Market Overview

Could this Stock Profit from Higher Construction Spending?

Thanks to higher construction spending, American home builders received another boost of optimism, with Toll Brothers (NYSE: TOL) up in early trading on Wednesday.

According to a new report released by the Commerce Department, building outlays increased by 1.5% in December, far beyond analyst estimates of 0.5%. The figures reflect the biggest gain in new construction since August 2011.

Private construction saw an even bigger jump, with spending up 2.1% in December, and homebuidling outlays were up 0.8%. While previous gains in apartment construction suggested that Americans were shifting to renting over buying after the tumultuous subprime housing crisis, a jump in single-family housing projects last December suggests that the trend to rent may be short-lived. December saw 470,000 single-family houses being built, the most since April 2010.

The move to build new single-family houses is in part an attempt to capitalize on several factors in homebuyers' favor. Home values continue to fall. The S&P/Case Shiller index showed a drop in home values of 3.7% in November. While this sounds like bad news for homeowners, it also means houses are cheaper for homebuyers. That, combined with mortgage rates under 4%, is making home buying more attractive.

At the same time, the news also makes homeownership a riskier investment than it seemed before 2007. This doesn't mean consumers will stop buying homes, but that they will buy them for different reasons. Buying a house is becoming a thrifty choice. Last July, a study by Trulia.com concluded that the cost of property taxes, a mortgage, and property-associated expenses is lower than rents in 74% of major U.S. cities. Lower property prices will just make homebuying seem a better bargain for people looking for a place to live.

Record low mortgage rates, thanks to the Fed's decision to keep interest rates low until 2014, is also making homebuying appealing to dealseekers.

While new-home developers may be depending on low prices and low mortgage rates to spur demand, the recent move to expand construction is risky. New-home purchases were at their lowest rate ever for 2011, with sales in December falling by 2.2%. Developers may be anticipating a drop in houses on the market, now that the foreclosure rate has fallen to pre-recession levels, but developers may be putting the cart before the horse. Low prices and low mortgage rates did not lure homebuyers in 2011, and it may be too early to predict a change in 2012.

Expectations are running high for homebuilders, especially Toll Brothers, which reached its 52-week high on January 18th at $23.31. Further growth may be in the cards, thanks to the strategic purchase of Seattle builder CamWest Development, which pushes it into the Pacific Northwest. With luxury home sales up in the region, the developer is entering an expanding market.

Toll Brothers will need to see similar spikes in luxury home sales nationwide to sustain its current high stock price. That will only be possible if new home sales recover from their slump and Toll Brothers can offload its current inventories, which have steadily risen since 2008. That hasn't happened yet; at $1.48 billion, net sales in 2011 were down 1.2% from last year's figures. The company has enjoyed growing margins and slightly higher revenues, prompting investors to hope that the company has returned to profitability for good, but it will need to sell more units to make that momentum stick.

Posted-In: News Retail Sales Best of Benzinga

 

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