Why Luxury May be the Order of the Day in Housing
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When Toll Brother Inc. (NYSE: TOL) reported earnings last week, the beat was significant, even amongst other home builders that have been putting up big numbers this year. As is often the case in this sector, the good news for Toll drove the stocks of its peers higher as well. While the stocks of most home builders have enjoyed healthy gains thus far this year, the trading patterns of large institutional investors suggest that the sector may becoming disjointed. Despite reasonable evidence that the housing recovery is actually under way, there are various trends that should be understood before committing any investment dollars.
Toll’s Impressive Quarter
For the third quarter, the company reported earnings of $0.26, which represents a dramatic increase over $0.02 for the same quarter a year ago. Revenue climbed 41% to $554.3 million, which was significantly above the consensus projection of $505 million. Perhaps the most significant note was the improved guidance included in the report. Toll increased the delivery price range of the 800 to 1000 homes expected to be delivered in the fourth quarter to $570,000 to $590,000; this is an increase of $10,000 at each end of the range. This price tag put Toll comfortably in the luxury home space and demonstrates the strength in this part of the market.
There seem to be two powerful trends taking place in the housing market whose combination favors builders of higher-priced homes. The first is that pent up demand is finally beginning to seep into the market. As homebuyers, particularly those who are able to come in at the luxury end of the market, grow impatient, some are beginning to buy. These buyers are satisfied that home prices have fallen sufficiently to justify making a purchase. Toll agrees with the sentiment, stating: “We believe the housing recovery is being driven by pent-up demand, very low interest rates and attractively priced homes. Customers who have postponed buying for a number of years are moving into the market with an industry wide shortage of inventory in many markets.” Recall that the bursting of the housing bubble began seven years ago.
The other significant trend that is present in the market is the continued tightness of credit, particularly for first-time homebuyers or those with lower incomes. When consumers are having difficulty obtaining a mortgage, the tenor of the market shifts. The National Association of Realtors reported in a news release that many lower-priced homes are being purchased as investment properties by individuals with the means to beat others to closing. While individuals wishing to live in these homes wait for a loan, investors who can make a cash offer are able to close. This trend also favors Toll because purchasers with incomes sufficient to obtain jumbo loans are far less impacted by credit constraints.
A recent survey of institutional investors showed heavy profit taking of homebuilders that operate at the lower to medium end of the home price spectrum. KB Home (NYSE: KBH) rose over 42% last quarter. This homebuilder operates at the low-cost end of the spectrum, targeting first time homebuyers as its core customers. Thus far this quarter, net sales by institutional investors is approaching eight million shares; the combined sales represent over 12% of the outstanding shares of the company. Similarly, PulteGroup Inc. (NYSE: PHM) rose nearly 43% last quarter. This homebuilder operates in the low-cost and mid-range part of the market in approximately 700 communities across the country. Thus far this quarter, net sales by institutional investors is approaching twenty million shares; the combined sales represent nearly 6% of the outstanding shares of the company. What this means for each is that hedge funds and larger asset managers are taking profits in these companies, and thus, at the lower-end of the home price spectrum. Conversely, shares of Lennar Corporation (NYSE: LEN), which are up over 62% year-to-date, hit a 52-week high late last week. The company looks to have solid institutional backing and shows positive signs for future strength. Lennar targets a higher part of the market than either KB or Pulte.
While mirroring institutional money is both difficult and not a guarantee of positive performance, it is hard to imagine the above stocks maintaining their trajectory without institutional support. While indicators for housing are somewhat positive – the Case-Schiller Index is up for four consecutive months – the ongoing credit tightness will make it more difficult for lower-end builders to fully breakout. Given the apparent disjointed nature of the housing market, Toll Brothers is the best way to play housing until pent up demand swells further, unemployment abates or credit loosens.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.