very impressively and hit a peak of nearly $110 in December 2021. It has since corrected by approximately 20% in the wake of higher mortgage rates. Clearly not a stock for the faint of heart.

DHI 2018 - 2022

The following table shows the incredible growth of the company as reflected by the company’s balance sheet. Pay particular attention to its inventory (homes and lots) line item. It has quadrupled since 2012, going from approximately $4.2 billion to approximately $16.5 billion.

Balance Sheet Sept 2012 - Sept 2021

Source: Seeking Alpha

One can see from the following chart that D.R. Horton is a behemoth and that its scale gives it a big advantage in terms of efficiencies and operating margin, although not as efficient as Lennar.

HOYA Capital Scale Has Become Significant Competitive Advantage

Source: Seeking Alpha article

Large builders have gained more market share during the pandemic which has made it a much more concentrated industry.

HOYA Capital Large Builders Have Gained Market Share 2014 - 2022E

Source: Seeking Alpha article

Here is a longer-term chart for D.R. Horton. One can see that during the housing bubble in the early to mid-2000s, the share price peaked in July 2005 and it took approximately 12 years to get back to that level. This is why investors always want to know what inning of the game they’re in because if you invest at peak bubble valuations then it can take a very long time to fully recover one’s investment (not taking into consideration lost purchasing power from inflation). From looking at this chart, the tremendous move upwards should give investors pause as it does look like it’s been primed for a significant correction.

DHI 1993 - 2021

The following charts show current housing activity, which continues to depict a housing market that has higher demand than supply. Existing home sales were quite robust in 2021.

Year-to-Date US Existing Homes Sales NSA (mm) January - December 2014 - 2021

While having recovered tremendously and showing strong growth in 2021, we are still at levels less than in the mid-2000s.

Annual U.S. sales of existing homes 2000 - 2020

There’s an argument, however, that home sales would be materially higher if there were more homes available for sale. These charts show how tight inventory levels are.

NAR US Existing Home Inventory (mm) January - December 2014 - 2021

Builders like D.R. Horton are understandably trying to supply the strong demand by constructing more homes. We now have more homes under construction than we did during the previous peak in 2005.

U.S. homes under construction, monthly 1970 - 2020 January 21, 2022

Unfortunately with labor challenges and supply chain issues, the completion of new homes is far less than the number under construction. This is the first time it’s been in deficit and since the bubble years we have downshifted quite materially to a situation where completions are not much more than the number of homes under construction.

Housing Completions Total - New Prvt House Under Construction 1970 - 2019 January 21, 2022

Back to the question in terms of what inning we’re in. All of the remaining charts come from this fantastic analysis of the U.S. housing market. To me, this is the money chart. Quite simply, we are not producing enough housing. This alone gives me some comfort that there’s a margin of safety for being invested in the U.S. housing market in growing areas. 

HOYA Capital The 2010's Was A Decade of Underbuilding 1980 - 2020

Let’s not rely on one chart, however, and look under the hood to analyze other important components to determine if there is a compelling risk-reward relationship for investors.

One important variable to analyze is the strength of homebuyers and homeowners. In the last cycle, they were quite weak due to low down payments, poor borrower quality, and interest rate exposure to adjustable-rate loans that had big payment change risk. There were also far more speculators in the market. Today we have less speculation and more well-capitalized buyers along with deep-pocketed funds and institutions looking to acquire homes to rent out, which takes supply off of the market for prospective home purchasers.

2022 Will Be Hottest On Record For Build-To-Rent January 21, 2022

And from a mortgage origination perspective, the quality of new loans being originated is much better than during the bubble days and this is another indication that we are more in the earlier innings than the later ones.

Hoya Capital Mortgage Origination By Credit Score 2003 Q1 - 2021 Q1

With interest rates having dropped, mortgage payments are quite manageable.

HOYA Capital Why This Time Was Different For Housing Market April 1981 - April 2021

And while home prices have appreciated quite impressively, they are still in line with incomes, unlike in the early to mid-2000s.

HOYA Capital Home Prices, Income & Rent 1997 - 2021

Demographics are also very supportive of housing as millennials come into peak home-buying ages and household formations are quite strong.

Household Formations Have Accelerated 1979 - 2021

Vacancy rates are also extremely low which should be supportive for housing demand as there are not a lot of vacant alternatives available.

Vacancy Rate At Multi-Decade Lows April 1980 - April 2019

And then there is Covid which has led to more people wanting to purchase homes to have more space and to be in less crowded areas and to get away from crime and homelessness in urban areas and to have more space to work remotely. 

Homebuilders Trade At Discounted Valuations 2013 - 2022

Finally, all of these positive factors can be neutered if one is paying too much for homes or for companies producing them. According to this chart, investors seem to be pricing in a future that is not nearly as rosy as the above indicators would suggest.

This would seem to provide investors with a decent margin of safety in the event that housing holds up better than the market is pricing in.


One comment on “Housing: What Inning Are We in?
  1. Dwight Frindt says:

    Thanks for this very insightful analysis.

Leave a Reply



Free Insights