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How Homebuilding Can Be Constructive to Your Portfolio

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First-quarter 2017 showed dismal economic growth. Nevertheless, housing got off to a good start this year attributable to low interest rates (trending down since March). This, along with solid job growth, has bolstered housing demand.

Last year was reasonably good for the housing market and the trend is expected to continue this year, courtesy of a healthy demand-supply balance, historically low mortgage rates, escalating rent costs and easy availability of loans. Again, there are signs of increased inclination of home purchases among millennials, a generation that had to some extent refrained some from entering the market.

For that matter, there are plenty of reasons to be optimistic about the broader housing sector for both the short and the long term.

Below we discuss some of the key factors driving the sector and what investors can expect going ahead.

Higher Demand, Low Inventory Boost Sales

Steady economic growth along with favorable demographics, historically low interest rates and the attractiveness of owning versus rent are driving demand. Although GDP growth in the first quarter of 2017 was slower than the preceding quarter, residential investment contributed 0.5% to GDP growth. Residential investment saw 13.8% annualized growth.

Per the National Association of Realtors or NAR, total existing home sales, which include both single-family and condos, rose 1.4% sequentially to a seasonally adjusted rate of 5.62 million in the first quarter, marking the highest growth in a decade. Also, total existing home sales increased 5% year over year.

For 2017, existing home sales are projected to increase 3.5% from 2016 levels, while new single-family home sales will increase 10.9% nationally, as per the National Association of Realtors’ Jun 2017 forecast.

On the other hand, a shortage in buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing. The convergence of healthy demand and low inventory levels is boosting new home sales and is expected to continue doing so for some time.

At the end of the first quarter, there were 1.83 million existing homes available for sale, which was down 6.6% year over year, as per data released by the NAR. The average supply during the first quarter was 3.7 months, showing a decrease from 4.2 months in the first quarter of last year.

Even at the end of April, the total housing inventory level had 1.93 million existing homes available for sale. The reported figure was 9% lower year over year and has fallen for 23 consecutive months.

Healthy Demand-Supply Balance to Lift Price

Last year, prices crept up every month. Although gains may decelerate to a certain extent, we expect prices to continue to ascend. The national median existing single-family home price in the first quarter was $232,100, reflecting an increase of 6.9% year over year. This marks as the fastest growth since the second quarter of 2015 that registered 8.2% price appreciation.

Higher rates may impact housing demand. However, the supply-side dynamics of the U.S. housing market support higher home prices.

We believe prices will continue to scale despite decelerating sales growth as demand for homes is like to grow on high consumer confidence and low unemployment. Improving labor markets, declining unemployment rates, low mortgage rates and limited home supplies are driving home prices, thereby boosting homebuilders’ top line.

Although the recent bump up in interest rates has raised concerns over the outlook of home prices in 2017, the rates should remain reasonable, in our view, keeping housing affordable. Modest hikes in interest rates in the context of an improving economic environment can be a positive for the housing sector.

After all, the underlying driver of the upward movement in interest rates is increased economic growth expectations. A booming economy boosts income as well. Thus, if the rise in income offsets the increase in mortgage payment, housing will do just fine.

Some analysts are of the opinion that the hike largely follows the euphoria of Trump’s election win. Probably, builders are hopeful that Trump will follow through on his pledge to ease some regulations that are marring housing affordability and business for small enterprises.

Stable Economic Growth

President Trump aims to double economic growth through an ambitious stimulus program featuring tax cuts, deregulation and higher infrastructure spending. Although this may face varied obstacles, we expect the plan to help the economy grow at a faster clip in 2017.

The U.S. economy grew 1.2% in the first quarter of 2017, down from 2.1% growth in the preceding quarter. Despite weak growth, the labor market helped the industry to maintain its stature. Through May 2017, the U.S. economy added jobs for 80 straight months. The unemployment rate was 4.3% in May, which was lowest since 2001. Improving economic growth supported by a better employment picture generally boosts housing activity and provides a basis for stronger demand.

With a fall in the unemployment rate, rising wages and decent consumer confidence, the U.S. economy looks quite strong despite rising pressure elsewhere.

Millennials Take Interest

Millennials, born after 1980, are anticipated to continue to make up a large and growing portion of the buyer section, although many disagree with this view. This is due to the fact that millennials occupy the largest adult generation and make up the greatest percentage of the workforce.

According to the 2017 National Association of Realtors Home Buyer and Seller Generational Trends study, millennials account for 34% of all buyers and make up for the largest share of home buyers.

Boosting Land Bank Amid Rising Costs

U.S. homebuilders have been seeking various ways to increase their land holding amid rising land acquisition costs and a tight labor market that hinder efforts to tap the recovery in the housing market. Again, limited capital for land development has left entitled lands in short supply while growing demand drove land prices higher. The labor market has also tightened with limited availability of labor, arresting the rapid growth in housing production.

Land development and homebuilding are correlated but fundamentally different operations. Prominent homebuilders are buying out major land developers that will help them to address the ongoing issues. In Jun 2017, D.R. Horton, Inc. (DHI - Free Report) offered to buy 75% of the shares of Forestar Group Inc. , a residential and mixed-use real estate development company, for about $520 million in cash. Successful completion of the deal will strengthen D.R. Horton’s foothold in Texas.

With an impressive second-quarter sales backlog of $4.4 billion and a well-stocked supply of land, lots and homes, D.R. Horton is a best-in-class homebuilder that will benefit from a strong strategic relationship with a separate land development company like Forestar. The deal will also help the company to deepen its focus on maximizing return on assets and inventory turns.

Another homebuilding company, Lennar Corp (LEN - Free Report) , acquired Florida-based homebuilder WCI Communities Inc., a premier lifestyle community developer and luxury homebuilder of single and multi-family homes in Feb 2017 to enhance its land holdings.

Falling Mortgage Rates Make Homes Affordable

High mortgage rates dilute demand for new homes as mortgage loans become expensive. This lowers buyers’ purchasing power and hurts volumes, revenues and profits of homebuilders.

According to the Freddie Mac mortgage survey, the 30-year fixed mortgage rate went down to the lowest levels in nearly seven months to 3.89% for the week ending Jun 8, 2017. The decline in rates should spur refinance activity even more, thereby leading to more home sales.

Even if mortgage/interest rates rise with the Fed probably announcing further federal fund rate hikes later this year or the next, the rates should still remain reasonable, in our view, keeping housing affordable. Modest hikes in interest rates in the context of an improving economic environment can be a net positive for the housing sector.

Moreover, improving labor markets, falling unemployment rates, low mortgage rates and limited home supply are supporting continued rise in home prices, thereby booting homebuilders’ top line.

How to Play the Industry

Major homebuilders are well poised on the positive fundamentals of the housing market. Particularly, given the cheap valuation compared with the broader market, this is perhaps the right time to pick a few stocks from this space. We recommend those that are witnessing positive estimate revisions and carry a Zacks Rank #1 (Strong Buy) or #2 (Buy):

One such company is M/I Homes, Inc. (MHO - Free Report) . The company sports a Zacks Rank #1 and advanced 54.2% in the last year. The stock has seen 17.3% upward revision in the Zacks Consensus Estimate for the current year and 12.8% for 2018, over the last 60 days.

Lyon William Homes (WLH - Free Report) , a Zacks Rank #2 stock, has gained nearly 39% in the last year. Earnings estimates for the current year and the next have also gone up by 8.1% and 2.7%, respectively, in the last 60 days. The upside in earnings estimate revisions point at unwavering confidence that analysts have in the company.

KB Home (KBH - Free Report) , a Zacks Rank #2 stock, has gained almost 56.6% in the period. Its earnings estimate for the current year has improved by 0.6% and 0.5% for 2017 and 2018 in the last 60 days. The company has solid expected earnings growth of 43.3% for the current year and 22.2% for the next. Also, the stock surpassed earnings estimates by an average 7.3% over the trailing four quarters.

M.D.C. Holdings, Inc. (MDC - Free Report) shares climbed 55.8% in the last year and carries a Zacks Rank #2. It has seen the Zacks Consensus Estimate for the current quarter being marginally revised upward in the last 60 days. The company has solid expected earnings growth of 27.1% for the current year on 13.1% revenue growth.

You can see the complete list of today’s Zacks #1 Rank stocks here.


Though homebuilders admit to rising labor shortage and land/labor costs, they remain optimistic about a measured recovery this year in tandem with steady economic growth.

Overall, the positive supply and demand fundamentals have led to incredible hikes in home prices and are likely to provide some resiliency in the face of moderately rising interest rates in 2017.

Investors could also take advantage of the opportunities in the near term and cash in on any sudden surge in the homebuilding sector.

Check out our latest “Housing Industry Outlook” here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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