Navigating the Housing Market’s Mixed Signals

0:04Tyler Crowe:A housing market deep dive with predictions and more. This is Motley Fool Money.

0:19Tyler Crowe:Welcome to Motley Fool Money. I'm Tyler Crowe and today I'm going to be joined by longtime Fool contributors Jon Quast and Matt Frankel. Now, I know we call it earnings season, but earnings season never really ends because there's always somebody reporting something. And we've actually had a couple home builders report recently. So we're going to use this as a chance to dive into the industry. And we'll also wrap up today with Stocks on a Radar. But we're going to start the day with a fresh serving of news that Starbucks is planning a major restructuring. The company announced it will cut its North American store count by about 1%, lay off about 900 employees, and it's all part of a$1 billion restructuring program to hopefully recharge a brand that perhaps people thought that the coffee had gone a little bit stale at Starbucks.

1:08Tyler Crowe:Now, guys, I have conflicting thoughts about this. On the one side, not throwing good money after poor returns is always preferred, hence the store count reduction. But I don't think contraction was really on people's minds when they brought Brian Nickel in over from Chipotle to right the ship. So where do you land on this news? And bonus to the question, what is your preferred coffee spot and preferred order?

1:35Matt Frankel:Well, Tyler, I think that Starbucks Optimist had hoped that we could keep all of these Starbucks stores and just simply get better efficiency out of them. I think that was the hope bringing in Nickel that it would just be better operations for all the stores. Nickel is basically saying that some of these stores don't fit into the vision for the company going forward. So not all of them can be saved. They really want to promote this coffeehouse vibe where you come in, you stay a while. and some of the stores he's saying are not conducive for that. So they're going to go, this is a pricey move, a billion dollar price tag.

2:11Matt Frankel:Much of it is going to happen this year, but there's going to be some ongoing expenses into next year. So not exactly what we had hoped for, but maybe a thing that has to happen. And they are saying we're going to get back to net unit growth next year. So maybe it all is a net positive in the end.

2:27Jon Quast:I'm generally a fan of this move as a Starbucks shareholder. Brian Nichol, he previously has already said that not all of Starbucks stores have a place in his new vision for Starbucks. For example, there are a bunch of stores that are drive-thru and pickup only and don't have anywhere to sit. And that's not what he's going for with the back to Starbucks plan. And it's also important to mention that, yes, it's contraction, but this will only reduce the North American store count by about 1%. So it doesn't appear to be very targeted. And I can tell you myself, there are about 10 Starbucks within a 20-minute drive of where I'm standing right now.

2:56Jon Quast:And there are a couple of them where I go in and I say to myself, how does this place make any money? So I'm totally a fan of if there's no reasonable way to turn it around to get rid of a location. The company did say that its store count will resume growth in fiscal 2026. So this does seem temporary. And to me, directing the company's resources at parts of the business that have the most potential is a good thing. Now, about my coffee order. Admittedly, I was sipping a Starbucks cold brew while I was prepping for the show. but I generally prefer smaller independent coffee shops. I was in New York City this weekend and I went to a place called 787 Coffee and got a horchata latte that was delicious.

3:32Jon Quast:So generally an independent coffee person. And we still don't know what John's order is.

3:36Matt Frankel:Man, y 'all are way too fancy for me. What is black coffee at the gas station?

3:40Tyler Crowe:Well, I mean, my preference is a double espresso black, so I'm not that far off from you. And I don't know if that makes me a preferred or a hated customer at Starbucks. So decent ideas, There's some good, some bad here. Let's put some actual conviction behind these views here, guys. Based on Nickel's plan here, some restructuring, some of the vision for bringing back that third place vibe that Starbucks kind of really wanted to achieve early on in its vision of the coffeehouse and may have strayed from that. Are you bullish on Starbucks, the stock, over the next three to five years after Nickel gets to implement this plan?

4:20Tyler Crowe:Or if not, are there alternative coffee or restaurant stocks you think will do better than Starbucks?

4:25Matt Frankel:Well, I'm certainly not bearish on Starbucks. I mean, Starbucks is such a great brand. It's been a great brand for a long time. And then in Brian Nickel, you have a great operator. So I think it's hard to be bearish with that combination. That said, it's hard to be overly bullish, as in market beating bullish for Starbucks right now, just because of how many unknowns there are still with the business. There's still ongoing inflation with coffee prices. it's trying to make moves with its China business, but what exactly that's going to be, we still don't know. And maybe there's still some pricing adjustments that need to happen on the menu.

4:57Matt Frankel:That's one of the problems from previous management that nickel might be still working out. So it's hard to know for sure how much upside there is with Starbucks, but certainly I wouldn't bet against it. Yeah.

5:07Jon Quast:I've bought Starbucks in the time since nickel joined generally on, on price drops and corrections. And I'm generally bullish. I don't think he'll replicate his Chipotle returns. That wouldn't be a very realistic target. But I'll go on record here as predicting Starbucks will beat the market over the next five years. The early results are strong. Yes, same store sales declines are continued. They've moderated nicely and all the numbers are trending in the right direction. So I'm very optimistic.

5:32Tyler Crowe:All right. Well, we got one person on record saying we got a market beating stock in Starbucks here. Coming up next, we're going to make sense of the really mixed signals we're seeing in the housing market coming up after this ad.

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6:19Tyler Crowe:For longtime listeners of Motley Fool Money, having Matt, John, and myself is a relatively new experience. But I do want to give fair warning. We love talking housing. So this isn't the first time and definitely won't be the last time we're going to be dizing into housing and homebuilders. And homebuilders tends to be a Hidden Gems-esque type investment out there with a couple. Certainly in the Hidden Gems universe, there's some homebuilders. So we get permission to do that since they're in the universe. I think it's fair to say that housing has been giving a lot of mixed signals lately. I mean, there's persistent reports about shortages of homes somewhere in the millions.

6:56Tyler Crowe:But then we look at existing home sales that are at the same seasonally adjusted pace we saw in the depths of the Great Recession or in the early 1990s when there were like less 100 million fewer people in the United States. You know, there's a lot of factors here. We got interest rates, we got employment, wage growth, home price inflation, etc. So we really wanted to get into a deeper dive in this topic. And it gave us a really good time because we've had a couple of recent earnings reports from Lenar and KB Home really before earnings get to kick off. So we get to focus on this a little bit more than we normally would.

7:27Tyler Crowe:So Matt, I want you to kick us off after reviewing KB and Lennar's most recent earnings report. What were some of the things that stood out to you in these earnings reports? And did they send any significant signals to you about the broader market?

7:41Jon Quast:First of all, I love these companies that have irregular fiscal years. They keep us busy between earnings season, for sure. Overall, the market environment still seems to favor new homes versus existing ones. John's going to talk about some of the incentives in a minute that are in the market. although mortgage rates are still relatively high and are keeping things generally slow overall. But while existing home sales were virtually flat month over month and year over year in August, new home sales soared by 20 % from July to August to a three-year high, much better than was expected. Now, the recent results are mixed.

8:13Jon Quast:You mentioned KB and Lennar. KB just reported earnings and revenue. They exceeded the company's guidance, although home sales declined by 7 % year over year. The company's been a great capital allocator. They bought back 11 % of their outstanding shares this year. That's pretty remarkable. On the other hand, Lenora reported a 12 % increase in new orders, although they're using more incentives, so their sales prices were down significantly.

8:35Tyler Crowe:Yeah, I wanted to give a little extra context on that new homes booming, existing home sales kind of stagnating. You know, this is one of those, today, I'm this year many years old when I found out, like, according to the St. Louis Federal Reserve, homes owned without a mortgage recently hit the highest recording since they started keeping track of it back in the 1980s. That will mean that somebody's probably been in the residence and for 30 plus years have paid down that amortizing mortgage. Downsizing, something that used to be more common for older homeowners, isn't really happening. And so we have all these owned homes out there and that's really, I guess you could say, putting sand in the gears, excuse me, of the existing home market and new homes have to fill the void.

9:17Tyler Crowe:So John, how are the home builders doing when it comes to filling that void.

9:22Matt Frankel:Yeah, it's interesting. You do need to bring new buyers into the market. Shout out to KB Homes. It seems to be doing pretty well in that regard. It said that half of its home buyers are actually first-time home buyers, so doing a good job there. But one of the things that these home builders are doing is incentivizing these purchases for a new home. And this is according to the National Association of Home Builders. More than one-third of builders cut their prices in August and two thirds offered incentives. And that incentive deal was actually the highest in five years. So we're seeing an uptick there.

9:54Matt Frankel:Let me give you a real life example of what that could look like. This is from realtor.com talking about a Dallas couple. They got a D.R. Horton new home and they got a lower rate at 3.9 % versus 6.3 % is what they should have gotten at the time. Their down payment was reduced from 20 ,000 to 13 ,000. And the final price of the home was reduced from$370 ,000 to$332 ,000. So essentially, they were able to save$50 ,000 up front and then hundreds of dollars per month on an ongoing basis because the interest rate was lower. So why are they offering incentives? Well, they're trying to get people into the homes.

10:36Matt Frankel:And it's interesting. I don't know, Matt, maybe you have thoughts here on whether or not this is a signal of weak demand counterintuitively. New home sales are going up, but it's through the incentives. Another thing to note here is the Census Bureau noted that new housing starts were down 6 % year over year in August. So what's going on here, Matt?

10:56Jon Quast:Yeah, well, you don't have to tell me about D.R. Horton's incentives. I'm actually standing in a D.R. Horton home as I'm recording this, and it was because they incentivized us to buy it in a few different ways. To Tyler's point, home equity is at an all-time high. It makes sense that a lot more people are in their house is free and clear. But I push back on the demand thing. It's not necessarily that demand is weak. The demand for housing, especially entry-level homes for the younger generations, is off the charts strong, but affordability is what's keeping people on the sidelines for now. Affordability and lack of inventory.

11:26Jon Quast:Builder incentives are a great tool for competing against the historically low levels of existing home inventory, giving people an attractive alternative like those incentives you mentioned. In a normal housing market, about 10 % of sales are new homes. Right now, it's closer to 30. Lenar even said in its earnings release that, quote, achieving these results required additional incentives. So it's definitely a big part of what's driving the growth for a lot of home builders right now.

11:53Tyler Crowe:Look, I'm just going to throw this out there. Yes, it looks like they, you know, big price cuts, but, you know, there might be a possibility that the initial price that was given was perhaps a little bit high. So it could look like we're giving somebody a great big cut. So let's keep that in a little bit of context here because, you know, every once in a while you do things to grease the skids like that. So it kind of helps to really lay the background of what we're looking at, the housing market right now. Existing home sales are slow. New home sales volume is okay, but demand is really high.

12:26Tyler Crowe:But it's taking a bit of greasing the skids in the form of incentives, maybe making it look like people got a great deal, you know, just to get them to sign on the dotted line. Homebuilders are doing mostly better than expected. And look, if we're looking at stock prices, a lot of these trade for really cheap valuations. We're talking price to earnings ratios in the single digits, which is quite low. So let's put our necks out there. Do you two see the homebuilders as a sector going to outpace the market over the next five years?

12:55Matt Frankel:Tyler, I won't comment on the entire sector. Maybe I can just comment on KB home symbol KBH. And so you talk about greasing the skids. This is a company that doesn't seem to be greasing the skids, at least not as much as some of its competitors. It's not really offering those incentives, perhaps because it is more of a customized home builder. And it's actually trying to get those customizations up, those build to order homes. And so that's helping it with its profit margins. Yes, demand perhaps, or at least revenue maybe is a little bit down. But you look at the valuation of the stock, as you point out, quite cheap.

13:31Matt Frankel:it's been able to take advantage of this with strong profits and reduce that share count by 25 % in recent years. So, and it pays the dividend. I like KB Home here. Yeah.

13:42Jon Quast:Tyler and I have talked about this on previous shows that it's a really good profit environment for home builders. I think Tyler's put it, you have to be an idiot to not make money as a home builder right now. The reason is that home prices in general or home values have risen a lot faster than the cost of constructing a home. So builders have not only, pricing some of that into their normal price. But there's a lot more room in the margins to wiggle around with. So it's still a good profit environment for home builders. As far as the next five years, I'd give that a big yes with the caveat that over the next five years, mortgage rates are going to be significantly lower than they are today on average.

14:19Jon Quast:If that's the case, and we see some of this pent up demand for especially entry level homes come back into the market, there's a lot to like about the home building space right now.

14:28Tyler Crowe:I'll put mine out there too. Look, as you said, I think that profitability has been great. And even the dumber of my two dogs could be a home builder CEO and probably make a pretty good return in this business. But I don't know if I want to put my neck out for the whole home builder industry because there's a couple of them out there that are run by my dumber dog. So I think there's a lot of great companies in this industry. And I think picking some of the group winners is going to do incredibly well. One company I have followed for a long time and I know is in the hidden gems universe is Greenbrick Partners, ticker GRBK.

15:03Tyler Crowe:But, you know, to stick my neck out there for a lot of the bad operators in this industry that could drag it down. No, I don't want to do that. I want to pick the good ones. With that in mind, we're going to take a quick break. And then after that, we're going to do stocks on our radar. Support for the show comes from Fundrise.

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15:57Tyler Crowe:I'd say it's a little early to say this is a tradition because we're only a couple months into our hosting of Motley Fool Money, but we're going to do our best to make stocks on our radar as a regular part of our Thursday Hidden Gem show. So we're going to go around the horn. And actually this week, I'm going to start off with stocks on our radar. And the company that's been really piquing my interest lately is Miami International Holdings, ticker MIAX. This is actually a company that IPO'd not too long ago, I think a couple of months ago recently. This is a company that has established exchange markets for equities, options, futures, commodities, and all the other things that we love to trade on a given basis.