Why Homebuilders like Beazer Homes $BZH and Landsea Homes $LSEA are a part of my Oil, Gold, and Land inflation protection strategy.

Have you or has someone you know been harmed by inflation?

During the last period of sustained inflation, gold, oil, and land outperformed almost every asset class.  Congress is running a deficit of 7% of GDP and we are reshoring industries with the rise of tariff retaliation and rivalry with China.  So I believe sustained inflation is a safe prediction, but it’s always important to ask what could make things go the other way.  Artificial intelligence increases productivity more rapidly than anticipated?  A massive increase in labor force participation?  Ending trade wars and re-embracing international trade? Massive deregulation in the US and Europe?  Productivity spike from widespread Zyn consumption?  Longevity breakthroughs that cause Boomers to unretire?  A nuclear renaissance rolled out in a short period of time?  I think the sustained inflation thesis is intact for now, even if it comes and goes in waves.

Getting exposure to land in the portfolio is an interesting problem, rising interest rates have sent REITs to the woodshed, and not all REITs have leases that automatically adjust to CPI like Medical Properties Trust (MPW) does.  One type of exposure to land that I have been using is through homebuilders.  Not only do homebuilders have a large inventory of land for their developments, but they usually have long term fixed rate debt as well.  While inflation lifts the land prices, it also evaporates the real burden of the debt burning the candle on both ends.  And there is also the structural tailwind of the current housing deficit.  

After the global financial crisis of 2008, the surviving homebuilders stopped building “on spec,” that is, homes were built only upon receipt of a customer’s deposit, and homes were not built based on the builder’s speculative prediction of the housing market.  This has led to a shortfall of single family homes, some estimates put that shortage in the millions of houses.  You can see on the graph below that total housing inventory for sale has been falling since the 2008 peak, and has fallen far below the long term average despite US population growth.  In 1983 the population of the US was 230 million and there were over 2 million homes for sale.  Today the population is 340 million and there are 1.2 million homes for sale.  Even without the inflation hypothesis, it’s a great time to be a homebuilder.

US Housing Inventory:

One caveat, there are approximately 700,000 single family homes being used for AirBNBs, and if you listen to doomer channels, you have heard about the risk of an AirBNBust.  Even if all those homes were put on the market today, we would still be below the long term average, which doesn’t account for population growth.  Meanwhile, AirBNB’s business model doesn’t seem to be collapsing with $10 billion in revenue in the last 12 months during a period of falling real wages.

At the moment, after the recent runup in homebuilder stocks, most homebuilders aren’t deep value enough for my degeneracy.  There are two that are still interesting, Beazer Homes (BZH) and Landsea Homes (LSEA) but both have their respective warts.  

BZH is interesting because after a shareholder survey a couple of years ago, management got the message and has shifted to a growth strategy, but the market hasn’t caught on yet as increasing the number of active developments is a slow process.  Last year BZH had 121 active residential communities where they are selling homes, today that number is 145, and they are on their way toward their goal of 200 active communities by the end of 2026.  This is a shift for management who spent most of the last five years maintaining a stable business and plowing all the profits into book value per share, from $16 to $35 since 2019 on flat revenue.  Once the market understands the growth trajectory, it could easily reach the same price to book ratio of their peers at around 1.3, or at the top of the next cycle, over 2.  

Price to book sits at 0.75 right now, so for every share you buy at $27.75, you get $38.31 of tangible book, but with fixed debt at 7.5% interest.  Each share represents $79.71 of gross book value, so if land and housing prices average a 4% increase, every $27.75 share should increase in value by $3.19 a year just from inflationary pressures.  That’s an 11.5% increase in value every year just due congressional debauchery.  On top of that, BZH has been building houses and selling them profitably to the tune of a 14.85% return on equity, or earnings of $5.19 per share in the last 12 months.  So for a $27.75 share, you will probably get around $3 a year in land appreciation and $5 a year in profits, with a little double counting overlap, but not including the multiple rerating that would come from the market pricing in a growth story.  Depending on how long a multiple rerating takes, this could be a two to four year 2.5x or better.

There are some things I don’t like about BZH, the founders are long gone, and management is not doing any insider buying.  They are administrative bureaucrats, but they are also doing an ok job.  Half of their sales are in California, but that is due to the fact that homes in California are $1 million dollars while homes in Florida are $450,000.  Their capital allocation policy so far has been to build book value, the market does not like stagnant businesses who don’t return capital to shareholders.  I like the thesis and the tailwinds more than I like the company, but to be fair, management was prudent in passing on overpriced land in the zero interest rate era, and they were proactive in searching for land bargains with their cash hoard when interest rates rose.  That is a pretty good performance by management from a business with no capitalists at the helm.  Still a terrible capital allocation policy

Landsea Homes has an abundance of capitalists at the helm, but they have their own problems.  Their largest shareholder is Ming Tian of Landsea Group of China.  Is LSEA a vehicle for Mr. Tian to have assets outside of mainland China, efficiency and profitability be damned?  Or is LSEA beholden to the Chinese Communist Party?  Either is a potential risk, but as LSEA is US domiciled, whatever the future of US China relations will come to be, the political risk here seems minimal.  LSEA has much less history to judge them by than BZH, and they are focused on aggressive growth, maybe even a bit reckless growth.  If BZH can be blamed for being a bit lazy, LSEA might benefit from slowing down a bit.  LSEA’s debt covenants are at the limit, they are biting off as much as they can possibly chew, and hoping they don’t hit a speed bump in the road.  To be fair, with mortgage rates already at 7%, the speed bump is most likely behind us at this point, but fast and loose is fast and loose.

Management has enormous confidence in their ability to execute and deliver, as there are sizable insider buys from five directors, the CEO, COO, CFO, the chief legal officer, and from Mr. Tian himself.  The founder is selling stock in size from his holding company, but buying a bit here and there personally.  This large selling initially boosted the share price as the security was suffering from too thin a float, but now it is depressing the price.  A temporary event suppressing price is a good thing though if it reverts to the mean on its own afterward  LSEA also does half of its business in California, but is aggressively targeting the sun belt for future growth.

LSEA is trading at 0.53 to tangible book, so every $9.53 share of stock represents $19 of tangible book, with floating rate debt at SOFR plus 3% ish, or $40.63 of gross book value.  Again, assuming 4% sustained inflation, it would result in an annual 17% return from the increase in the gross book value.  The average profits of $1.00 per share for the last three years would be another 10.4% on top of that, but again with a tad bit of double counting there.  It might take the much smaller LSEA more time to reach the same price to book multiple of its larger peers, but starting at a lower book value, it has much more room to rise.  Could LSEA be trading at 1.3x tangible book within five years?  It’s very probable.  That would be close to a 4x with inflation, profits, and a multiple rerating, but not including their organic growth trajectory.  If they did hit that proverbial speed bump while already at their covenant limits, it’s highly likely the deep-pocketed founder, Mr. Tian,  would step in to save the business, but with some dilution of course.

LSEA has started doing share buybacks, which given their small size and aggressive growth, is the wrong capital allocation policy at the moment.  It does send a powerful signal, though, that when they are large and profitable, they will return capital to shareholders unlike BZH who is apparently allergic to the concept of their fiduciary responsibility.  

I have listened to both management teams for over a year now, and while my bias alway lies with the capitalist over the bureaucrat, the unappreciated growth story of BZH and their stability is appealing, and the overaggressive behavior of LSEA is a bit of a turnoff.  BZH targets the slightly higher end with their 100% environmental compliance homes, and LSEA targets a bit lower down the socioeconomic scale, but neither is really a beneficiary of the K-shaped economy thesis.  Since you know that I am a small cap value degen, and I really place a large emphasis on the incentive alignment of management buying into the company, for this part of the portfolio I will be about two thirds LSEA and one third BZH.  But your biases and preferences might be different from my own, and I would never disparage someone if they preferred BZH over LSEA here.

And of course, we all know that our grocery bills have been going up more than 4% annually, and show no signs of slowing.  And as population density grows, land appreciates not just in nominal terms but in real terms.  That gross book value has some catching up to do as real estate prices were mostly flat due to the effect of rising interest rates.  The internal leverage of homebuilders selling at a discount is a great way to surf that wave.  If the inflation thesis is wrong, they are still decent businesses, with structural tailwinds and at a cheap price.