Depending on who you believe, the housing market is likely to improve in 2024 compared to the past two years, and homebuilders of single-family homes especially, stand to gain the most from the upcoming housing recovery. Forestar Group (NYSE:FOR) is a real estate developer that works with homebuilders to develop communities and is one of the largest single-family community developers in the US. Since going public in 2017, Forestar has developed communities nationwide (developing 1 out of every 50 single-family homesites in the US) and experienced a 1,000% increase in lots sold from 2018 to 2023, according to the company website.
Even after posting a market price return of nearly 100% over the past one-year period, FOR offers growth investors a Strong Buy opportunity with plenty of growth ahead while trading a price that is less than 8.5 times forward earnings estimates.
According to a recent story in USA Today, housing shortages will continue in 2024 primarily due to a lack of inventory, single-family home construction will tick up, mortgage rates will start to decline, and home prices will keep marching higher.
With a decline for mortgage interest rates and an ongoing housing deficit, Robert Dietz, the chief economist for the National Association of Home Builders is forecasting a gain for single-family housing construction starts in 2024. This will be the first year of increase after declines in 2022 and 2023.
According to Fitch Ratings, demand for new homes is forecast to improve slightly as inventory remains low and mortgage rates remain higher for longer.
Demand for new homes is forecast to improve slightly as existing home supply stays at low levels due to homeowners with relatively low mortgage rates will remain hesitant to move or sell their homes. Homebuilders’ ability to offer mortgage rate buydowns as incentives will make new homes an attractive alternative for potential homebuyers. The large well-capitalized homebuilders are expected to continue to gain share next year as strong liquidity positions and access to capital support growth.
In a story in Housing Wire, the CEO of Howard Hughes Holdings (HHH) is even more enthusiastic:
“The new home market has been extraordinary in 2023, and I think heading into 2024, we’re going to have the golden age of new home construction,” David O’Reilly, CEO of Howard Hughes, said in a recent CNBC interview.
And in a story in Money magazine, there are 4 factors that are likely to impact the housing market in 2024, according to “expert” predictions:
- Mortgage rates will decrease, leading to a pickup in demand.
- Inventory will increase possibly by as much as 30% over last year.
- Home prices will remain flat, or increase slightly, depending on where you are (and some cities will see a decline, like Las Vegas and San Francisco).
- Home sales will increase, from a conservative low estimate of 0.1% to an optimistic guess of more than 13%:
On the other hand, as the economy continues to chug along as evidenced by the recent surprise jobs report, mortgage rates may remain higher for longer than many were expecting which could put a damper on demand in 2024. Given the market’s reaction to the strong employment report, the expectations for lower mortgage rates in the near future may need to be adjusted. The 2024 outlook for the housing market from Freddie Mac offers a similar view of increased activity due to dropping mortgage rates, although the pace of increase may be slower than some expect:
We expect rate cuts in the second half of the year if the job market cools off enough to keep inflation muted. Under this scenario, we expect mortgage rates to ease throughout the year while remaining in the 6% range.
Falling rates will breathe some life into the housing market with some recovery in home sales. However, home sales are expected to grow only modestly due to a lack of inventory in the market. The demand for housing, however, will remain high based on a large share of Millennial first-time homebuyers looking to buy homes, which will push home prices up. We forecast home prices to increase 2.8% in 2024 and 2.0% in 2025 nationally.
Other costs are still impacting homebuilders as well, including the costs of materials, labor, and land. According to this recent Pro Builders Forecast for 2024, one of the top challenges in 2024 will be finding/entitling land to build on.
While some home builders had a productive year in 2023, like M/I Homes, Inc. (MHO), with a nearly 100% increase in the stock price, others remain undervalued and may be poised to take off later this year if the optimistic forecasts win out. Although MHO had a poor Q4 earnings report, missing on both earnings and revenues, the full-year results included a 20% increase in new contracts (and over 60% increase in Q4) despite substantially higher mortgage rates in 2023.
Another homebuilder, D.R. Horton (DHI) posted somewhat disappointing results on January 23 but stated that they expect things to pick up again starting in the first 3 months of 2024 (fiscal Q2), depending on the strength in demand.
For the quarter ending March 31, 2024, the company expects to produce consolidated revenue of $8.1B-$8.3B, exceeding the $7.99B consensus, and close on the sale of 20,000 to 20,500 homes vs. the Visible Alpha estimate of 19,092. Gross margin on home sales revenue is expected to be 22.6%-23.1% vs. 22.9% in Q1.
Forestar Group Nationwide Presence
With active projects in nearly half of the states across the country, Forestar Group is proud of its nationwide presence. In fact, according to their corporate profile (and as shown below in the slide from their Q124 investor presentation dated 12/31/23):
As of December 31, 2023, Forestar has active projects in 57 markets in 23 states. Based in Arlington, Texas, the Company delivered more than 14,900 residential lots during the twelve-month period ended December 31, 2023. Forestar is a majority-owned subsidiary of D.R. Horton, the largest homebuilder by volume in the United States since 2002. The Company primarily acquires entitled real estate and develops it into finished residential lots for sale to homebuilders with a strategic focus on asset turns and efficiency.
With a unique focus on supplying finished lots to single-family residential homebuilders, Forestar has seen its business grow substantially over the past 5 years. Builders have been constrained by the unavailability of affordable finished lots for construction, which can represent 20% to 30% of the total costs to build. From the company’s Q1 investor presentation, the following slide summarizes the opportunity as many homebuilders shift their strategy during times of economic uncertainty such as we have experienced in the past few years.
Forestar has been working to improve the market share of finished lots sold and has a plan to capture 5% of market share in the fragmented single-family residential lot development industry. They currently hold about a 2.3% market share so a 5% share would be roughly double the amount that they currently capture.
During the Q124 earnings call for the quarter ended December 31, 2023, the newly appointed President and CEO of Forestar Group, Andy Oxley had this to say about their expectations for 2024:
We believe the low supply of existing homes will continue to drive buyers to new construction and our strong relationship with D.R. Horton provides a clear path for growth. Our guidance for fiscal 2024 remains unchanged. Based on current market conditions, we expect to deliver between 14,500 and 15,500 lots and generate $1.4 billion to $1.5 billion of revenue. We are closely monitoring each market as we strive to balance pace and price to maximize returns in each project. We are the market leader in a highly fragmented and undercapitalized industry and uniquely positioned to take advantage of builder demand for finished lots. There is a significant opportunity to expand our presence in markets that we operate in, and our goal remains the same, to double our market share to 5% over the intermediate term.
Valuation and Ratings
The earnings growth can be seen quite clearly when reviewing the SA EPS Estimates and Surprises with the past 4 quarters in a row all showing positive EPS surprises and rising estimates for the upcoming four quarters.
Likewise, revenues have been growing steadily (except for a slight drop in 2023) over the past five years.
The results from Q124 were summarized by Chairman of the Board, Donald J. Tomnitz in the earnings press release:
“The Forestar team delivered solid results in the first quarter of fiscal 2024, including an 84% increase in pre-tax income to $51.2 million, a 41% increase in revenues to $305.9 million and a 39% increase in lots sold to 3,150 lots. Forestar delivered attractive double-digit returns and strong profitability, with a pre-tax profit margin of 16.7%.”
Those are impressive results and a strong positive outlook for the upcoming year, yet the market priced the stock post-earnings as if it were struggling to remain profitable, dropping by about -4% in the past month.
The FOR stock gets an A+ for Valuation from the SA Quant ratings and is ranked #2 out of 171 in the Real Estate stocks sector.
Wall Street analysts like the stock, with 3 Strong Buy and 1 Hold rating in the last 90 days.
SA Analysts also like the stock, but it is relatively undercovered with only 1 Buy rating back in November 2023.
Summary and Recommendation
Perhaps now that the market is starting to realize that maybe interest rates (and therefore, mortgage rates) may not start to come down as soon as some had hoped, the real estate sector is starting to pull back from its giddy recent highs. In fact, REITs just saw the third straight week of declines as the Fed kept its policy rate unchanged.
Real Estate Select Sector SPDR ETF, which tracks the S&P 500 real estate stocks, was down by 0.47% W/W and 4.37% YTD. FTSE Nareit Mortgage REITs index declined by 4.33% from a week ago.
Yet regardless of the macro trend and the sagging level of interest in real estate stocks, there are some bright spots in the sector, including the recently public Smith Douglas Homes (SDHC), which did an IPO on January 11 pricing shares at $21. Those shares are now trading at $26.10 as of market close on 2/2/24.
Forestar is somewhat dependent on DHI for its future performance as it supplies about one-third of the lots needed by DHI annually. As the performance of DHI improves so will FOR. In fact, you can see the correlation between the two stock prices in this chart comparing the price performance of both over the past year.
Although the price of DHI slumped the most in one day since 2020 after reporting disappointing Q124 home orders, the price has since recovered and is poised to continue its rise upward in 2024. DHI stock also has good Quant factor grades and is ranked #2 out of 23 stocks in the Homebuilding industry.
In summary, Forestar Group has strong long-term growth potential with aspirations to capture 5% of the market share for residential finished lots, they enjoy the benefits of a strategic relationship with D.R. Horton, and they have a strong balance sheet with about $840 million in liquidity as of 12/31/23, and they are geographically diversified across the US.
The FOR stock has seen significant price appreciation of nearly 100% in the past year but is still priced quite inexpensively at a forward P/E of less than 8.5. With expected EPS of about $4 by September 2025 and at a conservative P/E of about 12x, that would result in a stock price approaching $48. At the current price of about $31 that represents approximately 50% upside in 18 months. However, earnings are being revised upwardly and those EPS estimates may be increasing over the next several months. That could mean an even better upside if things play out as expected this year.
Conversely, if mortgage rates stay high for most of the year and demand remains subdued, homebuilder activity may take a breather and things could deteriorate a bit. Meanwhile, the stock is trading as if the economy is still headed for recession which it clearly is not. Therefore, I rate the stock a Strong Buy at a price below $32 for growth investors who are willing to ride out some short-term price volatility.