PM Buzz Zaino talks about housing industry’s post-Financial Crisis recovery and how that’s created opportunities for his deep value strategy.
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How has housing rebounded from the Financial Crisis?
New home sales peaked just before the Crisis at roughly three times where current sales volume is. There was a long period of decline as mortgage foreclosures created a big supply of homes in the marketplace. Prices declined, financing was not available or certainly very restricted. And so home sales stayed low for a long period of time.
Then the last couple of years credit availability has improved. And the problem has been the availability of supply. Because the builders, during the period of time of their troubles, didn’t have the ability to buy parcels of land, and because of that they currently don’t have the parcels of land to build new communities. It takes a while after you buy the land that you have to then get permitting from the community and environmental circumstances, so it takes a year or two after you purchase the land to actually have the parcel of land ready for development.
And because of that, the supply is not really meeting the demand for new housing. And the new housing is coming from the first-time buyer and the move up buyer. Those people are just saturating what is available to them. The builders are experiencing good sales throughout their communities. Margins are fair, and profitability is good—cash flow is good. So we’re in a sweet spot right now.
As we go forward we’re going to be meeting some inhibitions, and that is, interest rates are rising, and costs to build are rising. So that the ultimate price of a house is going up, and financing costs are going up also. So the affordability index, which was high, will begin to be declining. You’ll probably see that in the newspaper headlines.
Which areas of home-buying have been most affected?
Of the areas that are going to be most affected I would think the most attractive area has been the first-time buyer. And those are the people who are going to be affected most by affordability. So you may lose some along the way there. The most attractive area is going to be the move-up buyer, because they already have a house, and of course as prices go up, then the price of their house is going to go up.
What is your outlook for your holdings?
Our holdings are not at peak level. We think that the economy is such that because of higher employment, increases in incomes, the home market will still be good in the current year. And so you want some exposure. But it’s probably seen at least half of its journey in appreciation. In terms of the suppliers, the suppliers are in a little better position because they don’t get a lot of new competition. They tend not to add a lot of capacity. So their increased volume produces great cash flow and great margins. And they can do pretty well. And they’ve moved up, but they haven’t moved up quite as much, and so they’ve got room to run.
Article by Buzz Zaino, Royce Funds