When the housing bubble burst in the early part of this century, new housing starts plummeted. A weak economic recovery, a large supply of repossessed homes, falling home prices, and stringent mortgage underwriting standards suppressed demand for single family homes. In addition, the demand boost expected from the huge wave of millennials entering their prime home buying years failed to materialize as they delayed purchasing a home to an age beyond that typical of previous generations.
As time passed, the excesses of the housing bubble were eliminated. Since the bursting of the bubble, growth in U.S. households has meaningfully outstripped the supply of new homes, leading financial firm Jefferies to estimate there is a shortage of 2.5 million homes to meet current demand. The shortage is most acute among starter homes, as rising construction costs make it difficult for builders to earn sufficient profits on homes affordable to first-time home buyers. The COVID-19 pandemic and civic unrest have only exacerbated the problem, as changing working arrangements and lifestyles have made single family homes with additional indoor and outdoor space more desirable than apartment living to many. We believe these factors underpin an attractive long-term outlook for building products companies, particularly those that can help lower costs and increase efficiencies for home builders.
According to Realtor.com, between 2012 and June 2021, 12.3 million new households were formed in the United States. During the same period, 7.5 million single-family homes were started, and 7 million were completed. Assuming household formations continue at their 2021 rate, new single family home completions would have to double their current rate to close the gap within six years.
Housing Production Has Not Kept Pace With Population Growth
The situation has been particularly acute at the lower end of the market, with entry-level housing supply at a 50-year low.
New Entry-Level Housing Supply at Five Decade Low
The imbalance between supply and demand has contributed to record home price appreciation.
Housing Supply and Prices
We believe demand for housing will remain strong. Millennials make up the largest section of the U.S. population, but they lag previous generations in terms of homeownership. However, the percentage of millennials purchasing homes has accelerated in the last several years.
Homeownership Rate (Ages 23-38)
Source: 2019 U.S. Census-Current Population Survey (CPS)
Millennial Homeownership Rate Trend
Source: 2019 U.S. Census-Current Population Survey (CPS)
Furthermore, the pandemic has accelerated this trend. A recent Clever Real Estate survey indicates that 30% of millennials stated the pandemic caused them to begin house-hunting sooner than planned. In the same survey, 50% of millennials cited the desire for more space as the primary motivation for home ownership. These trends are part of the reason for an increase in migration from cities to suburban areas.
Source: Federal Reserve Bank of New York/Equifax Consumer Credit Panel, American Community Survey
Source: Bureau of Labor Statistics
One of the reasons supply of new homes has not kept up with demand is the rising cost of home construction. A recent decline in lumber prices has eased pressure somewhat, but costs for a variety of other materials, including plastic water pipe, fabricated structural metal, cooper pipe and tubing, and steel mill products rose over 20% between April and July of this year, according to a report by the National Association of Home Builders (NAHB). In addition, according to a recent Associated General Contractors of America and Autodesk survey, 89% of contractors are having a hard time finding craft workers, while 88% of firms are experiencing project delays. Regulatory costs have also risen, with an NAHB survey showing that regulations at all government levels add $93,870 to the cost of a home, up from $65,224 in 2011.
In the short term, the demand for housing may fluctuate based upon the health of the economy and interest rates, among other factors. In addition, resolution of supply chain issues and slowing economic activity may ease the pressure on building material costs. However, we believe the pent-up demand for housing will take years to satisfy, and many cost pressures, especially labor-related ones, may be more structural than temporary, and at a minimum will take a significant amount of time to rebase. Therefore, we believe there is an opportunity in stocks that can benefit from the favorable outlook for housing, especially if they can help address the cost pressures faced by home builders.
In the Keeley Teton Opportunities portfolio an example of a stock well positioned to take advantage in this environment is Builders FirstSource, Inc. (BLDR), a supplier and manufacturer of building materials, manufactured components and construction services to professional homebuilders, sub-contractors, remodelers and consumers. BLDR produces prefabricated structural building components, including roof trusses, floor trusses and wall panels. Their Ready-Frame® service precuts all the lumber for a house, which improves construction time and reduces waste. This initiative removes labor from the job site and provides a better finished product. Also, BLDR has invested in digital technology to streamline its customers’ ordering process, which takes labor out of quote-to-sales cycle.
Another company in the portfolio that benefits from strength in the housing market is JELD-WEN, a leading manufacturer of doors and windows. It also helps contractors take labor out of the construction process. JELD installs its own employees at customer construction job sites and is developing turnkey solutions as well as high-quality prefabricated product to make builders more efficient.
Keeley Teton Opportunities seeks to identify stocks with positive long-term outlooks that are not fully reflected in their current valuations. Builders FirstSource, Inc. and JELD-WEN are good examples. They trade at attractive valuations due to near term concerns about rising interest rates and supply chain disruptions despite being well positioned to take advantage of favorable trends in the housing market.