Why Homebuilders May Be the Best Place to Invest Now

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With interest rates and, in tandem, mortgage rates falling to the lowest levels in years, it makes sense that some on Wall Street are looking to the top homebuilders as consumer interest heats up again. With traffic to real estate websites surging, and pent-up demand, especially in the entry-level market, exploding, it makes sense to look at the top companies in the industry.

Merrill Lynch points out that new home sales surged 7.1% month over month in August to 713,000 units, well surpassing consensus expectations of 659,000. In addition, it has been noted that the older millennials are stepping in to home buying, with many now very positive over their first home purchase.

We screened the Merrill Lynch homebuilder research universe looking for companies rated Buy and found two that are very solid picks now. With interest rates likely to stay low for years, this could be a longer term trend.

D.R. Horton

This is one of the highest volume builders in the United States and a top pick at Merrill. D.R. Horton Inc. (NYSE: DHI) is the largest public builder by closings in the country, delivering roughly 52,000 homes in 2018. It is positioned in 79 metropolitan markets in six major regions and develops single-family homes primarily for first-time and move-up buyers.

Approximately 80% of revenue comes 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.

The company boasts some of the highest quality and fastest growth potential via entry-level exposure and competitively advantaged market share, and it can weather cost pressures with strong free cash flow. Most on Wall Street see upside to estimates from the usage of its $1 billion operating cash flows per year. The company’s priorities are share buybacks, debt reduction and bolt-on mergers and acquisitions.

Shareholders receive a 1.14% dividend. The Merrill price target for the shares is $65, while the Wall Street consensus target is much lower at $53.09. The shares traded Thursday at $52.65 apiece.

Lennar

This company is another top pick at Merrill 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 49,000 homes in 2018. The company is well positioned in 21 states in 49 markets 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.

Lennar offers investors a miniscule 0.29% dividend. Merrill has a $64 price target, and the posted consensus figure is $60.44. The stock was trading at $55.85 a share.

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These two stocks have solid upside to their respective targets. With the mortgage interest levels raised, the great majority of the homes sold by these companies will be eligible for the deduction. In addition, if mortgage rates continue to fall the rest of 2019 and next year, sales should continue to move higher, possibly much higher.