It’s 13F Time Again!

It’s that time of the quarter again when the Securities and Exchange Commission’s (“SEC”) Form 13F reveals the moves of institutional investment managers managing over $100 million in assets. It’s a bit like getting a backstage pass to see what some of the big players in the investment world are up to. One name that always stands out is Berkshire Hathaway (BRK.A), and this quarter was no exception.

Berkshire Hathaway, led by the Oracle of Omaha himself, Warren Buffett, made some intriguing moves that caught the attention of the financial world, as they often do. Let’s dive into the details without the need for pictures or complex graphs.

Buffett’s New Homebuilder Bet

One of the standout aspects of Buffett’s recent moves is his increased interest in homebuilders. He added to his portfolio by acquiring 6 million shares of D.R. Horton (NYSE:DHI), 11 thousand shares of NVR (NVR), and 150 thousand shares of Lennar (NYSE:LEN). However, it’s important to note that these additions aren’t massive bets for Buffett. D.R. Horton, the largest addition to his portfolio, accounts for just 0.2% of his overall holdings.

Buffett’s Changing Investment Strategy

Bloomberg has pointed out a shift in Buffett’s investment strategy. Berkshire Hathaway, known for its long-term buy-and-hold approach, has started to make shorter-term moves. This shift became apparent when Berkshire disclosed a stake in Taiwan Semiconductor Manufacturing Co. last year, only to significantly reduce that position in subsequent months. It’s a notable departure from the traditional Berkshire playbook.

The Homebuilder Trend

Now, let’s talk about the broader homebuilding trend. Homebuilders have been on a fascinating trajectory in recent quarters, defying expectations. Despite soaring mortgage rates, they’ve been performing remarkably well.

Freddie Mac data shows that mortgage rates have climbed to 7% (30-year fixed), the highest level since the early 2000s, in response to the Federal Reserve’s efforts to control inflation. What’s remarkable is that homebuilders have continued to thrive in this environment.

Homebuilders vs. the S&P 500

Homebuilders have not only weathered the storm but have also outperformed the broader market, as indicated by Bloomberg data since 2018. Even when rates started to rise in early 2022, they gained momentum as rates moved from 3% to 4%, using 10-year government bond yields as a proxy.

Historical Patterns vs. Current Conditions

Traditionally, homebuilders perform well when rates are declining, as lower rates make homeownership more attractive, boosting demand and orders. However, the current situation is different. Rates are so high that existing homeowners are reluctant to sell, fearing the burden of expensive mortgages. Consequently, new listings have decreased by 16% year-on-year.

Changing Dynamics

Another sign of the changing dynamics is the share of new single-family home sales as a percentage of total sales. At the beginning of the second quarter, it was close to 35%, well above the long-term median of 15%. This shift highlights the reluctance of existing homeowners to sell.

The Thin Ice of Homebuilders

While it’s not time to sound the alarm, homebuilders are treading on increasingly thin ice. A surge in housing supply could pose a risk to homebuilding stocks. This supply increase might be triggered by a drop in interest rates due to economic weakness or rising unemployment, forcing some homeowners to sell their properties.

“Ironically, if rates went significantly lower from here, it could juice demand a little bit, but you also might have a lot of competition coming in from the resale side of things,” warns Oppenheimer & Co. analyst Tyler Batory.

Builder Confidence and Incentives

Adding to the complexity, builder confidence is declining due to rising mortgage rates. In August, the National Association of Home Builders/Wells Fargo Housing Market Index fell to 50, marking its first decline since December 2022. High construction costs and a shortage of skilled labor have contributed to this decline.

Sales Incentives and Building Permits

Builders are increasingly resorting to sales incentives to attract buyers. The August HMI survey revealed that rising mortgage rates prompted more builders to use price reductions to boost sales. However, building permits, a key indicator, continue to decline, signaling that homebuilders are not ramping up production.

Pricing Power and Risks

One of the critical factors to watch is pricing power. Median sales prices are currently higher than in 2022, indicating that homebuilders are benefiting from strong pricing power. However, if this pricing power erodes, it could lead to weaknesses in the sector.

Buffett’s Bets: D.R. Horton and Lennar

Buffett’s recent investments in D.R. Horton and Lennar are noteworthy. D.R. Horton, with a market cap of $43 billion, focuses on affordable homes, with nearly 70% of its homes priced under $400 thousand. This strategic emphasis has helped the company increase its market share significantly over the past decade.

D.R. Horton’s Performance and Strategy

Despite challenges like high mortgage rates and inflation, D.R. Horton reported a 37% growth in net sales orders in the third quarter of fiscal year 2023. The company is committed to increasing market share, improving labor capacity, and managing construction costs.

Lennar’s Unique Position

Lennar, with a market cap of $36 billion, has a strong presence in states like Florida and Texas, which have seen an influx of residents. The company also targets entry-level buyers, a segment facing a supply shortage.

Lennar’s Strategies and Earnings

Lennar reported stabilized market conditions, with customers adapting to higher interest rates. The company has been using pricing and incentives to achieve sales targets, resulting in an increase in market share.

Earnings Expectations

Looking ahead, Lennar expects to deliver between 17,750 to 18,250 homes in the upcoming quarter, with gross margins projected between 23.5% and 24.0%. On a full-year basis, the company has raised its delivery expectations, reflecting its confidence in the market.

Valuation and Conclusion

Both D.R. Horton and Lennar seem promising, but they face challenges. Their growth depends on the housing supply remaining limited. Margins are under pressure due to high rates and incentives.

My Perspective

In conclusion, while I see potential in these homebuilders, I believe there are risks, especially considering the possibility of forced selling in an economically stressed scenario. I wouldn’t be surprised if Buffett picked up these stocks at lower prices this quarter, and I don’t anticipate him holding them for the long term.