Home Builders Face Affordability Hurdles This Spring

A pullback in mortgage rates has helped boost home builder stocks this year after a dismal 2018, when the U.S. housing market slowed under the weight of higher borrowing costs, rising prices and a thin supply of homes for sale.

Investors are betting that the decline in the average rate for a 30-year mortgage will help more Americans become owners this spring homebuying season. But many analysts and economists are projecting a decline in home sales for the full year.

“Spring will not be as strong as last year, in part because spring last year was pretty strong, but also because homebuilders are trying to adjust price for a more cautious consumer who is concerned about price and competing with additional inventory,” said Carl Reichardt, managing director and homebuilding analyst at BTIG.

While steady job growth has fueled demand for homeownership, rising prices and a shortage of properties for sale has made homes less affordable for many buyers, especially those seeking to transition from renting to owning.

Sales of newly built U.S. homes surged 16.9 percent in November from the previous month to a seasonally adjusted annual rate of 657,000, according to the Commerce Department. Despite the healthy gain, sales remained 7.7 percent below the pace from a year earlier.

The 35-day government shutdown delayed the release of more recent sales data. Analysts project that December new-home sales, due out next week, declined 13.5 percent from November, according to FactSet.

Meanwhile, sales of previously occupied U.S. homes dropped 1.2 percent in January to the slowest pace in more than three years, according to data from the National Association of Realtors. Sales are down 8.5 percent over the past 12 months.

The U.S housing market stalled in 2018 after a long period during which price increases outpaced income growth. That had been offset by historically low mortgage rates, until rates began rising steadily a year ago, reaching a seven-year high near 5 percent.

Mortgage rates hew closely to changes in the yield for the 10-year U.S. Treasury note, which went into a skid in early November as nervous investors drove up demand for U.S. government bonds during the October-December stock market sell-off.

The average rate on the benchmark 30-year, fixed-rate mortgage rate has been steadily declining since its mid-November high of 4.94 percent. Last week, it slipped to 4.35 percent, the lowest average in more than a year.

Buyers will see lower borrowing costs on home loans. However, that alone won’t mean they’ll have it easy this homebuying season, notes Danielle Hale, chief economist for Realtor.com.

“Home prices are higher than ever before and expensive homes are far more plentiful than entry level homes,” Hale said.

That trend, in turn, could mean fewer sales for many homebuilders, because newly built homes tend to be more expensive relative to resale properties. And in recent years, builders have tended to focus on catering to homeowners looking to trade up to a bigger or nicer home.

“As much as an affordability issue there’s also a psychological issue,” Reichardt said. “Buyers have been resisting higher home prices, not simply because they can’t afford to pay what builders are asking, but because they don’t want to.”

Big builders that have taken steps in recent years to build more communities priced for first-time buyers are likely to fare better this spring. Of those, Reichardt singled out D.R. Horton and Lennar. The analyst has “Buy” ratings on both.

The Federal Reserve’s decision to take a “patient approach” in determining future interest rate hikes has helped lift stocks broadly this year, and the move has been especially positive for homebuilders.

That’s because when the market is uncertain about homebuilders’ prospects for earnings growth, interest rates become a proxy for earnings, notes Reichardt.

Despite their recent gains, shares in most U.S. homebuilders remain sharply lower than a year ago. That means investors should be cautious when considering the sector.

“2019 is going to be a tough year, which is why we’re not especially favorable on the stocks,” Reichardt said. “At the same time, we don’t think this is any kind of repeat of the last down cycle.”