Shares of public home builders were met with a pessimistic start to the fourth quarter as Treasury yields rose, continuing the downward trend that began in the late-summer.
In the third quarter, builder stocks faced a significant decline due to the rapid increase in mortgage rates, causing concern among buyers, builders, and investors alike. As the housing market enters its slower season, the trajectory of mortgage rates continues to pose a major challenge. However, the long-term outlook for these stocks remains positive.
Freddie Mac’s closely-watched weekly gauge revealed that mortgage rates reached a more than two-decade high at the end of the third quarter. Last week, the average 30-year fixed mortgage rate rose to 7.31%, reflecting investor expectations for inflation and the economy. This increase in rates is closely tied to the rise in the 10-year Treasury yield, which frequently influences mortgage rates.
The elevated mortgage rates have resulted in higher financing costs for potential home buyers, creating additional pressure on both buyers and home builders. In fact, the National Association of Home Builders’ confidence gauge dipped into negative territory last month, partially attributed to the surge in rates. Additionally, contract signings for new home purchases declined more than anticipated in August.
Chief economist Robert Dietz of the National Association of Home Builders stated, “Sales weakened in August with average mortgage rates above 7%. While some builders were able to mitigate this effect through mortgage rate buydowns, rates have since increased, suggesting that the pace of new home sales will further decline in September.”
Mortgage Rates on the Rise
Mortgage rates are showing signs of continued increase, with the 10-year Treasury yield reaching its highest point since October 2007. Lawrence Yun, the National Association of Realtors’ chief economist, warns that rates could climb as high as 8% in the near-term. This news has significant implications for home builders and investors.
Home Builders Experience a Déjà Vu
Over the past quarter, all 13 traditional home builder stocks in the SPDR S&P Homebuilders ETF (ticker: XHB) have seen a decline in value. According to FactSet data, these stocks collectively dropped an average of 12%. This is the first time since last year’s third quarter that builders have faced such losses, which were triggered by a surge in mortgage rates during the summer.
Impact on Home Builder Stocks
UBS analysts John Lovallo, Spencer Kaufman, and Matthew Johnson have reacted to this trend by reducing their price targets for home builders by an average of 8%. They attribute this adjustment to higher interest rates, macroeconomic uncertainty, and a decrease in investor sentiment.
Outlook on Mortgage Rates
Economists and analysts predict that mortgage rates will remain relatively high for a significant period of time. Fannie Mae’s September housing forecast estimates that rates will average 7.1% by the end of 2023 and gradually drop to an average of 6.3% by the end of 2024.
Despite these challenges, the housing market continues to evolve, and builders and investors alike will need to adapt accordingly. It is crucial to monitor the fluctuating landscape and make informed decisions to navigate this changing environment successfully.
Revised Mortgage Rate Expectations
Viswanathan and Ashworth anticipate that mortgage rates will rise through the end of 2023. They now project rates to reach 7.1% by the end of that year, an increase from their previous estimate of 6.6%. Looking ahead to 2024, they expect rates to stabilize at 6.8%, up from the earlier projection of 5.9%. The revised forecasts reflect a significant shift in the mortgage rate landscape.
Implications for the Housing Market
The rising mortgage rates pose a potential challenge for the housing market. However, UBS analysts suggest that builders could counteract any stalling demand by offering attractive incentives to prospective buyers. This approach proved successful in late 2022 and early 2023 when similar strategies reignited activity in the market.
Despite some concerns, the SPDR Homebuilders ETF showed positive performance for the year, with an average increase of 50% among its 13 builders during the third quarter. This relative outperformance may result in turbulent short-term trading conditions, as noted by the UBS analysts.
The Long-Term Outlook for Builders
While short-term fluctuations may occur, the UBS analysts remain optimistic about the future of builder shares. They argue that the U.S. housing market is currently under-built, which, coupled with high mortgage rates, incentivizes homeowners with ultralow rates to stay put. Consequently, this reduces the number of previously owned homes available for sale and drives demand towards builders.
Furthermore, the UBS analysts highlight the advantages that public builders possess over their private counterparts. Access to land, labor, materials, and financing are key factors contributing to their prime position in this unique housing cycle. As a result, they expect public builders to continue reaping significant benefits.
In summary, the upward revisions in mortgage rate expectations signal changes in the housing market dynamics. However, with the potential for builders to stimulate demand through attractive incentives, and the long-term advantages enjoyed by public builders, the outlook for the industry remains promising. As we move forward, it will be fascinating to observe how these factors shape the future of the housing market.