California is one of the hottest spots for real estate now, and prices are rising at some of the highest rates in the country. It’s all about psychology, said economist Robert Shiller in a recent CNBC interview. For all we know, it could be the Silicon Valley effect considering the number of tech companies located in the area. The point is there’s no real explanation for it and that’s what’s scary. Historically, the San Francisco real estate market has been in bubble territory, so who is to say that it’s not heading in that direction?
East Coast malaise
While West Coast housing prices are on fire, things aren’t as hot in the Eastern part of the United States. That’s evident in the performance of one New Jersey-based home builder Hovnanian Enterprises, Inc. (NYSE:HOV). The company recently returned to profitability after two years of financial losses, and expects to be profitable over the balance of this year. One of Hovnanian’s hang-ups has been its struggle with high debt costs.
An interesting thing about Hovnanian Enterprises, Inc. (NYSE:HOV) is its diverse customer base. Last year, the company had a combination of deliveries across first-time home buyers, move-up, and luxury home buyers, which is a good model to offset weakness in economic cycles. As of the second quarter, it has $1 billion in contract backlog, up 34% compared to a year ago.
And total revenue in the second quarter climbed 24% to $423 million versus last year. But back in 2005, before the housing crisis, Hovnanian Enterprises, Inc. (NYSE:HOV)’s gross margins were as high as 26%. Today’s gross margins are more in the range of 19% and the company has a new normal target range of about 20% to 21%.
New competitor
Hovnanian has some growing competition and it goes by the name The Ryland Group, Inc. (NYSE:RYL). In July, this Westlake, Calif.-based home builder and mortgage financier acquired Cornell homes, which gave it a foothold in the Philadelphia market and makes it a competitor in the surrounding Tri-state (New York, New Jersey, and Connecticut) area. After the recent acquisition of the Dallas-based business of LionsGate Homes. Ryland now has an entry point into the Dallas market, where it’s likely to benefit from the rising population in Texas.
While Hovnanian Enterprises, Inc. (NYSE:HOV) is diversified across home-buyer types, The Ryland Group, Inc. (NYSE:RYL) is diversified in its revenue streams. The company’s mortgage financing arm is profitable (it generated pretax earnings of $7.6 million in the second quarter compared to $2.9 million in the year-ago period), and the home developer has a rising loan pipeline. It just declared a dividend of $0.03, and has about $705 million in cash and marketable securities as of the second quarter.
Not so hot
Credit: Lennar Corporation (NYSE:LEN)
But Lennar’s performance has been hot even though the Florida housing market is not. Although based in Miami, Lennar operates in states like Arizona, Texas, and Georgia where home values are strengthening.
The company has been experiencing rising demand since 2012, thanks in large part to rising rental rates that make buying a new home a more attractive option. Home building has lagged the population growth in Lennar Corporation (NYSE:LEN)’s markets, which is driving the higher demand. There are land constraints, but Lennar has been scooping up land over the past couple of years which puts it in a desirable position.
Lennar Corporation (NYSE:LEN) had $1.1 billion in cash and cash equivalents at the end of 2012, and the company retired some $302 million in debt last year. It pays a dividend of $0.04 and it can repurchase up to 6.2 million shares under an existing share-repurchase program.
Off the fence
The Case-Shiller housing index, a gauge of home prices, advanced 12.2% in May, with some of the strongest showings coming from markets such as Atlanta, Las Vegas, and San Francisco. But Robert Shiller, according to a CNBC interview, doesn’t suspect that a bubble is forming and instead believes these conditions might continue for another year or so.
Another pervasive theme throughout housing is that buyers that have been on the sidelines about making a home purchase are getting off the fence. Mortgage rates have been inching higher since May, and so far it really hasn’t been a deterrent, housing executives say. Instead, buyers are jumping in before rates go even higher. So rising rates are actually helping housing activity, not hurting it.
The home builders all have a pretty good story to tell. Pipelines are full, margins are rising, and buyers haven’t shown signs of being deterred by rising mortgage rates. While I like all three of these home builders, Hovnanian might be the best. And that’s because it’s just now hitting its stride with plenty of upside ahead.
Gerelyn Terzo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Gerelyn is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Could Silicon Valley Cause a Housing Bubble? originally appeared on Fool.com and is written by Gerelyn Terzo.
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