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On Nov 30, Zacks Investment Research upgraded KB Home (KBH - Analyst Report) to a Zacks Rank #1 (Strong Buy) as the stock surged on strong housing permits data announced last week.

Why the Upgrade?

On Nov 26, the U.S. Department of Commerce announced that building permits for the month of October came in at 1034,000. The figure was above the consensus estimate of 935,000 and also grew 6.2% sequentially from September’s figure of 974,000. Single-family permits grew 0.8% higher than the previous month’s figure of 615,000. In fact, building permits were at a 5-year high in October.

The better-than-expected building permits data lifted share prices of homebuilders like KB Home, PulteGroup, Inc. (PHM - Analyst Report), Lennar Corporation (LEN - Analyst Report) and The Ryland Group, Inc. (RYL - Snapshot Report).

The strong housing data clearly indicates that the recent increase in interest rates has not completely dampened the housing recovery. Homebuilders, of late, have been witnessing a slowdown in order pace and traffic due to rise in interest rates since May. High interest rates dilute the demand for new homes, as mortgage loans become expensive and lower a buyer’s purchasing power. Accordingly, the sharp increase in interest rates shocked many customers and a few put off their purchase decision; thus increasing cancellation rates and lowering orders for many homebuilders.

However, most analysts believe that though interest rates have started increasing lately, they are still below historical levels. Housing is thus still affordable and demand remains intact. Supply, however, remains limited by low home inventories, both for new and existing ones. A shortage of land and labor is also restricting the production of homes. Home prices have thus, started moving up with market demand gaining momentum but supply remaining limited. In fact, rising home prices and thinning home inventories have created a sense of urgency among homebuyers to buy a house before prices increase further.

With the ongoing speculation that the Fed could taper or end their $85-billion bond-buying program in 2014, there is a good chance that the interest rates could shoot further up.

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