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Builders' Confidence, Economic Growth Raise Hopes for Housing

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Although the home sales data is not impressive so far this year, the larger picture is indeed a big success. Homebuilders still expect strong demand for new homes as low unemployment and steady economic growth support Americans’ buying power.

Of course, finding buildable lots has been a major challenge in the industry in recent times, which could limit their ability to meet demand. That said, homebuilders are currently well placed, belonging to a top-ranked Zacks Industry (top 14%), suggesting that the market headwinds were unable to take the sheen away from the sector.

There are plenty of reasons to be optimistic about the broader housing sector for both the short and the long term. Below we discuss a few key factors driving the sector and what investors can expect going ahead.

Robust Economic Growth

The U.S. economy is anticipated to grow at a 4% annualized rate in the second quarter, per the Atlanta Federal Reserve’s GDPNow forecast model showed on May 25. This is quite a sharp increase from 2.3% GDP growth registered in the first quarter of 2018.

Fueled by robust economic growth, Fed policymakers are looking at three rate hikes this year, setting the stage for an increase in mortgage rates. Nevertheless, Americans are seeing wages growing at the quickest pace since the end of the last decade.

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 2018.

This upbeat expectation holds particularly true when one of the nation’s key economic drivers, i.e. construction activity, is gradually strengthening its footprint accompanied by a declining unemployment rate. The unemployment rate has fallen to 3.9% in April 2018 — the lowest since December 2000.

Improving economic growth supported by a better employment picture generally boosts housing activity and provides the basis for stronger demand.

Solid Builders’ Confidence

Builders’ confidence increased two points to 70 in May from a downward revision of 68 in April, reinstating builders’ confidence in the current housing market. Importantly, the reading was above the 50 mark in the first five months of 2018, indicating a favorable outlook. Moreover, this is the fourth time in 2018 that the index has reached 70.

Notably, the National Association of Home Builders or NAHB/Wells Fargo Housing Market Index (HMI) includes builder perceptions of current single-family home sales, sales expectations for the next six months and traffic of prospective buyers.

Higher Demand, Low Inventory to Boost Prices

Steady economic growth along with favorable demographics and the attractiveness of ownership versus rental are driving demand. Although recent home sales have been volatile month over month, the year-over-year growth rates are indeed compelling. New home sales were up 11.6% year over year in April 2018.

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 giving a boost to prices and is expected to continue doing so for some time.

The supply of April existing homes decreased 6.3% from the year-ago period. It has fallen year over year for 35 consecutive months. As such, it will take only four months to deplete the current supply of homes in the market versus 4.2 months a year ago, according to NAR.

Thanks to low inventory and high demand, median sales price of existing homes increased 5.3% in April 2018 from a year earlier. The median sales price of new homes sold in April was $312,400, 0.4% higher from the year-ago period.

We believe prices will continue to scale as demand for homes is likely to grow on high consumer confidence and low unemployment. Improving labor markets, declining unemployment rates and limited home supplies are driving home prices, thereby giving a boost to homebuilders’ top line.

For 2018, National Association of Home Builders or NAHB expects continued growth for home construction and remodeling. The home improvement sector should also remain strong given recent home price gain, increases in homeowner wealth and other lifestyle improvements.

Millennials Take Interest

Millennials — those 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.

First-time buyers comprised 33% of sales in April 2018, which is up from 30% in March but slightly down from 34% a year ago. NAR’s 2017 Profile of Home Buyers and Sellers, released in late 2017, revealed that the annual share of first-time buyers was 34%.

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 drives land prices. 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 address the ongoing issues.

In February 2018, Lennar (LEN - Free Report) acquired CalAtlantic Group Inc. in a $9.3 billion deal (including debt), which creates one of the country’s top homebuilders. Since the closing of the transaction, Lennar remains confident that the company will exceed its prior $100 million synergy-savings expectations for fiscal 2018 and is on track to meet $365 million synergies for fiscal 2019 as well.

In February 2017, Lennar acquired Florida-based homebuilder WCI Communities Inc., a premier lifestyle community developer and luxury homebuilder of single and multi-family homes, to enhance its land holdings.

Meanwhile, in March 2018, M/I Homes, Inc. (MHO - Free Report) , one of the nation's leading builders of single-family homes, closed the acquisition of the residential homebuilding assets and operations of Pinnacle Homes, a homebuilder in the greater Detroit, MI market.

Again, William Lyon Homes (WLH - Free Report) completed the acquisition of RSI, a Southern California and Texas-based homebuilder, and three related real-estate assets on Mar 9, 2018. This addition spreads the company’s footprint in the Inland Empire of California and marks its entry into Texas.

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 the Zacks Homebuilding Industry.

We recommend those that are witnessing positive estimate revisions and carry a Zacks Rank #1 (Strong Buy) or 2 (Buy): Century Communities, Inc. (CCS - Free Report) , M.D.C. Holdings, Inc. (MDC - Free Report) , KB Home (KBH - Free Report) , Meritage Homes Corp. (MTH - Free Report) , William Lyon Homes and Beazer Homes USA, Inc. (BZH - Free Report) .

Century Communities and M.D.C. Holdings sport a Zacks Rank #1 (Strong Buy), while the rest carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Conclusion

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.

The housing industry is cyclical and is affected by consumer confidence levels, prevailing economic conditions and interest rates. Although rising interest and mortgage rates, land and labor shortages, and rising material prices raise concerns, the 2018 outlook for homebuilding seems to be solid given strong economic growth and labor market. Investors could also take advantage of the homebuilding-sector opportunities in the near term.

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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