There is a major housing shortage in this country.
It is estimated that the current demand for homes exceeds the national supply by a whopping 4.5 million. The shortfall has caused the median U.S. home price to soar a staggering 40% just since the pandemic. And that’s the average home price. In certain areas, prices have increased a lot more.
There are several reasons for the supply shortfall. The overall level of new home construction has declined since the financial crisis and hasn’t kept up with population growth. Prime land has become scarcer. And inflation has made supplies and labor far costlier. But high prices aren’t the only problem in the housing market.
In response to the highest inflation in 40 years, interest rates have soared, and mortgage rates have risen to multi decade highs. The higher mortgage rates greatly increase monthly payments for the same size mortgage. Combine higher payments with higher prices and buyers get frozen out. Zillow estimates that only 15.1% of current non-homeowner households can afford a typical mortgage.
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The problem isn’t just with buyers. It’s with sellers too. Many would-be sellers have been reluctant to sell their homes and trade up because they don’t want to swap their low-rate mortgages for a high-rate one. There aren’t enough new homes, and existing homes aren’t coming on the market either. Buyers can’t buy and sellers won’t sell.
But there is reason to believe the housing problems will get a lot better in the years ahead.
Lower Rates … at Last
Mortgage rates are falling. The average U.S. 30-year fixed mortgage rate has fallen to 6.1% from 7.22% this past May and 7.8% a year ago. And rates are likely to continue to trend lower from multi-decade highs in the years ahead. Prices are coming down too. The average U.S. home price has declined about 7% since the beginning of last year.
The housing problem is also well-known. It was even brought up several times at both political parties’ conventions this summer. Remedies in the form of tax breaks and other things may follow. The market almost always corrects itself. Diminished supply will surely be met with increased construction. At the same time, improving mortgage rates and pricing combined with pent-up demand is likely to increase housing market activity in the years ahead.
While the situation is likely to improve, the supply/demand imbalance will likely remain for several years. That’s a problem of the housing market and economy to work through. But it’s good news if you’re a homebuilder. New homes should be in high demand for years to come, and sales should increase with the improving conditions.
And I’ve got just the homebuilder stock to take advantage…
Toll Brothers (TOL): The Best Homebuilder Stock to Buy Now
Toll Brothers, Inc. (TOL) is the leading luxury homebuilder in the United States. The company operates in over 60 markets across 24 states and caters to move-up, active adult and second-home buyers. Although the main business is home sales, Toll Brothers owns and operates several related businesses in architecture, engineering, mortgage, title, land development, landscaping and lumber distribution.
At first glance, the company may seem to miss the mark. There is a huge demand for first-time homes and new homebuyers. Toll Brothers isn’t in that market. But it benefits greatly from the current housing shortage with more predictable and dependable affordable luxury buyers. It offers prestigious locations and distinctive architecture for a range of dwellings including traditional homes, city apartments, and adult communities.
Most first-time homebuyers will buy their houses from existing homeowners, and many of those people will trade-up. There are a couple of powerful trends that make step-up moves likely. Wealth creation has been excellent as many buyers have benefited from a strong stock market over the last decade plus, not to mention increasing home values, and individual wealth is above historical averages.
New homes are also cheaper on a relative basis. Historically, the premium paid for new builds has been 17%, but that has fallen to 5% in 2024 as existing home prices have soared. Millennials are in their prime home buying years and baby boomers are making lifestyle changes. Toll Brothers is a very strong player in empty nester homes and active adult communities.
In this market, Toll Brothers and similar companies have been gaining market share like crazy from private companies. Public, or publicly traded home builder companies, now represent 53% of this country’s new home settlement, up from just 27% in 2012. Toll Brother’s operational results have reflected the improving environment.
Since 2013, book value per share has grown by a compound annual growth rate (CAGR) of 13%, from $19.68 to $76.50. Return on equity has had a CAGR of 14% and earnings per share (EPS) have experienced 28% annual growth over the same period, from $0.97 to an estimated $14.50 to $14.74 for 2024.
How has this reflected in stock performance?
TOL has blown away the returns of the S&P 500 in every measurable period over the last 10 years. But that prompts justifiable concern. Have you missed the boat on this homebuilder stock?
I don’t think so. Earnings have risen steadily while the company has also been hugely active in buying back shares. Since 2016, Toll Brothers repurchased a whopping 50% of existing shares on the market. As a result of higher earnings and less shares, TOL sells at both a current and forward price/earnings ratio of less than 11 times, half that of the overall market.
How do things look going forward?
The industry dynamics have greatly improved in just the last few years. Demand will outstrip supply of new housing for many years to come. And Toll Brothers has still barely made a dent in the potential. Toll Brothers is currently selling about 10,700 homes per year. But according to the company, the potential or addressable market for its type of homes is an estimated 575,000. That’s only 1.9% penetration.
There is something besides size and name recognition that is crucial to the home building operation – land. Sure, a good homebuilder can whip up a great home. But you need the land to build it on in desirable locations, which is increasingly scarce and very difficult to get approval to develop. Toll Brothers has the deep pockets and know-how to run a large and effective land acquisition operation. Toll Brothers currently has a backlog of 73,000 owned or optioned properties. The premier inventory provides a massive advantage over competitors.
Homebuilder stocks typically get a bump in times of interest rate cuts. And Toll Brothers is poised to get the biggest boost of them all.
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