4 Homebuilders to Buy Now After Being Hammered on New Tax Plan

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While most of the details in the new Trump tax plan were received in a pretty positive fashion, one that did not go over well was the limitation on the deductibility of mortgage interest. The change to the mortgage interest deduction drew immediate attention last week. Under current tax law, Americans can deduct interest payments made on their first $1 million worth of home loans. The new bill would allow existing mortgages to keep the current rules, but for new mortgages, home buyers would be able to deduct interest payments made only on their first $500,000 worth of loans.

Immediately the sharks circled the homebuilders and they all were sold off in quick fashion. The sell-off in the group may be way overdone, since the housing related changes should not impact the majority of homeowners. Almost 90% of existing home sales are less than $625,000 (grossed up for mortgage) and the increased standard deduction should drive higher net discretionary income.

We screened the Merrill Lynch research universe for homebuilding stocks that were rated Buy and found four well-known companies that may be great values. It is important to remember that interest rates for mortgages are still close to generational lows, and demand for first and move-up second homes is growing, especially in fast-growth areas like Texas and Florida.

D.R. Horton

This is one of the highest volume builders in the United States. D.R. Horton Inc. (NYSE: DHI) is the largest public builder by closings in the country, delivering roughly 40,000 homes in fiscal 2016. The company is positioned in 78 metropolitan markets in six major regions, and it develops single-family homes for first-time and move-up buyers.

Approximately 80% of revenue is derived from the Southeast, South Central and West regions, all of which continue to see very solid growth. The company also provides mortgage financing and title agency services to homebuyers.

D.R. Horton shareholders are paid a 0.90% dividend. The Merrill Lynch price target for the stock is $55, and the Wall Street consensus target is $42.61. The stock closed trading on Friday at $44.32 a share.

Lennar

This remains a top pick and is well set in the entry-level market. Lennar Corp. (NYSE: LEN) is the second largest public homebuilder by closings in the United States, delivering over 26,500 homes in 2016. The company is well positioned in 18 states in four major regions targeting first-time, move-up and active adult buyers.

Lennar has diversified its core homebuilding operations with the addition of real estate investment and management, multifamily and single-family and commercial real estate development in California. The company also owns a financial services business.

In addition the company also recently announced that it would merge with CalAtlantic group, which it will acquire for $51.34 a share. The company expects to fund the acquisition with a combination of 80% stock and 20% cash.

Lennar investors are paid a minuscule 0.29% dividend. Merrill Lynch has a $65 price target for the stock, and the consensus target was not available. Shares closed trading on Friday at $54.62 apiece.

PulteGroup

This is another top company with a wide product portfolio. PulteGroup Inc. (NYSE: PHM) is one of the largest public homebuilders in the United States, delivering around 20,000 homes in 2016. The company is also well-positioned in approximately 50 markets in 26 states, targeting the first-time, move-up and active adult buyer groups.

PulteGroup primarily builds single-family detached homes, although it also constructs townhouses, condominiums and duplexes. The company owns a captive financial services business that provides mortgage financing, title, insurance and closing services.

The company posted solid third-quarter results, and the analysts said this in their research report:

Our 2018-19 estimates are driven by strong order growth, price realization, margin execution and some share repurchases. We reiterate our Buy rating on the company and continue to view the company as a top homebuilder stock pick.

Investors are paid a 1.19% dividend. The $34 Merrill Lynch price objective compares with the consensus price target of $30.53. The share price ended last week at $30.31.

Toll Brothers

This company is more focused on the higher end of the market, and business remains good. Toll Brothers Inc. (NYSE: TOL) is a leading U.S. homebuilder with a focus on luxury suburban and urban markets. It operates in four distinct geographic segments, building homes catering to move-up, empty-nester, active-adult and second-home buyers.

Toll Brothers has entered into various joint ventures to develop land or high-rise construction projects. More than 45% of the company’s sales are attributable to the Northeast and Mid-Atlantic regions.

Shareholders of Toll Brothers are paid a small 0.73% dividend. Merrill Lynch has set its price target at $48. The posted consensus target is $43.15, and the shares closed on Monday at $43.90.

You can bet there will be some intense lobbying by the real estate industry to get the numbers for the mortgage interest deduction moved higher. Either way, it won’t touch most of the homes being sold, and it still will be there up to $500,000 for higher end home buyers.