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Homebuilders have been a great investment throughout the years. However, things have slowed down a bit recently, given the threat of higher interest rates and slowdown in mortgage lending.
Still, there is an underrated part of the housing market that could lead to the next boom. This market targets people that can’t get conventional mortgages.
Now, we’ve already seen a rise in seller financing, which allows lower-income families the ability to buy homes without the hassle of traditional mortgages. Banks still aren’t offering mortgages to riskier clients and people that have damaged credit histories. In fact, last year we saw the number of new mortgages in the top U.S. metropolitan areas for $100,000 or less hit the lowest level in a decade.
Investment firms are looking to capitalize on this market by buying homes and offering them to lower-income families under seller-finance agreements. Shelter Growth, a Connecticut-based investment firm run by a former Goldman Sachs (NYSE: GS) partner, is one such example. Its slogan is that it’s “creating investments to capitalize on the next phase of the U.S. mortgage market.”
Even private equity is capitalizing on the rise in seller financing; Apollo Global Management (NYSE: APO) is the big name in the space. With all these trends, there will need to be more affordable housing built.
The easiest way to play the lower-income housing movement is with the homebuilders that are catering to this segment. Now, some of these are seller-financed buyers, but people taking advantage of Apollo’s offerings won’t be moving into brand new homes right off the bat. But these types of programs at least get the ball rolling on homeownership and make move-up purchases more likely.
Here are the two best homebuilders to play the low-income housing boom:
No. 1 Low-Income Housing Boom Play: D.R. Horton (NYSE: DHI)
D.R. Horton already targets the first-time and entry-level homebuyer, but the company has launched a new brand, called Express Homes, which is looking to tackle the lower-income homebuyers. Beyond that, the shift in demographics – which includes millennials (the largest generation in U.S. history) eventually becoming homebuyers – will be a big positive for D.R. Horton.
The weak wage growth and boom in student debt has delayed the full housing recovery in the lower-priced housing segment. D.R. Horton is getting out in front of the potential reversal, and as the largest homebuilder in the U.S. it has a major leg up.
Lest we forget, D.R. Horton has also been making big bets that lower-income homebuyers will look to move into their houses quickly. Hence, it’s been utilizing a higher-risk speculation strategy that involves building these houses before they’re sold. It’s certainly a risk, but with all the data pointing toward a boom in lower-income homeownership, it’s a risk worth taking for D.R. Horton.
No. 2 Low-Income Housing Boom Play: KB Home (NYSE: KBH)
KB Home is one of the largest homebuilders in the United States. It targets major states like Texas and Florida. The beauty of KB Home is that it specifically targets first-time homebuyers, who tend to be in the lower-income space. For the first quarter it delivered nearly 25% more homes than last year, and it appears to be shaking off any weather-related issues from late 2015.
KB Home is also able to tap into the step-up buyer market that doesn’t necessarily need mortgages. It’s a smaller homebuilder – about a tenth of the size of D.R. Horton in terms of market cap. Yet it has a lot of exposure to the Western U.S. – such as Arizona, New Mexico and California – where the housing markets have some of the best potential for a stronger-than-expected rebound.
The median price of new homes has been on the decline thanks to homebuilders offering more affordable homes. And companies that will be able to capitalize on the potential rise in lower-income homebuying are already getting out in front of the movement.
The likes of KB Home and D.R. Horton should have a leg up on the competition over the next few years. What’s more is that they both offer investors dividends and are relatively cheap from a valuation perspective.
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