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The following segment was excerpted from this fund letter.
LGI Homes (NASDAQ:LGIH)
For portfolio management reasons, we sold our stake in LGI Homes (LGIH) during the fourth quarter (at a loss.) We continue to hold our shares in another homebuilder, Green Brick Partners (GRBK), a position in which we currently have an unrealized gain.
When we initially purchased LGI Homes in March 2022, the housing market was in the late stages of one of the most robust demand environments that we have seen in more than a decade. Although builders were very clearly overearning – and impending increases in mortgage rates would throttle growth and margins – we determined that the longer-term secular growth story would temper any short-term demand declines.
Since the housing collapse of 2008, there have been roughly 12 million new households formed in the U.S., compared to only 8 million newly built single-family homes. Irrespective of higher mortgage rates, there is still an undeniable shortage of housing inventory. On average, there are roughly 2.4 million homes for sale at any given time, a million units more than the current level of approximately 1.4 million houses.
Housing prices have increased about 50% since the beginning of 2019. This, combined with a 3.2 percentage point increase in mortgage rates, has resulted in an average 80% increase in house payment for the same home compared to four years ago.
These affordability strains make the case for investing in homebuilders less clear. Long-term prospects remain promising, but homebuilder balance sheets carry significant investments in raw land inventory, which can become impaired in the event of a material market correction. As we took a basket approach to our housing investment (our current profits in Green Brick roughly offset our losses in LGI), we decided to reduce our exposure to the sector, sell LGI and redeploy proceeds elsewhere.
The recent signs of what may be the early stages of a housing market downturn have many investors calling for a major housing correction on the order of that experienced in 2007. While there may be certain similarities to the last housing crisis as it relates to affordability, there are also some very major differences.
In 2007, the housing market had experienced years of construction in excess of both historical averages and new household formation – the exact opposite of conditions today. There are a host of other differences, as well. Consumers have much better balance sheets today than they did in 2006, with homeowner equity currently at an all-time high. Unlike the last housing bubble, delinquencies remain near all-time lows, so the forced credit sales that compounded the problem in the last bubble should be far less of an issue. Another material difference is the adjustable-rate mortgage (ARM). Towards the end of the last housing boom, ARMs accounted for well above 30% of all mortgages. This created a ticking time bomb as rate increases flowed into higher payments. Today ARMs account for less than 10% of the U.S. mortgage market.
Putting it all together, we think builders are in a much better position to ride out the near-term weakness in the housing market than they were during the previous cycle. At today’s prices, we continue to see opportunity in the homebuilding sector, despite the significant near-term headwinds. We also believe that the current housing correction is likely to be more regional in nature and that Green Brick, which operates largely in business-friendly, pro-growth markets, will significantly outperform its peers.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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