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Why underperforming housing starts affect builders like KB Home

Brent Nyitray, CFA, MBA

Starts, permits, sales, and prices as spring selling season begins (Part 1 of 5)

Housing starts are a critical predictor of future homebuilder sales

Housing starts are released jointly by the Census Bureau and the Department of Housing and Urban Development. Analysts use the information to anticipate future production for homebuilders, future demand for raw materials, and labor costs. This data will even affect the forecasts for home-related retailers, like Lowe’s and Home Depot.

Housing starts cover the number of privately owned housing units that started in a given period. For multi-family units, each individual unit is considered a housing start. If there’s a lot of multi-family construction happening, then housing starts can become elevated, and investors must take care not to read too much into the builders of single-family homes.

Single-family rises, while multi-family falls

Housing starts rose from 920,000 to 946,000. Multi-family starts were 292,000 in March —a decrease from the 311,000 pace in February. Single-family starts increased from 599,000 to 635,000. Single-family starts have been much stabler than multi-family starts and have shown a steady rise.

Starts rebound smartly in the Midwest and Northeast, slip in the South and West

Right now, there’s a boom for rental properties as institutional investors chase the high-single-digit rental yields that are available. This is making life more difficult for young adults, who find themselves most vulnerable in the job market, struggling with student loan debt. Rental properties are competing with the likes of Blackrock (BLK) and Blackstone (BX) for starter homes.

This is the second time in a row we’ve seen a year-over-year decrease. This number is well below historical averages. From 1959 to 2002, housing starts averaged about 1.5 million units per year. In fact, housing starts typically bottomed at a million units during recessions. The fact that the market only recently cracked the one million mark shows just how deep this housing recession was.

Implications for homebuilders

The drop in multi-family starts is good for the builders because they compete with rentals for new household formations, and as the supply of rental properties increases, rents should fall relative to house prices. This could negatively affect new home pricing at the margin. However, that has yet to become evident in the earnings of the homebuilders, which were generally quite strong. So far, homebuilder earnings have been a mixed bag, with Lennar  (LEN) and KB Home (KBH) performing well, while NVR missed. We’ve seen big increases in gross margins from Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), and Toll Brothers (TOL).

Right now, the difference between renting and buying is still extremely wide by historical standards. When you consider the difference between median house prices and median rents, purchasing is cheaper. Rock-bottom interest rates and low prices for starter homes are making homeownership very affordable. As the job market improves for younger adults, those who are currently renting will contemplate homeownership. The Obama Administration has been pushing banks to lend more and use FHA loans for the first-time homebuyers. FHA loans require only 3.5% down, so they’re perfect for the first-time homebuyer. This move from renting to purchasing will help homebuilders in the long term.

Continue to Part 2

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