đ Hidden Wealth in Homebuilders?
An industry analysis
An interesting market today? The American homebuilders market.
Currently, there is a housing shortage of 4 million (!) homes in the United States.
But is it an interesting market to invest in? Letâs dive in right away.
Increasing demand
In 1960 a family meant a married couple and two kids.
That was the American Dream. A house. A white picket fence. A stable, predictable life.
Not anymore.
Today, more people live alone than ever before. Couples without kids are everywhere. Families arenât what they used to be.
This has caused a major shift in housing demand.
Back in 1960, there were only 6.9 million single-person households. By 2022, that number had skyrocketed to 38.1 million. And itâs still climbing.
Builders canât keep up. Demand keeps rising. Prices keep climbing.
The old way of thinking? Itâs gone. The housing market? Changed forever.
Supply canât follow demand
When you want to buy a house, you can do two things:
Buy an existing house
Build a new house
Buy an existing house
You can choose to buy an existing home rather than having a new one built by homebuilders.
For every new home sale over the last decade, 8.5 existing homes were sold.
According to Fairtree, the existing home inventory for sale is shrinking. This is a good sign for homebuilders.
Build a new house
You can also choose to build a new house instead of buying an existing one.
This is where homebuilders come into the picture.
The homebuilder market is very fragmented with a lot of competition.
There are over 400,000 homebuilders in the U.S. Most of these are small builders with only a few projects.
The largest public builder, DR Horton, closed around 83,000 homes in 2022. This makes up just 8% of the total 1.02 million single-family homes built that year.
Here is the market share of publicly traded homebuilders in the US:
End market growth
Over the past decade, 11.3 million new homes were built in the United States.
This means the homebuilder market has grown by only 8.3% since 2014.
And this while there is a housing shortage in the US of around 4 million homes.
How is this possible?
Itâs a supply issue. Delivering homes has become more difficult in the past decade:
Labor shortages: delays in construction slow down the building process
Lot shortages: limited space for developing new homes
Lending issues: interest rates increased significantly recently
High labor and material costs
Legal and regulatory barriers
The good news?
The market is still very fragmented.
This provides a lot of opportunities for the best homebuilders in town.
Just take NVR for example. Itâs one of the best-performing stocks in the world.
NVR delivered a return of 180,000% (!) to shareholders since 1990. $10,000 turned into $18 million.
What are homebuilders?
Homebuilders usually donât build homes all by themselves.
They act as coordinators bringing together all the pieces needed to make a house.
They design and construct new homes, and sometimes even whole neighborhoods.
Homebuilders operate in two main ways:
A standard model
A Land-Option Model
The Standard Model
A classic homebuilder buys land and builds houses on it.
They own the land. This means they have to spend a lot of money upfront.
As a result, the standard model requires quite some capital to operate.
Some listed companies implementing the standard model*:
DR Horton: the market leader known for affordable housing
Lennar Corp: A major U.S. homebuilder with innovative designs
PulteGroup: Offers quality homes for various buyers
Toll Brothers: Builds luxury homes and residential communities
*Please note that some of these companies partly use the Land-Option Model.
The Land-Option Model
The Land-Option Model works differently.
Builders donât buy the land right away.
Instead, homebuilders make a deal with landowners and receive the option to buy the land later.
They only exercise the option when a homebuyer has agreed to build a house on the specified land.
This is a very attractive way of doing business because it makes homebuilders way more flexible and less capital-intensive.
The only two homebuilders putting their main focus on this model:
NVR: A great homebuilder and cannibal stock
Dream Finders Homes: A growing builder with customizable homes
Outlook
The US Residential Construction Market size is expected to grow by 4.5% per year over the next 4 years.
Cyclicality
Unfortunately, homebuilders are cyclical companies.
Why?
When the economy is strong, more people buy homes. This leads to more construction and higher profits for builders.
When the economy slows down, fewer homes are sold, and builders cut back. These ups and downs repeat over time.
Homebuilders also benefit from low interest rates and the other way around. More housing will always be a question of affordability.
The increase in interest rates during COVID-19 caused more cancellations for homebuilders like DFH. The good news is that the trend has already reversed.
Standard model versus The Land-Option Model during the Financial Crisis
The cyclicality of a homebuilder depends on the kind of business model used.
A company with a Land-Option model is less cyclical. Those businesses suffered less during the Financial Crisis.
During the 2008 housing crash, NVR, which used a Land-Option model, was one of the few housing companies to remain profitable.
The reason?
Businesses with land-option models typically donât own a lot of (speculative) land.
Instead, they have an option to buy the land.
When demand drops, they just choose to not exercise their options.
A comparison
To measure is to know.
The companies weâre most interested in?
Builders FirstSource: Not a homebuilder, but a supplier of building materials
DR Horton: The market leader known for affordable housing
Dream Finders Homes: A growing builder with customizable homes
Lennar Corp: A major U.S. homebuilder with innovative designs
NVR: A profitable homebuilder with a smart business model
PulteGroup: Offers quality homes for various buyers
Now we are going to compare the stocks we selected.
This comparison will help you to see which company stands out.
We will give each company points depending on their performance on each metric.
This will help you find the best company within the potentially attractive US homebuilders market.
1. Balance Sheet
We love to invest in companies with a healthy balance sheet.
Companies with a healthy balance sheet? DR Horton, NVR, Dream Finders Homes Lennar Corp, and Pultegroup.
Builders FirstSource has quite a lot of goodwill which we donât like.
1 Point = DR Horton (+1), Dream Finders Homes (+1), Lennar Corp (+1), NVR (+1), and Pultegroup (+1)
0 Points = Builders FirstSource
2. Inventory Turnover
The most important thing for homebuilders? A high inventory turnover.
Inventory turnover shows how efficiently homes are sold. It indicates how quickly cash is generated.
Hereâs how it is calculated:
Inventory Turnover = Cost of Goods Sold / Average Inventory
The higher the inventory turnover, the better.
The homebuilders with the capital-light âLand-Option Modelâ (DFH and NVR) have the best inventory turnover.
Builders FirstSource has a high inventory turnover because it is not an actual homebuilder. Instead, the company supplies building materials.
Companies with lower inventory turnover? DR Horton, Lennar Corp, and Pultegroup.
2 Points = Dream Finders Homes (+1), NVR (+1)
1 Point = Builders FirstSource (+1), DR Horton, Lennar Corp, and Pultegroup