Wedbush's Jay McCanless: Berkshire's bullishness on DR Horton and Lennar shows promise for housing

Key Concepts

• HomeBuilder Sentiment
• Mortgage Rates
• Buyer Traffic
• Supply Side Challenges
• Consumer Confidence
• Move-up Buyer vs. Entry-Level Buyer
• Berkshire Hathaway's Investment in Homebuilders (Lennar, D.R. Horton)
• Housing Under-building
• Zillow's Software Business
• Existing Home Sales
• Lock-in Effect

HomeBuilder Sentiment and Market Challenges

The HomeBuilder sentiment has pulled back in August due to elevated mortgage rates, weak buyer traffic, and ongoing supply-side challenges. Despite a fall in mortgage rates, the market hasn't improved significantly. The traffic subindex showed an increase from July to August, which is a positive sign. Builders need more traffic to their neighborhoods.

Impact of Mortgage Rates and Buyer Types

Lower mortgage rates haven't had the expected impact on homebuilder stocks. Move-up buyers and luxury buyers are still active, but entry-level buyers are struggling. Companies like D.R. Horton and Meritage have had to buy down mortgage rates and offer incentives to attract buyers. A drop in the headline mortgage rate to the low sixes or high fives could bring more people back to the market.

Consumer Confidence as a Headwind

Consumer confidence is a significant headwind, potentially more so than in previous years since the GFC. Builders have highlighted this issue in recent earnings calls. Improvements in consumer confidence, along with lower rates, could help the market.

Berkshire Hathaway's Investment

Berkshire Hathaway increased its exposure to the sector by adding shares of Lennar and initiating a stake in D.R. Horton. Berkshire already owns the largest manufactured housing company, a top 15 stick builder, and USG. This signals that Berkshire is bullish on housing long term. The US is estimated to be 2 million to 5 million homes underbuilt, and Berkshire is trying to capitalize on this need.

Zillow's Performance and Software Business

Zillow's stock has had a strong year, up almost 57%. Zillow's software sales to realtors and realtor boards are a key growth driver. Zillow has been growing faster than the underlying real estate market for the last five quarters. Existing home sales are currently around 3.9 million annually, compared to a normal 5.5 million to 6 million. The expectation of a turnaround in resales and the increasing adoption of Zillow's software tools contribute to its positive outlook.

Return to Normalcy

The "lock-in effect" (where homeowners are hesitant to sell due to low existing mortgage rates) and low consumer confidence are delaying a return to normal. Improvements in either consumer confidence or a drop in mortgage rates to the high fives could help the market recover. There is a lot of pent-up demand.

Notable Quotes

• "The traffic subindex actually showed an increase from from July to August. That's the first increase we've seen in a while. And if that's a sign of better things to come, I think that's one of the big things the builders have needed this year is more traffic coming out to the neighborhood." - Jay Mccanless
• "Depending on which stat you want to believe, we're somewhere between 2 million and 5 million homes under built in the US. And so I think Warren Buffett and Berkshire are trying to take advantage of that." - Jay Mccanless

Technical Terms and Concepts

• HomeBuilder Sentiment: A measure of the confidence and outlook of home builders regarding current and future market conditions.
• Traffic Subindex: A component of the HomeBuilder sentiment index that measures the number of potential buyers visiting model homes or sales offices.
• Lock-in Effect: The phenomenon where existing homeowners are reluctant to sell their homes because they have low mortgage rates and don't want to take out a new mortgage at a higher rate.

Conclusion

The housing market faces challenges from high mortgage rates, low consumer confidence, and supply-side issues. While move-up buyers remain active, entry-level buyers are struggling. Berkshire Hathaway's investment signals long-term confidence in the sector. Zillow's software business is driving growth, and a return to normalcy depends on improvements in consumer confidence and lower mortgage rates.