Don't Count Out the Homebuilders

05/02/2017 2:50 am EST

Focus: REAL ESTATE

Marshall Hargrave

Contributing Editor, Wyatt Investment Research

Investors are starting to shun the homebuilding industry as the rising rate environment becomes more challenging for the industry. But in fact, housing has remained resilient over the last few years, explains Marshall Hargrave, contributing editor to Wyatt Research's Daily Profit.

The idea that rising rates equals reduced demand for mortgages appears to be a flawed thesis for the time being, for several reasons.

First, the Federal Reserve’s plan to boost interest rates will be very slow and drawn out, meaning rates will remain relatively low for a long, long time.  

And it may be counterintuitive, but the slight increase in interest rates could actually be a catalyst for a segment of homebuyers. That is, some potential buyers are looking to get in before rates go up even more.

So, don’t count out all homebuilders stocks. Here are three thriving homebuilders well worth owning in this environment:

D.R. Horton (DHI)

D.R. Horton is the largest homebuilder in the U.S., operating in nearly 30 states. This type of widespread operation gives the company inherent geographical diversification. The stock pays the largest dividend among major homebuilders; its yield is 1.2%.

One of D.R. Horton’s biggest advantages could be the fact that it caters more toward first-time homebuyers  — millennials, that is. Yes, it’s been challenging for millennials to purchase homes in recent years; that is one of Gundlach’s key bear theses for housing.

Bit conversely, there’s a lot of pent-up demand here. Some 60% of millennials aged 18 to 35 years old live with parents, relatives or roommates, which is a 115-year high.

Meanwhile, the mortgage market is becoming more favorable for first-time buyers applying for loans. That’s a win-win for D.R. Horton, it appears.

NVR (NVR)

NVR isn’t as cheap as other homebuilders — trading at 13.6 next year’s earnings estimates — but it’s easily one of the best operators in the industry. The company runs a “land-light” business model —  that is, it doesn’t buy, invest in, or develop land. As a result, it’s kept a pristine balance sheet.

By buying up already finished lots, NVR has perfected a business model that helps maximize returns for shareholders. Thus, the company’s return on invested capital of nearly 25% is industry-tops.

If you’re looking for a financially conservative company with high margins, you’d be hard-pressed to find a better one than NVR.

Lennar Corporation (LEN)

Lennar pays a modest 0.3% dividend yield, but the real reason investors love the homebuilder is that it owns a massive amount of land. Unlike NVR, Lennar has a decent debt laid that it has amassed by buying land. Lennar is making a bet that land supply will continue to dwindle over the next half-decade. 

Lennar is the second-largest homebuilder in the U.S. and expects the land shortage to offer impressive pricing power for the company going forward. Lennar management has even said that it sees a sense of general optimism in the housing market these days.

In the end, concerns about interest rates and homebuilders looks overblown, especially for the top players in the industry.

The three homebuilding stocks above are positioned to remain resilient despite the minor boost in rates, each with its own catalysts and growth angle in the homebuilders industry. These are the contenders to own now.

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