Expectations for 2020 tempered after housing starts climb to levels not seen in a decade

ByWill ParkerDec. 24, 2019 7:00 am ET – Via The Wall Street Journal

U.S. home builders benefited from low interest rates this year as housing starts climbed to levels not seen in a decade and new-home sales surged after a disappointing 2018.

Builder confidence, as measured by the National Association of Home Builders, is now the highest since 1999. And publicly traded home-builder stocks beat the S&P 500 average this year, rising 40% as of Dec. 23, compared with the broad index’s 29% gain over the same period.

Home builders cranked up volume partly by focusing on homes more buyers can afford. Large builders including Meritage Homes Corp. and MDC Holdings Inc. made strategic shifts to produce a higher number of less-expensive homes, targeted at a generation of millennials with lower purchasing power than average buyers in the past.

In the third quarter of this year, the average price of a Meritage home fell 4.4% while the number of home orders rose 24%, driven by demand in the entry-level category. Through the RoofHome-builder stocks have outperformed the S&P 500 this year.Industry versus broad marketSource: FactSet%S&P HomebuildersSelect IndustryS&P 500Jan. ’19MarchMayJulySept.Nov.-5051015202530354045S&P Homebuilders Select IndustryxAug. 23, 2019×25.63%

“You’re seeing shifts down in average price,” said Jonathan Boise, a home-builder analyst at Fitch Ratings. “Typically, for the builders that are focusing on entry-level product, that’s resulting in stronger growth than their peers.”

Strong buyer demand for more-affordable homes stoked mergers and acquisitions. In November, Taylor Morrison Home Corp. said it would purchase a West Coast competitor, William Lyon Homes, a company that does more than half of its business in the entry-level market. Scheduled to close in 2020 and valued at $2.4 billion, the deal was among the largest announced in the industry this year.

Some home builders and analysts question whether growth will continue at the current pace next year. Fitch, for example, predicts new-home sales will only grow 1.5%, compared with 9% in 2019.

Interest rates are expected to remain low, meaning mortgage costs will still be cheaper than in 2018, a continued incentive for more buyers to come into the market. And Fannie Mae forecasts that housing-construction starts will increase 10% next year to reach a postrecession high, giving supply a needed boost.

But cost increases fueled by labor shortages and regulatory challenges are making it harder to deliver homes with affordable price tags, according to builders. Labor costs are going up partly because home builders are having a hard time recruiting workers in a strong economy.

“We’re fighting the agriculture industry, the restaurant industry for the same people,” said Chuck Fowke, a custom-home builder in Tampa, Fla. “Today, you’ve got a lot of young people going to work for FedEx or Amazon, and a lot of times in our industry there aren’t benefits available for entry-level people that are starting out.”

As a result, residential-construction workers are more likely to be older than the workforce at large, and the industry continues to be short 300,000 to 400,000 workers in any given month, according to Robert Dietz, the National Association of Home Builders’ chief economist. Worker productivity in the sector has been mostly flat for more than two decades, he said.

Trade concerns remain a problem for the industry. Although lumber prices have since fallen, a 2018 price increase related to the Trump administration’s Canadian tariffs was enough to raise the average home construction cost by $9,000, according to the group.

“Those tariffs are still in place,” Mr. Dietz said.

Next year could be riskier for home builders as more companies move to meet demand from entry-level shoppers, who “typically look for homes that could be delivered within a short period,” according to a recent Fitch report.

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To meet demand, some home builders are planning to build more “on spec,” building homes that don’t yet have buyers, as opposed to building based on customer orders.

Thanks in part to the industry’s strong showing in 2019, analysts said mergers and acquisitions could continue in 2020, with publicly traded builders accounting for a greater share of total home-building. Fitch, for example, expects regional builders focused on the entry level to be attractive targets for acquisition.

Large builders are looking at companies with landholdings that are legally ready to be developed. Such deals are a way to navigate long permitting processes, said Chris Jasinski, managing partner at JTW Advisors, which advises in home-builder mergers. “Increasingly it’s just another land-acquisition vehicle,” he said.

Source: The Wall Street Journal

Write to Will Parker at will.parker@wsj.com