Starter Homes in Demand With Builder LGI Shares Soaring
Cheryl Pate-Yow rushed to LGI Homes Inc. (LGIH)’s sales office south of Houston the day after receiving a mailer that said she could own a new home for $689 a month, only $24 more than rent on her one-bedroom apartment.
“I’m sick and tired of renting and my money goes nowhere,” Pate-Yow, a 46-year-old former chef, said during a visit to LGI’s Hall Park community showroom. “I didn’t think I could afford to own, but I got this flier in the mail.”
LGI, an entry-level Texas builder that has moved into six more states, is demonstrating that the U.S. housing crash didn’t diminish the desire for homeownership. The company’s strategy of luring renters with low-cost houses and assisting them with getting mortgages has spurred record sales and made LGI the top-rated builder among analysts. It’s also attracting competition as D.R. Horton Inc. (DHI), the largest in the industry, starts a brand aimed at first-time buyers with prices starting at $120,000.
“They’re proving that there is demand on the very bottom end,” said Peter Martin, a San Francisco-based analyst with JMP Securities LLC. He has LGI as his top homebuilder pick after a more than 60 percent jump in the shares since the company’s November initial public offering.
LGI, based in The Woodlands, Texas, is catering to homebuyers who have been left behind in the two-year-old real estate recovery. The share of U.S. first-time purchasers, historically about 40 percent, was 27 percent in May as slow wage growth, tight mortgage standards and rising prices put buying out of reach for many Americans, according to the National Association of Realtors.
Rental costs have surged as demand for leasing soars. The median rent in the U.S. has been about 30 percent of median income for the past two years, the highest share in data dating back to 1979, according to Seattle-based Zillow (Z) Inc.
“One of the reasons we’re so busy is that it’s very attractive from a value standpoint when you compare the cost of renting to homeownership,” LGI Chief Executive Officer Eric Lipar said in a telephone interview.
For those who can qualify for a mortgage, buying is now 38 percent cheaper than renting, according to San Francisco-based Trulia, an online real estate information firm. Among young renters, 93 percent want to be homeowners someday, based on a company survey late last year.
“The barriers to homeownership are high, but they’re keeping some people out who could be spending a lot less on their housing longer term if they owned instead of rented,” said Jed Kolko, Trulia’s chief economist.
That’s created an opportunity for homebuilders, which since the housing crash have been focusing on buyers with easier access to credit who can afford larger, more expensive properties near employment hubs. The median price of a new U.S. house reached a record $285,400 in March and was $282,000 last month, according to data reported yesterday by the Commerce Department. Sales jumped 18.6 percent in May to the highest level in six years.
Horton’s low-cost Express Homes brand has the potential to account for 20 percent of the Fort Worth, Texas-based builder’s revenue in two or three years, according to CEO Donald Tomnitz. Horton, which had $6.1 billion in sales during fiscal 2013, is already marketing the homes in 45 communities in six states.
“My goal is, how do you increase the pool of affordable buyers?” Tomnitz said at a May Wells Fargo & Co. conference in New York. “Job growth helps, and that’s what really drives our business. But if you’re not getting help from the job side, then how do you change your product offering?”
Stephen Kim, a New York-based housing analyst with Barclays Plc, said companies that take the lead in serving entry-level buyers have “first-mover advantages,” because they’re stockpiling lower-cost land before competitors.
“This is a market that to some degree has been overlooked, and it’s poised to get better,” Kim said in a telephone interview. Public homebuilders, many of which have mortgage units, are often able to “handhold” buyers through the loan process, he said, making new homes more attractive than existing properties for first-time owners.
LGI covers closing costs and works with mortgage and insurance companies to streamline underwriting for government loans that require no down payment -- or a small one -- for buyers who meet minimum credit requirements.
Each week, the company blankets apartment complexes and single-family rentals near its eight Houston communities with 12,000 mailers, said Brian Batten, vice president of sales for the Houston area. The fliers, which ask, ‘Tired of Renting?,’ highlight the monthly cost more than the asking price. They exclude tax and insurance, which can cost hundreds of dollars more.
Unlike most builders, LGI starts houses before they’re under contract so that buyers don’t have to wait months to move in. It takes an average 45 days to deliver a home once the concrete pad is complete, Batten said.
The company has been profitable every year since it was founded in 2003 and never saw a falloff in demand as the housing market cratered in 2008 and 2009, said Lipar, whose father, Tom, started LGI. In the first quarter, closings jumped 92 percent from a year earlier to 485 homes. The average sales price was $156,535, up 10.8 percent from a year earlier.
LGI shares climbed 68 percent to $18.44 since its Nov. 6 IPO through yesterday compared with an 8.1 percent gain in the Bloomberg homebuilders index. It’s the only builder with the equivalent of a buy rating from all the analysts tracking the company, according to data compiled by Bloomberg.
The company’s strategy has helped people such as Pate-Yow who may have had trouble getting a loan.
Pate-Yow said she will qualify for a zero-down payment mortgage once she clears up a $505 unpaid phone bill, even though she’s unemployed and disabled from being stricken by cancer. Her husband, Joshua Yow, 21, reported income only from his work as her at-home caregiver, she said.
“We told them how much we made and all that stuff and that was good enough for them,” she said. “No closing costs. No down payment. They like to close quick.”
While the goal of creating more affordable housing is laudable, risks arise when entire communities belong to buyers with low down payments and fragile finances, said Jack McCabe, a housing consultant based in Deerfield Beach, Florida.
“If there’s any problem with the household income or an illness or something like that, it’s very easy for people to walk away,” McCabe said in a telephone interview. “There’s a possibility that we’re going to see neighborhoods in future years devastated by foreclosures because people didn’t have a stake in their homes.”
Some builders aren’t trying to reach entry-level buyers because banks are afraid of being penalized for giving them mortgages if something goes wrong, according to John Burns, a housing consultant based in Irvine, California.
“The problem is that many borrowers, who most would say are good credit risks, cannot get a mortgage because they have some sort of credit history problem, such as a missed payment, a medical bill dispute, or a short period of unemployment,” Burns, CEO of John Burns Real Estate Consulting, said in an e-mail. “The banks are waiting to be told that they can lend to these people.”
The majority of LGI’s visitors don’t qualify for a mortgage initially, Lipar, the CEO, said. The company offers advice on how to raise credit scores so potential buyers can make deals in the future.
Visitors to LGI sales offices apply to be prequalified for a mortgage, and answer a questionnaire about what they’re looking for before only touring homes that they can afford. While the homes come with extras that can include granite kitchen countertops, buyers don’t get to choose from a menu of upgrades.
“This is a group of people that wants out of their apartment,” JMP’s Martin said. “They’re not selling to a move-up person. They’re selling to a person with a dramatic need.”
LGI is in markets with strong rental demand and employment growth, much of which is fueled by service jobs, Martin said. The company has moved into Arizona, Georgia, Florida and New Mexico and announced plans to enter Colorado and North Carolina.
Both LGI and Express Homes hold prices down by building in outer ring suburbs where land can be less than half the cost of prime parcels, said Brad Hunter, the chief economist at housing-research firm Metrostudy. He is advising some builders to develop in outlying locations because demand from entry-level buyers will grow as the economy improves.
“Most of our customers drive 10 to 20 minutes further but for a similar payment they can own rather than renting, so it’s an easy sell,” Lipar said.
Millennials, saddled with unemployment and student debt, are postponing marriage, parenthood and homeownership. That won’t last forever, Hunter said.
“I’m encouraging them to look at what today look like C locations that in another year will look like B locations and not long after that will be the new A locations,” Hunter said.
Not all builders are convinced it’s a good idea to target buyers who need to “drive until they qualify” for a mortgage.
“We don’t do fringe locations,” Robert Francescon, co-CEO of Century Communities Inc., a Greenwood, Colorado-based homebuilder that went public last week, said in a telephone interview. “We’ve seen during the downturns that fringe locations are the first to get hit, the hardest hit and the last to recover.”
KB Home, the Los Angeles builder that traditionally targeted entry-level buyers, now constructs about 48 percent of its houses for the move-up and senior markets. The average selling price of its houses was $305,200 in the first quarter, up 12 percent from a year earlier.
“Between a lack of job growth in a lot of cities and lack of mortgage availability, it’s really hurting the first-time buyer,” CEO Jeffrey Mezger said at a JPMorgan Chase & Co. (JPM) homebuilding conference on May 14. “When that gets unlocked, you’ll see an incredible opportunity in our industry. It’s going to take some time.”
Pate-Yow, who suffers from four types of cancer, doesn’t have time to wait. She married June 14 after deciding to buy the house. She expects to move in the first week of July, and is eager to plant her yard with a vegetable patch and fruit trees.
“It’s only about $1 per day more than I pay for my apartment now,” she said. “If you can get a house for as much as an apartment, it’ll sell out quick.”
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