Description

Overview –

We believe that the recent run in housing has been driven less by secular shifts that are brandied by the media and the industry but rather by a decrease in mortgage rates lowering the average mortgage payment and buoying consumers ability to purchase housing. With the subsequent movement in home prices we believe that this has remarked home prices to fit this change in mortgage payments. The street has misunderstood this dynamic and has modeled a structural lift in housing demand as home demand is in the process of rolling over. While we are not calling for a severe downswing in housing, we believe that estimates need to be reset and this will pressure securities tied to housing. There is a chance that the froth that has been in the housing market could make this reset more acute than the ‘18 reset but do not believe that we are close to an ’05 moment. We recommend a short on PHM as an example of a residential based security but there are other securities that could fit the thematic short as well.

Description and Background –

PHM is the second largest homebuilder in the country delivering over 24,000 homes in 2020. The average selling price of homes was 430k showing PHMs broad housing exposure. This compares to Lennar at 394k and 370k for NVR which are slightly more entry level exposed. It is important to note that as you go farther down the ASP scale you are more exposed to mortgage rates as these homes are less likely to be cash purchases.

Homes are typically bought using a mortgage. This changes the consumer from looking at a home price to viewing the purchase as a monthly payment. From 2019 the average mortgage rate has decreased from ~3.75% to 3.1% on the most recent published average 30yr fixed rate. As mortgage rates have decreased, these rates have inflated the prices of homes as consumers can afford more home with the same mortgage payment. Importantly, mortgage rates dipped as low as ~2.8% in 4Q20. We believe the current housing stock is priced closer to those rates than the current 3.1% and the ~10% increase in rates has a commensurate decrease in what consumers can afford.

Our short thesis is predicated on mortgage applications beginning to roll over and showing itself in order trends. As evidence of this the most recent MBA Purchase NSA Index was -14% yoy and +1 on a 2yoy basis. This compares to a 4Q20 average of +25% and +35% respectively and a 1Q21 average of +15 and +18% respectively. For an example of the indexes ability to predict slowdowns in the last mini-tightening of ’18 mortgage applications decelerated from +7% and +15% in 4Q17 to +1% and +8% respectively. This led to a deceleration of PHM order growth from +14% to -12% in 4Q17 and 4Q18 respectively. On a gross basis orders decelerated from +12% to -9% from 4Q17 to 4Q18. We believe this shows how correlated mortgage purchase applications are to new orders.

In the face of this deceleration the street is modeling a 41% increase in 2Q21 order growth and a 53% growth in orders per community, a 3Q21 order growth rate of 8.5% and 10% respectively, and a 4Q21 growth rate of 9% and 10% respectively. We believe these estimates are too high in the face of the current mortgage application data. The comps are progressively getting harder and run rating the current mortgage application stack through year end would show negative year over year order growth in the mid to high teens for 3Q21 and 4Q21.

Valuation –

These stocks typically trade on p/b multiples and in 3Q/4Q18 PHM rerated from close to 2x TBV per share to ~1.5x tbv to share on a more moderate deceleration in year over year order growth. A similar rerating would lead to a ~30% decrease in PHM stock or a $35 target price.

Catalyst

Deceleration in housing

10yr moves higher or lower

Lagged cost inflation hits p+l in 2h21/1h22