ANNVIPS
The US construction and property development industry has shown remarkable strength this year despite significant declines amongst most REITs. The record-breaking increase in long-term interest rates has dramatically slowed residential and commercial property sales. However, only the commercial property market has experienced significant price declines. Residential homes have retained their value despite record-low affordability levels and generally weak household financial spending capacity. The core difference is that, nationally, single-family homes remain in short supply; however, there is significant variation in the SFR property market across the country.
The past three years have been excellent for most large homebuilders. Even with the substantial increase in materials and labor costs in 2020-2021, the sharp rise in home prices has allowed most builders to maintain profit margins. Home prices have recently slipped slightly, but construction costs have fallen further as the supply-chain issues from the COVID era become less extreme. Thus, while most stocks, notably REITs, are struggling, niche builders like Green Brick Partners (NYSE:GRBK) are trading near all-time highs.
Green Brick is a relatively small builder with a market capitalization of ~$1.9 billion. It is a dominant builder in select markets, such as Atlanta and the Dallas-Ft. Worth area. These markets are comparatively high-demand compared to the US due to positive population trends and related housing shortages. Of course, GBRK has risen by a staggering 11X over the past decade and has doubled in value over the past year, making it potentially at risk of overvaluation. Its share price slipped by just over 20% over the summer as many fundamental trends in the construction market turned over. Accordingly, I believe it is an opportune time to take a closer look at the company and relevant economic fundamental trends to determine its future potential better.
High Growth in Growing Property Markets
Green Brick is smaller than most public developers but is the fastest growing at 65% YoY sales order growth, a superior figure to all other notable public homebuilders. Its debt-to-capital is also lower than most at just 22.9%, compared to a peer average of 33.3%. The company’s gross margins are solid at 31.3%, compared to a peer average of 22.1%. Despite this, its “P/E” valuation is not higher than most of its peers at 6.8X, while LGI Homes (LGIH) is valued closer to 12X. Of course, “P/E” valuations are subpar for builders because their EPS can fluctuate dramatically with cyclical trends.
A core cause for Green Brick’s success is its focus on the Atlanta and DFW markets. However, it also develops in South Florida, Austin, TX, and Colorado Springs, CO. All of these markets are in comparatively high demand with solid property price increases. See below:
Both of these metropolitan areas saw above-average home price growth during the 2020-2022 period. Additionally, both have seen above-trend labor force growth over the past decade; however, DFW’s labor force growth is much more substantial than Atlanta’s. Notably, Dallas home prices fell faster than the market over the past year, potentially signaling that the market’s resilience may not be as strong as widely believed.
Further, Dallas and Atlanta have above-average unemployment levels, with a steeper up-trend than seen nationally. See below:
Green Brick’s stellar performance is partially attributable to managerial wisdom; however, its concentration in these critical regions is certainly its primary driver of outperformance. These markets have had more robust economic growth, encouraging its single-family housing market, particularly considering the slightly cheaper labor and materials costs in most Southeastern US. If these two markets turn over, as potentially indicated by the unemployment trends as DFW’s home price contraction, then Green Brick’s niche advantage would quickly become an obstacle. It is not particularly diversified compared to other public builders, and the solid positive cycle in the Southeast over recent years could naturally turn over against Green Brick.
There is also a massive difference between pending home sales and new housing permits in the Southern US. This issue is seen across the United States but is particularly notable in the South, which has had more resilience in building permit levels than the rest of the country. See below:
Across the US, home valuations based on price-to-income ratios are now slightly higher than at the ~2006 peak of ~6.8X, compared to today at 7.3X. However, Dallas, Atlanta, Colorado, and (some of) Florida have median price-to-income ratios below 4X. While home valuations have risen across the country over recent years, a significant catalyst was very low mortgage rates from 2017-2021, allowing most homeowners to refinance or purchase at very low interest costs. The massive increase in mortgage rates has essentially removed most younger new home buyers from the market. This could become a critical issue for the company because its primary focus is on catering to the growing young working adult population in its operating regions.
Still, not all property market indicators relevant to Green Brick are bearish. The fact remains that existing home inventories are extremely low in the US, with vacancy rates at record lows in the Southern US. See below:
Low home inventory and vacancy levels significantly support otherwise very poor market conditions. Home valuations and affordability are objectively worse than at the peak of the 2000s property market bubble. Family formation levels, family real income growth (currently negative), and deficient personal savings levels indicate weak demand for new homes, particularly from younger homebuyers. However, relatively few homes are available to buy, even with decade-high home construction rates.
Based on all of this data, I believe it is fair to say that home prices should not decline too quickly in Green Brick’s key operating regions. However, if mortgage rates remain high for too long, price declines are much more likely. Eventually, significant construction activity should cause home inventories to rise sufficiently to end shortage dynamics, potentially pushing the market back into a glut. With inventories and vacancy so low, I suspect it may take around three years for that to occur. By then, Green Brick may sufficiently slow its development activity to maintain stability.
Further, until then, the company’s margins should benefit from a potential decline in construction materials costs, offsetting the impacts of minor home price declines. See below:
The spike in home prices significantly aided Green Brick’s gross margins despite the surge in materials costs. I do not expect the company to continue to benefit from higher home prices; however, a decline in materials costs could benefit the firm. Currently, materials prices are relatively stagnant, but high inventory levels indicate that they may soon decline slightly.
What is Green Brick Worth Today?
Green Brick’s economic backdrop is mixed by some extremely positive factors (such as low inventories), while many others are generally bearish. Bearish factors include the affordability impact of high mortgage rates on new home buyer sales and the positive trend in unemployment in the DFW and Atlanta areas. I expect Green Brick’s gross margins to remain near current levels, with a negative trend expected in the long run depending on mortgage rate changes. A broader economic recession or continued increase in mortgage rates may accelerate the housing market’s slowdown.
Green Brick’s inventory levels are very high today, though they have not risen dramatically over the past eighteen months as mortgage rates rose. Its high inventories are associated with its very strong EPS. See below:
The company’s high inventories indicate that its EPS should remain near current levels over the next year, given no plummet in home prices. Since I expect home prices to stagnate and potentially slowly decline for some time, Green Brick should be able to watch trends and reduce its construction activity ahead of any significant market dips. In my opinion, Green Brick’s performance over recent years indicates that its managers are aware of market trends and should act accordingly. Thus, while I expect its EPS to decline given market conditions, I do not believe it will become significantly negative, as is often the case for overextended builders during recessions. The company’s low debt-to-capital ratio also gives it solid stability in a recession, should its income turn negative.
Overall, I believe Green Brick is fairly valued today, but that is mainly subjective since income levels are very volatile in the homebuilding industry. Compared to peers, Green Brick has a very low “EV/EBITDA” and “P/E” but a higher price-to-sales ratio. See below:
Since GBRK has a high “P/S” and a low “P/E” compared to peers, its profit margins are the primary difference between it and its peer groups. Should its margins slip toward its peers, Green Brick could face issues since its price-to-sales is much higher than some of its peers. Its closest peer is likely LGI Homes, which trades at a similar price-to-sales but a much higher price-to-income ratio, making Green Brick a likely superior investment.
The Bottom Line
Mostly, I am slightly bearish in the homebuilding sector and very bearish in the construction materials industry. That said, I am neutral on GRBK and, although I am not bullish on it, believe it may have the best long-term value potential amongst its peer group. I base that view on its strong historical performance, generally low valuation, and focus on higher growth markets. Of course, those “high growth” markets may turn over faster than others in a recession, as indicated by the DFW area’s unemployment trend and home price change over the past year.
Given low home vacancy and inventory levels, as long as a decline matches the slightly economic negative trend in construction costs, I believe it is not a massive issue for the firm. Still, should US banks continue to face the problems relating to commercial real estate, or if there is a relatively large recession, Green Brick could perform worse than many expect. Although GRBK may have the best value opportunity in the homebuilding industry, I tend to believe builders are generally overvalued today as investors focus too much on property price increases over the 2020-2022 period, forgetting the massive increase in mortgage rates that has caused record-low affordability since then. If not for low inventories, the US property market would probably be in a 2007-like free-fall today. Still, the housing shortage largely offsets that possibility, particularly in growing states and cities.
Overall, Green Brick is a mixed bag. It is my favorite homebuilder, but I would not personally buy it until expectations for homebuilders and construction companies become more reasonable. Its most significant individual risk is likely its concentration in the DFW region, making it less regionally diversified than most; however, that risk is more than accounted for in its lower valuation. Of course, its geographic concentration is also the primary catalyst for its stellar EPS growth in recent years. Investors who, unlike me, have a very positive outlook on US homebuilders may find added alpha-generation potential in Green Brick.
