One of the best ways to be a successful investor is to identify a long-term trend and invest in it. Demographics show that the long-term outlook for construction of single family houses in the U.S. looks quite good, and millennials have a lot to do with that.
Much is written about the various generations in the U.S.: how they are categorized and the size of each cohort. According to population estimates released by the Census Bureau, millennials have surpassed baby boomers in size. What does this size have to do with housing starts and future construction? There are two key reasons why the size of the millennial generation creates a long-term trend in favor of single family home construction. The first is their age. The second is they are getting a later start.
According to the Census Bureau, household growth averaged about 2 percent annually from the mid-1960s until the early 1980s when baby boomers were at their prime household formation ages. Household formation rates were later cut in half. Millennials are just reaching their prime years of household formation. The 2008 recession slowed the natural process of formation down for economic reasons. This, coupled with the general trend of millennials having children at a later age, creates a pent-up demand that could be on the rise for over a decade. Moreover, while millennials are starting families later, the birth rate for women between 30 and 34 has increased steadily by 5 percent since 2011, per a CDC report.
There has been a reported trend about young adults being drawn to urban centers, and therefore, not interested in home ownership. However, according to research by Jed Kolko, former chief economist for Trulia, the overall U.S. population is now less urban than before the start of the housing bubble. While college-educated young adults may have been drawn to urban areas as they began to have children, the desire and need for more space is increasing, with single-family homes generally being the choice.
So we have millennials, the largest demographic group ever, entering their early 30s, starting households and having children. Single housing starts show that single-family home construction should have a bright future. According to the Bureau of Economic Research, the annual rate of single housing starts in July 2016 was 770,000. While that is well above the low point of approximately 400,000 hit in 2009, it is not much higher than the lows hit in all of the recessions since 1970. Prior peaks have been between 1.4 and 1.8 million.
Where to invest. Considering the impact millennials are having on the housing market, a company to consider for investing in this trend is M.D.C. Holdings (MDC). M.D.C. primarily sells single-family homes on both coasts and its business consists of two primary operations: homebuilding and financial services. It focuses on first-time and trade-up home buyers. During the second quarter of 2016, the average sales prices of its homes was more than $445,000, indicating that its customers are more affluent and are likely less impacted by short-term changes in interest rates.
Additionally, M.D.C. was one of only two homebuilders to maintain an investment grade credit rating through the housing downturn and not cut its dividend. The current dividend yield is approximately 3.8 percent and the company has a forward price-earnings ratio around 9.3X earnings. The fact that managements' interests are in line with the shareholders are a plus; the CEO and COO together own more than 20 percent of MDC's stock.
Another company to consider is KB Home (KBH). While not as attractively priced as MDC stock, a forward earnings multiple of 11.3X earnings coupled with an historical focus on first-time home buyers and management, indicates that KB Home remains committed to millennials. KBH stock has seen several quarters of year-over-year increases in average selling prices, with first-time buyers selecting larger homes as one of the contributing factors.
When investing in the homebuilder sector, it should be recognized that the industry can be impacted by short-term concerns related to interest rates, consumer confidence, lending standards and employment. Consequently, stock prices can be volatile and investors should be aware of this. However, the millennial movement is a long-term trend that should bode well for this industry.
Disclosure: As of this writing, neither Phillips nor clients of the firm own positions in MDC or KBH.
More From US News & World Report