Rising mortgage rates seem likely to cool the housing market and sink homebuilders' stocks. That's the conventional wisdom, but mutual-fund manager G. Kenneth Heebner, co-founder of Capital Growth Management (CGM) in Boston, says it's all wrong. Heebner, 62, has been buying the builders since 2001, and they now represent 78% of his $470 million CGM Realty Fund, which is up 46.2% this year. Heebner recently spoke with Dallas correspondent Stephanie Anderson Forest. Here are excerpts:
Most people are expecting a slowdown in housing. So why are you so bullish on the homebuilders' stocks?
The key reason is these companies are going to grow earnings 20% a year for the next five years. And they are going to do that whether housing activity goes up from here or sideways from here. The only thing that would interrupt this would be a big decline in the housing market.
Will rising rates and continued high unemployment do that?
A 30-year, fixed mortgage today is around 6.3%. In 2002, it averaged 6.7% and in 2001, over 7%. In those years, rates stimulated housing demand, so rates have to go a lot higher before they become an issue.
With employment, for example, there is a level of distress that hurts demand. In Austin, San Antonio, and Dallas, where telecom and technology employment have suffered, demand has been hit. But in other parts of the economy, where unemployment has risen but not as sharply, demand has not been hurt.
Where will the 20% earnings growth come from?
The publicly traded homebuilders are well financed. They have publicly traded debt, which in many cases is investment-grade. They are diversified geographically, have management depth, and build to order, not on spec. Most of all, these companies keep gaining market share. The top 10 publicly traded homebuilders have a 21% market share, up from 5% in 1990.
How does that help them?
These companies have the money to buy the parcels of land that are increasingly scarce in the major metropolitan areas and in markets like all of California, Baltimore-Washington, and eastern Pennsylvania-New Jersey. In Orlando, the public builders have 20% of the market but control 50% of the land supply. These builders get the most desirable land.
How many builders are in the fund?
I own most of them. I don't have a strong preference for one over another. They are all selling between six and seven times 2004 earnings. It's hard to forecast which one will do best because they all are making acquisitions -- and they are all very good at it.
What are some of the larger holdings in the fund?
Lennar, Hovnanian, Ryland Group, and NVR. Hovnanian, which is well positioned on the East and West Coasts, is the biggest holding (11%) because of appreciation (up 94.5% this year). If it goes up more, I'm going to have to sell some. I'm not going to let it become 20% of the fund.