Here's the Bull Case for Housing Stocks, and This One Homebuilder in Particular

Housing is red hot right now. Open the paper and you are sure to see stories of bidding wars for individual properties as buyers try to take advantage of low interest rates and an evolving work-from-home culture.

Is it too late for investors to climb on board? On this clip from "Industry Focus" on Motley Fool Live, recorded on May 20, host Nick Sciple and Motley Fool analyst John Rotonti discuss how they view homebuilder stocks today, and why NVR (NVR 0.42%) in particular is a stock Rotonti is bullish about.

Nick Sciple: I pulled a quote off your Twitter, John. Folks should go follow him, JRogrow on Twitter. You said, "I think NVR can be one of the best performing stocks over the next five years." Let's talk about that. Why do you believe that?

John Rotonti: Thanks, Nick. A lot of times I'll find an investment and my thesis will basically be, "XYZ company is a really good business, trading at a pretty good value. " That will be the thesis. With NVR, I think there is a undeniable long-term theme, macro trend that I'm really excited about, and a really good business. You get the best of both worlds. I have housing, which is, like I said, a long-term trend that I'm really excited about, and there's one homebuilder that I think leaps and bounds above all others, and that's NVR.

Sciple: Since you mentioned that, there's a macro story here with the overall housing market, there's a micro story with NVR, and we're going to break our discussion up that way. Let's start off with the macro point of view. Anybody that's been following the housing market knows it's been hot. In particular, the last year prices have shot up through the roof. What's going on with housing? What's driving the macro forces behind what we're seeing in the market?

Rotonti: There are several bullet points here. I think the first big one is that housing inventory is at an all-time record low of two months. There are currently two months worth of homes available for sale in the US, and that's an all-time record low. That's a structural problem because people want to have roofs over their heads. They want to start families, they want to start households. There's maybe many reasons, but one of the big reasons is the US has been underbuilding new homes for a decade now. Another stat is we've been building about 1/3 fewer homes than we did for most of the late 20th century. The Wall Street Journal recently put out numbers from Fannie Mae or Freddie Mac, one of those two, but basically says that were 3.8 million homes short in the US, so roughly four million homes are needed in the US. So this is a major structural problem. Homes are, not only for most people, or for many people, their largest financial asset, their biggest investment, but it's also where they raise their families and create some of their best memories. It's part of the American dream and we don't have enough houses to go around here in the US. That's the big one. Number 2, mortgage rates in the US are extremely low right now. I'm not saying housing is extremely affordable, because existing homes, the markets are so hot in some cities more than others. But this also great for NVR, Nick, because existing homes are so expensive that new homes are more affordable. That's a big driver of that, and the fact that existing homes are so hot, new homes are more affordable, that gives homebuilders some pricing power. It gave them ability to raise their prices to come up somewhat on terms with what existing home sales, which are just too expensive right now. We have not enough homes, existing homes that are too expensive, mortgage rates at three percent for a 30-year fixed. That is generational low. It's not as low as we got at some point last year, but relative to averages of five or six percent, depending on what time-frame you're looking at, mortgages are extremely affordable, three percent. When you take inflation into account, that's literally almost free money. Another major tailwind is millennials, the largest age cohort in US history. They're entering their prime home buying years. If you add up, Nick, that we are under-built by almost four million homes and that the largest cohort of Millennials are entering their prime home buying years, I think we can have a longer than normal housing cycle. Homebuilding is cyclical. I think we're going to have a longer than normal upcycle. Now, the thesis is not dependent on that. NVR is one of these companies, and we can get into this later, that is literally praying for a downcycle. I'm serious. We can get into why, but if there is an upcycle, NVR will go with the trend and keep up with the industry. If there's a downcycle, NVR kicks it into high gear, takes a bunch of share, buys back a bunch of cheap stock, and plants the seeds for the next decade of future growth. There is a lot of tailwinds here, Nick.

Sciple: Right. If you look at a chart with housing investment, it really fell off a cliff in 2008 with new home inventory. You mentioned a multiyear low, and at the same time, the population just keeps ticking up. If you look at millennial homebuyers just now entering the portion where if you want to have the house with the yard and the kids and all those things, there's a structural reason you need to do that. You mentioned housing is on the absolute bottom of Maslow's hierarchy of needs. One of the most inelastic expenses you have out there. You combine this big upswing in demand as the millennials enter their prime home buying, home purchasing years at the same time where we have a structural shortage in supply, basic economics tells you that that's a good market for the folks selling that good.

Rotonti: Yeah, Nick, and you mentioned something that I should have mentioned. You said if you want to have a home with a yard. There is some strong evidence that households are moving out of densely populated cities in a COVID world, because they want more space to work, learn, exercise, and play at home in a socially distanced way. They want that yard to be able to get outside. They want some space between them and their neighbor, versus being in a high rise where you have neighbors close to you on both sides, above and below you, shared AC vents, shared circulation of air. They want to be able to work from home, play from home, learn from home in a socially distanced way. Redfin CEO, Glenn Kelman, last year said, he is expecting something, and this is a quote, "Close to an exodus from really large cities." In the January 2021 Barron's Roundtable, Henry Ellenbogen, one of my all-time favorite investors said this, "One of the most fundamental trends that will come out of 2020 is that America will spread out. The first suburbanization trends started in 1810. I would argue we're now in the 5th phase and it is going to be as powerful, if not more so, than the first four." So there's some strong evidence, even if we start making our way back into the office, that people are moving to the suburbs.