We've been getting reports -- like the one from Redfin (NASDAQ: RDFN) recently -- that the housing market is getting saturated. And yet, shares of Toll Brothers (NYSE: TOL) popped 12% after the homebuilder reported better-than-expected profits and increased guidance. What gives?
In this segment from MarketFoolery, host Chris Hill and analyst Tim Hanson explain a few factors that could be causing this disparity -- like different market segments, shifting demographic profiles, and rising interest rates -- and what it all means in the bigger picture of the housing market.
A full transcript follows the video.
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This video was recorded on Aug. 21, 2018.
Chris Hill: We have talked recently on this podcast about the broader housing industry, in terms of the real estate market, talking about Zillow and Redfin, and talking about home improvement with Home Depot and their results. Let's start with actual home builders today. And that's Toll Brothers. Toll Brothers' stock up 12% this morning. Third quarter profits for the luxury home builder came in higher than expected. Toll Brothers also raised guidance. It seems like some people were surprised by this. I get the feeling that you were not.
Tim Hanson: It's interesting. Toll Brothers, within the home building industry, is generally regarded as the luxury home builder. Bigger ticket homes, higher price points, so on and so forth, with a lot of exposure to California, some of the markets that have been a little bit hotter. I think with recently rising interest rates, if you look, they had a really strong second quarter, as well, the quarter prior to this. If you look at the data and the recent rising interest rates, I think people were expecting them to have cooled off a little bit. But they said no, basically every market remains strong. They like their backlog, profitability looks stable, so they were feeling pretty good.
I think there are a number of demographic trends that point to continued strength in the housing market. It's been going for a couple of years now. I think last time I was on the show, we talked about Home Depot and people reinvesting in their homes. There are a couple of interesting trends. One, is older Americans, 55-65 and older, are owning their homes longer and buying retirement homes, and you can expect them to live longer, so that housing stock's not going to turn over maybe as frequently as it would have in the past. Second, you're finally seeing mid-30-year olds finally get together and start homes. Then, as a knock-on effect of that, the renter rate overall is coming down.
Now, where it settles out is an interesting question. If you look at prior to the housing bubble it was at around 35%. During the housing bubble, when everybody was buying homes, it dropped all the way to about 30%. It had spiked following the housing crisis at about 37%. Now it's about 36%. Does it go back to 35%? In which case, maybe this housing boom is going to be not so sustainable in the future? Or does it start to drop again and get closer to, maybe settle out 33-32%? Then, I think you would see a couple of more years of strong growth in the industry.
Hill: One of the things that came up recently was Glenn Kelman, who's the CEO at Redfin, talking about, in terms of their latest report, how buyer demand is waning. I think of Redfin as tying in with Toll Brothers, I think of Redfin as being a little bit more toward the luxury end of the market. They're not trying to be all things to all homebuyers. I'm curious how what we just saw today from Toll Brothers squares with that, or if it's always going to be the case that people who are actually building the homes, they're going to be the leading indicator, as opposed to the Redfins of the world.
Hanson: It's an interesting question. I had also read the reports about buyer demand waiting. Obviously, you would expect that in a rising interest rate environment. I find your characterization of Redfin as being on the luxury end of the market kind of interesting. I don't know a ton about Redfin, but I'd always thought their main competitive point was lower rates, like, "We compete on price." I'd figured it was more of a middle market exposure. Maybe I'm wrong, I'm not sure.
Hill: If we're talking about housing and it's a question of who's right, between you or me, I'm going with you.
Hanson: [laughs] I appreciate that, but God knows I can be wrong pretty frequently. The other thing that's interesting about home builders vs. ultimately a broker, a realtor is that the home builder controls their portfolio, and a realtor is only as good as a portfolio, the inventory that they get from people. It could be that you're seeing a little bit of what we saw a few years ago, which is that two-speed economy. Wealthier people are still feeling really positive, but in a rising interest rate environment, the more price-sensitive consumer is backing off a little bit. Maybe you see less of that in Toll Brothers' portfolio, a little bit more of it in Redfin, which would result in the incongruous guidance. Time will tell. It'll be interesting to see how the non-luxury home builders report through and what they're seeing in this time period. Obviously, they'll have very different exposures.
Hill: Yeah, that was one thought I had as you were talking. It really has been the case for the last few years, when Home Depot reports their results, the safe way to bet is, Lowe's is going to report roughly the same thing, slightly less good, but still directionally in the same way. I am curious now to see D. R. Horton, what kind of numbers are they putting up?
Hanson: People are definitely investing in their homes. I was recently doing a lot of reading about the pool industry and Pool Corp, which is basically a vertically integrated distributor of pool products. They were saying that people who had put off investing in either building a new pool or doing maintenance on an expensive part of their pool, they've been seeing a multi-year trend toward people doing that work now. Again, if you have a pool, you're probably at the higher end of the market, so you're a little bit more insulated than some other people. But, all these are really interesting trends to watch.
Chris Hill has no position in any of the stocks mentioned. Tim Hanson has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends ZG and Z. The Motley Fool has the following options: short September 2018 $180 calls on HD and long January 2020 $110 calls on HD. The Motley Fool recommends HD and Redfin. The Motley Fool has a disclosure policy.