“And those $0 down (home) loans? They are primarily drawn from the U.S. Department of Agriculture’s Rural Development Guaranteed Loan program. Unlike mortgages guaranteed by the Federal Housing Administration, or those from most private lenders, the USDA offers 100% financing…

…While meant to be limited to rural areas, many of the places it covers are in the exurbs LGI focuses on. Tom Lawler, a Fannie Mae veteran who is now an independent housing economist, says he isn’t a fan of LGI’s practice of promoting USDA loans. Nor is he enamored by it advertising its houses by monthly payments rather than price.”, Justin Lahart, “Why This Home Builder Doesn’t Have to Slip on Oil”, The Wall Street Journal, December 15, 2015

“The USDA offers no-down payment home loans, VA offers 100% LTV cash-out mortgages and FHA isn’t far behind with only 3% or so down (and to subprime FICO score borrowers). Why post-crisis, now that we all know that nominal housing prices can fall not only regionally, but nationally, is our government continuing to offer these risky mortgages that can easily result in hundreds of thousands, if not millions, of borrowers being underwater on their mortgage and billions in taxpayer losses? And why should a for-profit firm like LGI be allowed to make big profits with “no skin in the game” (The risk of the 100% mortgages is fully taken on by the American taxpayer.)? LGI’s business model doesn’t exist without USDA’s 100% financing!”, Mike Perry, former Chairman and CEO, IndyMac Bank

Markets

Why This Home Builder Doesn’t Have to Slip on Oil

LGI Homes’ focus on first-time buyers is helping it outstrip rivals

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LGI Homes closed on 934 homes in the third quarter, up from 557 a year earlier. An LGI-built home in Hockley, Texas. PHOTO: LGI HOMES INC.

By Justin Lahart

LGI Homes has been growing so quickly investors could be forgiven for thinking they had been transported back in time to the housing boom. The way the home builder’s stock has fallen this month, they could also be forgiven for thinking they are back in the housing bust.

It doesn’t help, either, that LGI’s home state of Texas represents a big chunk of its business, exposing it to the oil-price rout. Or that LGI builds its houses on “spec”—that is with no identified buyers. Or that it is focused on the exurbs and touts the chance to own a new home “for $0 down.”

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Even so, with a focus on first-time buyers, the company is filling a void left by an industry that may be overly risk averse. And December’s 25% drop in LGI’s stock gives investors more compensation for risks around the high-growth company.

LGI closed on 934 homes in the third quarter, up from 557 a year earlier. That 68% gain compares with an overall rise in new single-home sales of 10%. Its revenues grew 88%, and its gross profit margin of 26% is well above most peers. With the drop in its stock price, the company now trades at just 8.4 times expected earnings. That is below most large builders’ multiples despite its much higher growth profile.

Investors’ immediate concern is that with oil below $40 a barrel, LGI’s exposure to Texas, which accounted for more than half its closings in the third quarter, will hurt it. So far, though, its Texas business isn’t showing signs of flagging. And its business outside the state has grown quickly, representing 47% of closings in the third quarter versus 30% a year earlier. Communities scheduled to open in five new markets will further diversify it away from Texas.

Meanwhile, its building on spec is looking more like a feature than a bug lately. This has allowed LGI to offer subcontractors steady work. As a result, while other large builders have struggled with a dearth of available labor, LGI didn’t experience such shortages.

And those $0 down loans? They are primarily drawn from the U.S. Department of Agriculture’s Rural Development Guaranteed Loan program. Unlike mortgages guaranteed by the Federal Housing Administration, or those from most private lenders, the USDA offers 100% financing. While meant to be limited to rural areas, many of the places it covers are in the exurbs LGI focuses on.

Tom Lawler, a Fannie Mae veteran who is now an independent housing economist, says he isn’t a fan of LGI’s practice of promoting USDA loans. Nor is he enamored by it advertising its houses by monthly payments rather than price.

But he thinks it is a plus that LGI is focused on building exurban homes that are affordable to first-time buyers. This is an underserved area after the housing bust sent many mom-and-pop builders out of business and led large public builders to retrench.

LGI will be reaching more of those buyers in the year ahead, and yes, there are risks in that. But a home builder willing to take on some risk may be a welcome thing these days.

 

Posted on December 16, 2015, in Postings. Bookmark the permalink. 2 Comments.

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