Earnings from Lennar and KB Home may provide insight into how long the imbalance in the dynamics of supply and demand for home builders will continue.
Home builders are reaping the benefits of tight supplies and seemingly insatiable demand in the housing market
Companies boast of ability to pass price increases on to home buyers without issue
It’s a “whack-a-mole” game as home builders search for building materials they’ve run out of
Talk about nailing it: Home builders are expected to have mostly hit the high beam of earnings results in another quarter marked by a swift shift in demand that simply couldn’t be met.
As a result, Wall Street expects home builders such as Lennar (LEN) and KB Home (KBH) to knock out solid results this month, mirroring activity and earnings already reported from competitors like LGI Homes (LGIH) and D.R. Horton (DHI).
And some analysts expect to hear more of the same ahead. According to Evercore ISI analyst Steven Kim, the current housing shortage has been “15 years in the making and is impervious to rapid change.”
That’s open for debate, but the economic tenets of supply and demand appear to be in full force in the home building industry. Many home builders across the country are reaping the benefits of extremely tight supply and what appears, at least for now, to be an insatiable consumer appetite for home buying. Home builders boast that they’re mostly passing on those escalating costs through higher sales prices consumers appear to be willing to pay.
Alex Coffey, a senior specialist of client and market structure insights at TD Ameritrade and co-host of the “Fast Market” program on the firm’s media affiliate, the TD Ameritrade Network*, called this a “ginormous backlog” because people want to buy homes that are not getting built yet or are in the process of getting sold.
DHI, for example, ended its quarter with a record backlog of 5,632 homes. “This was the highest backlog in our history and an increase of 199.7% year over year,” said chief financial officer Charles Merdian on the company’s early May conference call. “The value of our backlog on March 31 was a record $1.6 billion, an increase of 257.6% year over year.”
That matters to investors who are likely looking for insight into what might lie ahead in one of the industry’s most unprecedented periods of growth. Given the housing-bubble experience of the 2008 Great Recession, many seem worried that history might repeat itself.
LEN is scheduled to report after the markets close on Wednesday, June 16, with a conference call the following morning. KBH is expected to report later in June.
The pandemic disrupted the supply chain in ways once thought unimaginable, forcing temporary shutdowns in lumber mills and other global housing materials factories and wreaking untold havoc on international ports used for transporting and unloading products.
“Supply was contracted by the pandemic, which led to rising costs in materials and labor—and it all took place at the same time demand started to increase as more and more people were looking for more space to do work activities either full time and/or part time,” Coffey explained.
The National Association of Home Builders estimated the surge in lumber prices alone has pumped an extra $36,000 into the average cost of building single-family homes. In early June, NAHB reported “shortages of materials are now more widespread than at any time” since tracking began in the 1990s.
More than 90% of builders reported supply deficits of appliances, framing lumber, and OSB, or engineered wood, according to the NAHB/Wells Fargo Housing Market Index. Exactly 90% of builders said there was a dearth of plywood, while 87% said supplies of windows and doors were scarce.
“The shortages are not only extremely widespread, but extremely broad based,” the report stated.
According to Coffey, “It is the classic dynamic in economics where you watch supply and demand moving in directions that are not in sync, with supply going down and demand going up as prices soar.”
One home-building executive said the materials shortage has dawned a “whack-a-mole game” of trying to find the latest thing it’s out of.
That has led to strong jumps in the stock prices of many home builders, fueling the S&P Homebuilders Select Industry Index ($SPSIHO) to a record high of 8112.88 in early May (see figure 1).
But those runs reversed course only days after the Census Bureau reported a 13% drop in single-family housing starts in April compared with March, the sharpest pullback since the pandemic choked the economy in the year-before period.
“It’s a sign of exhaustion,” said Matt Maley, chief market strategist at Miller Tabak, on CNBC.
As prices of new and existing homes hit record levels, home builders began pulling back because beyond supplies, they simply could not find the skilled labor and land they needed to keep up, according to the Census Bureau.
Some 15% of home builders reported in the monthly survey that they were putting the foundations of homes in place—counting as a “start” in monthly statistics—but holding off going beyond that until supply found more stable ground.
Q1 results for companies that reported recently were mostly spectacular, underscoring the heightened demand for homes brought about by this opportune combination of millennials seeking more space during the pandemic and a long-postponed move toward family formation in what has typically been the suburbs.
“The American dream of homeownership is an essential aspiration of the American population, and the seemingly imminent resolution of the pandemic is not slowing the growing demand,” according to Lennar Stuart Miller, Lennar’s (LEN) executive chair, on the firm’s Q1 conference call in March. “Apartment dwellers can today afford a first-time home, and demand is strong and growing.”
“Yesterday’s first-time homes are selling quickly and at higher prices, enabling first-time move ups,” Miller added. “The market for yesterday’s move-up home is strong and enabling customers to consider and purchase a larger home with a larger yard, with an office, a nicer kitchen, and a new set of necessary spaces for an evolving market.”
But given so much rockiness, is that sustainable? Coffey encouraged investors to listen for any insights builders might have on what’s ahead.
“So much of this narrative has been on the lack of supply for how much demand there is, but how quickly can these home builders get these homes built and ready for the customer?” Coffey asked.
Here are some questions investors might want to consider:
“Right now is a unique time,” Coffey said. “All these things seem to be working against the house buyer, but at some point these dynamics shift, and when they do, how is that going to impact home builders going forward?” Therein lies the brick.
Investments in real estate-related securities are subject to the same risks as direct investments in real estate, including loss of principal. The real estate industry is particularly sensitive to economic downturns.
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