Buffett Turns Bullish On Homebuilders
The saying goes… Great minds think alike.
So I’m feeling pretty “great” after reading Warren Buffett’s latest letter to Berkshire shareholders.
You see, Mr. Buffett made the same comment about the housing market that I said to Sector ETF Trader subscribers back in October. I don’t think anyone would disagree his mind is great, so I get to be great for today!
In his annual letter, Buffett said “that within a year or so residential housing problems should largely be behind us”.
The good news for you is there’s still time to get in on this profitable trade.
It’s no secret the housing boom drove the economy up. And it’s not a secret the housing bust drove the economy into the ground. It happened because of an imbalance in the housing market. Supply and demand got out of whack.
During the boom, builders were supplying about 2 million new homes a year. But new households were only demanding about 1.2 million a year.
It’s easy to see how after a few years we have a huge glut of homes. Now, the problem never would have gotten as bad as it did without a few enablers along the way.
Those enablers were the speculators and the banks. Combining loose lending, low interest rates, no down payments, and people who can’t pay the money back is a bad idea. It created artificial demand, especially in areas like Arizona, California, Florida, and Nevada.
It was like a game of musical chairs… without any chairs. The music played for so long nobody thought it would ever stop. But when the music finally stopped, it wasn’t just one person getting hung out to dry. Everyone went down.
How do you correct the problem of excess homes? New housing starts must fall below the rate of household formations.
The builders have done their part and cut supply. In 2009, new housing starts hit their lowest pace in the 50 years it’s been tracked. Only 554,000 new housing starts were registered in 2009.
The problem is, as the economy tanked and jobs disappeared, new household creation disappeared too.
New household creation dropped from an annual rate of 1.2 million to under 500,000 per year over the last three years.
It’s not as if these people just disappeared. They’re just acting rationally. If you can’t get a job, you’re not going to buy a house or rent an apartment for yourself. No, you’re going to bunk with family or friends until things improve. And that’s exactly what people are doing.
But what happens when the economy starts to pick up and jobs are available? Those same people bunking with family and friends are going to want a place of their own.
A tidal wave of pent up demand will start hitting the housing market. We could even see some areas swing to a housing shortage. And if the economic recovery keeps up its current pace, it will happen before the year is out.
I see a number of ways to profit.
If you’ve got the cash, I recommend buying multi-family apartment buildings. The housing shortage will cause rents to rise. Some industry analysts are calling for rents to increase at 4% to 10% per year over the next five years. That’s a stream of increasing cash flow and rising property value that will be hard to beat.
If you’re looking for an easier way to cash in on a smaller scale, take a look at the homebuilders.
Right now the inventory of new homes is at its lowest level since 1971. The National Association of Home Builders estimates builders will need to crank out about 1.8 million new homes per year over the next ten years to keep pace with demand.
That means homebuilders are about to begin another cycle of expansion and growth. It won’t be as crazy of a boom as we had in the 2000s but it will be very profitable.
For the most part, homebuilders’ stocks haven’t recovered as quickly as the rest of the market. So there’s still plenty of upside.
An easy way to get exposure to all of the publicly traded homebuilders is the SPDR S&P Homebuilders ETF (XHB). XHB holds stock in 28 homebuilders and other housing-related companies.
So ready or not, there’s another profitable housing cycle just getting started. And you don’t even have to take my word for it. Take Warren Buffett’s… Great minds do think alike.
Category: Real Estate
