The real estate sector is considered to be one of the most critical and sensitive sectors of a country’s economy, as it is a clear gauge of the state in which consumers within the economy of each country is in as well as an indication of economic expectations. It is pretty much like a vicious cycle; the more confident the investor on the outlook of the economy, the more s/he is willing to participate on the upturn and invest in a new home. And so the snowball effect kicks-in, and the more it kicks in, the more wealth is created and the more people consume and pump money in the economy (as opposed to increase savings).

The US housing sector is one of the largest in terms of depth and the ease at which US citizens can get their hands onto a property is unparalleled, albeit it is highly regulated. In our previous publications, we have clearly stated that we are upbeat on the prospects of the US economy in the short-medium term and that the US economy is well positioned to sustain it current trend of persistent and healthy quarter-on-quarter growth. It hence goes without saying that the US real estate sector is one which needs to be given its due importance. A company which we follow closely, from a bond (fixed income perspective) is KB Home.

KB Home is one of the largest and most recognized homebuilding companies in the United States and has been building homes for nearly 60 years. KB Home constructs and sells homes through its operating divisions under the name KB Home. The company’s homebuilding operations offer a variety of new homes designed primarily for first-time, move-up and active adult homebuyers, including attached and detached single-family residential homes, town-homes and condo. KBH delivered 7,215 homes at an average selling price of $328,400 in 2014.

Following the collapse of the US housing market in the aftermath of the 2007/2008 crisis, KBH moved quickly with the increased demand for housing and improving economic conditions to take advantage of opportunities to expand its business and restore profitability as the housing recovery began to take shape in 2012. KBH initiated an aggressive land acquisition and land development investment strategy to position more of its new home communities.

Management has undertaken steps to accelerate growth by investing approximately $3.17 billion in land and land development overall, leveraging the strengths of its operational platform, thereby enhancing profitability and generating higher revenues. This substantial investment contributed to year-over-year increases in the community count, revenues, average selling prices and housing gross profits in 2014.

In 2014, the housing market continued to improve compared to the several difficult years of the housing downturn. The present recovery which is well into its third year has been driven primarily by steady demand for homes, fairly low inventories of homes available for sale and generally healthy economic and demographic factors. Housing demand has been supported by population growth as well as affordability largely due to relatively low home loan interest rates, coupled with a surge in consumer confidence. However, the performance of individual housing markets varied throughout the year, with home sales activity and selling price appreciation robust in certain markets and volatile in others due to in the main rising inventory levels.

Given its relevance in the US economy and cyclicality, it would be naive to ignore the possible risks to the downside, which could come in many forms primarily the softening or sustained deterioration of home sales activity and/or selling prices, weak general economic, income and employment growth, high consumer debt levels, including elevated student loan balances, to name a few.

If the housing environment becomes more challenging, there would undoubtedly be a corresponding adverse effect on the business of KBH business and bottom line.

Notwithstanding this, we remain aware of the fact that KBH operates within a highly cyclical sector which explains its highly leveraged business model. This has historically enabled KB Home to accumulate debt in an attempt to take advantage of upturns in economic cycles. In our opinion, we view KB Home well positioned to continue to take advantage of the US economic recovery and we view an investment in KB Home bonds as commensurate with the risk involved. Furthermore, following the correction in the US High yield market in the second half of 2014, we view the current levels at which KB Home bonds are trading to be an attractive entry point for the bond investor seeking to build a direct exposure to the US High Yield market.