Home, they say, is where the heart is. These days, homes are causing nothing but heartburn.
That the housing market is weak—and housing stocks with it—is not breaking news. The Federal Reserve started raising rates in March, mortgage rates have risen with them, and housing activity has, if not ground to a halt, at least meaningfully slowed. Housing stocks, whether home builders, home-improvement retailers, or the new breed of real estate agents and home flippers, have paid the price, with the
SPDR S&P Homebuilders
exchange-traded fund (ticker: XHB) down 28% in 2022, underperforming the
S&P 500,
which has dropped 18%.
Such declines typically trigger our contrarian impulses, but home-building stocks might not be the bargains they appear to be. That’s especially true after Thursday’s monster rally, inspired by October’s weaker-than-expected consumer price index, which sent the Homebuilders ETF up nearly 10%. Mortgage rates remain too high, and houses too unaffordable, for a surge of buyers to start pushing prices higher again. The best that can be hoped for is stagnation, for both the housing market and housing stocks—and even that might be wishful thinking.
Recent housing data confirms just how bad it is out there. New-home sales fell 11% to a 580,000 seasonally adjusted annual rate in September, while existing-home sales declined 1.4% and housing starts dropped 8.1%. In August, home prices rose 13% year over year, but declined 1.1% month over month, the largest drop since December 2011. And there’s really no end in sight, with housing starts expected to have declined in October as well.
“The whole economy isn’t in a recession, but the housing market is,” says Dave Donabedian, chief investment officer at CIBC Private Wealth US.
The problem, of course, starts with mortgage rates. At a recent 7.08% for a 30-year fixed-rate home loan, the rate is more than double the 2.98% rate of just one year ago. If the increase had happened slowly, it might not have been an issue, but the move higher happened at warp speed. With a four-percentage-point gap between the mortgage rate that homeowners currently have and where new mortgages would be, people are less likely “to move and give up their low-rate mortgage,” writes Credit Suisse analyst Daniel Oppenheim. “A more gradual increase would have had less impact on turnover, but the sharp increase will lead to sharply lower existing home sales activity.”
Not that anyone can afford to buy them. Deutsche Bank strategist Jim Reid defines affordability as a 20% down payment and mortgage payments of $2,500 a month at prevailing 30-year rates. Toward the end of 2021, that made a $700,000 home affordable, by Reid’s math, when the average home price was around $600,000. But with mortgage rates four percentage points higher, a $450,000 home would qualify as affordable. “A 30-year mortgage market with the ability to constantly refi at lower and lower rates is a boon in a falling rates market, but if rates gap higher as they have this year, you create valuation gap risk in house prices,” Reid writes. “It just depends if there’s a catalyst for this to correct quickly or if the air will leak out of the bubble more slowly. Regardless, housing looks extremely expensive if rates stay at these levels.”
Housing stocks already reflect a lot of the pain.
D.R. Horton
(DHI) and
PulteGroup
(PHM) have both dropped 23% this year, while
Toll Brothers
(TOL) has slumped 36%. That was actually an improvement over where the losses were at the start of the week thanks to the CPI-inspired rally, which saw Pulte jump 13% and D.R. Horton and Toll Brothers gain 11%.
And those gains mean home-builder stocks aren’t nearly as cheap as they were just a few days ago. D.R. Horton trades at eight times 12-month forward earnings, up from 5.8 just a week earlier. PulteGroup trades at 5.61 times, up from 4.73 times one week earlier. And Toll Brothers trades at 5.1 times, up from 4.5 times.
Yes, they’re still cheap, but not quite as cheap as they were before the CPI print. For a sustained rally, the home-builder stocks need to have visibility on the course of inflation and rate hikes, visibility that probably doesn’t exist yet despite the stock market’s enthusiastic reaction to Thursday’s CPI. “If you can see the interest rate environment getting more friendly, you close your eyes and buy,” Donabedian says. “We’re not there yet.”
Write to Ben Levisohn at Ben.Levisohn@barrons.com
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