Back to top

Industry Outlook

The 2016 spring selling season was better than last year. Springtime weather in general boosts construction activity and traffic trends. Moreover, the sustained period of low mortgage rates this spring was incentive enough to buy a home.

With an improving economy, encouraging job numbers and affordable mortgage rates, homebuilding should gain further steam as the year progresses. For that matter, there are plenty of reasons to be optimistic about the broader housing sector over both the short and long term.

Below, we discuss some of the key reasons driving the sector and what investors can look forward to in the coming months and years.

Rising Demand and Low Inventory Boost Home Sales

Steady economic growth, along with increasing household formation, favorable demographics, low interest rates and the attractiveness of owning versus renting is fueling demand.

On the other hand, a shortage of 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 for some time.

Total housing inventory of existing homes was 5.7% lower at the end of May than a year ago, per data released by the National Association of Realtors in June.New home inventory for sale was 244,000 units at the end of May, a 5.3-month supply at the current sales pace, only slightly up from April levels.

Steady Economic Growth

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

So far in 2016, the employment numbers have been fairly strong.

With a fall in the unemployment rate, rising wages and decent consumer confidence, the U.S. economy looks quite strong despite rising pressure elsewhere and Brexit-related economic uncertainties. The market, in general, believes that the repercussions of the departure of the U.K. from the European Union will not have any major impact on U.S. homebuilding activity.

Affordable Mortgage Rates, Moderating Home Price Gains

Housing was an affordable option in 2015 as mortgage rates remained near historic lows. High mortgage rates dilute the 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 from 4.17% in 2014 to 3.85% in 2015. In 2016, the trend continues with rates going down further to 3.60% in May. Even if mortgage/interest rates rise with the Fed probably announcing further federal fund rate hikes later this year or next, 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 net positive for the housing sector

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

From the buyers’ point of view, though home prices are rising across the country with increasing demand, the price gains are moderating.

Low mortgage rates and moderating home price gains give homebuyers much-needed confidence. This in turn stokes demand.

Land as Native Strength

The well-stocked supply of land, plots and homes of large homebuilders like Lennar Corp. (LEN - Free Report) , D.R. Horton, Inc. (DHI - Free Report) and Toll Brothers, Inc. (TOL - Free Report) provide them with a strong competitive position to meet demand in future quarters, thereby growing sales and home closings.

Toll Brothers has secured some of the most sought-after urban locations in the country, such as New York City, Northern New Jersey, Philadelphia and Washington D.C., where land is scarce and approvals are not easy to come by.

Interestingly, homebuilders like PulteGroup, Inc. (PHM - Free Report) and Lennar are moving away from a land-heavy acquisition strategy to acquiring land with a shorter two- to three-year average life to improve its returns. Pulte also focuses on investing in land in closer-in locations where demand is more sustainable.

Smaller homebuilders have also realized the importance of land investments to support future growth. KB Home (KBH - Free Report) and Beazer Homes USA Inc. (BZH - Free Report) are stepping up land investments to strengthen their position in an improving housing market.

Conclusion

Though they admit to rising labor shortages and land/labor costs, homebuilders in general expect the housing market to continue its measured recovery this year in tandem with steady economic growth.

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

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>