The Coming Bull Market in Multi-Generational Homes
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Great investments are found at the intersection of short term and long term trends. Recently homebuilders have revalued to the upside as housing starts have left their recessionary lows. Some of the stronger homebuilders like Lennar Corp (NYSE: LEN) build multi-generational homes which will see increasing demand as America's dependency ratio increases. Homebuilders have come off of their cyclical lows, but smart builders which take advantage of long term demographic trends are still attractive for long term investors.
The Long Term Trends
"The Center’s report includes an analysis of the nation’s future “dependency ratio”—the number of children and elderly compared with the number of working-age Americans. There were 59 children and elderly people per 100 adults of working age in 2005. That will rise to 72 dependents per 100 adults of working age in 2050."
(Pew Social Research 2008)
The increasing number of citizens unable to work relative to working citizens will have a major effect on American society. Pensions and 401k accounts will have to be stretched further. Medical costs continue to rise and it will become more difficult to justify sending the elderly to expensive nursing homes for long time periods. Multi-generational homes like Lennar's latest offering in Valencia, California offer a simple way to deal with these factors by placing two homes in one. The younger generation can take care of the older generation while both are able to maintain a sense of privacy and individuality.
In Latin America it is common to see multiple generations living together. This is partly driven by culture, but it is also driven by the cold economic reality. Lower per capita GDP and lower median per capita income means there is less surplus available and people are forced to be more economical. The American dream is a great legend, but the reality is that real wages have decreased over the past couple decades and there are serious concerns about growth over the next 100 years. We cannot predict the future, but we can look at past and current trends to gain a general understanding of where a nation and the world is heading. Multi-generational housing is a great way to invest in a low growth environment amidst global resource constraints.
The Short Term Situation
During the recent crisis homebuilders took a huge hit as unemployment spiked and the foreclosure rate greatly increased. Consumer spending suffered due to massive household debt loads which were not based on sustainable debt to income ratios. Bankruptcies and foreclosures started to deal with these bad debts, but they left banks with a large amount of shadow housing inventory. Currently consumer's debt service as a percent of income is down to more sustainable levels and they are finally in a place where they can start to buy homes again.
Every company is unique and Lennar is not an exception. As stated in their May 2012 presentation new homes sales and home sales prices both increased in Lennar's markets in 2011 relative to 2010 while the national housing market respectively saw 4% and 6% decreases. The firm is not in a boom like that of the early 2000s with 5 year revenue growth at -19%. Nevertheless they posted positive net earnings of $95.3 million in 2010 and $92.2 million in 2011. Their total debt to equity ratio of 1.31 is not spectacular, but it is better than some of their competitors. Lennar's innovative use of multi-generational housing developments is not easily seen in these numbers, but regardless it gives the company a long term advantage over their peers. Growing a new product line and discovering how to best tap into developing trends cannot be accomplished overnight. Lennar is a good company to watch as the housing market continues to crawl out of the abyss.
Finding a distinctive value proposition is dreadfully important and Toll Brothers (NYSE: TOL) has placed their chips on the luxury sector. Focusing on the upper end of the housing market gives Toll a distinct advantage as higher skilled workers have more earnings power and lower employment rates than unskilled workers. The company has a total debt to equity ratio of .73 and trades at a reasonable PE ratio of 10.9. The company still bears the effects of the recession with a low ROA of 1.7%. On a price to free cash flow basis TOL's 46.4 ratio makes the company a second choice to LEN with their 11.2 ratio.
KB Home (NYSE: KBH) looks rather risky as it is focused in highly volatile markets like California, Nevada, and Florida. Over the last two quarters they turned an EBIT profit, but on a TTM basis they still posted an EBIT loss. In 2012 their EPS loss of $.76 is the worst number of the three homebuilders examined here. Unlike Toll and Lennar, KB has negative free cash flow yet it trades price to book ratio of 3.18 is higher than that of TOL or LEN. Also, TOL's gross margin of 18.6% is higher than KBH's 15.9%. With their negative earnings and focus on volatile markets KBH is best seen a speculative play with relativity risky future.
America is aging and the results will be felt throughout society. Multi-generational housing offers a great way for families to save money on medical costs and give a higher quality of life to the elderly who do not want to be condemned to some expensive and obscure nursing home. At the same time the younger generation benefits from this type of housing as they have their own home and more privacy. Lennar is a strong and diversified homebuilder which offers a great way to play this trend. The company is not trading at cyclical lows, but those willing to invest for the long haul should take note of the long term growth opportunity.
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