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Industry Outlook

Though Brexit-related uncertainties and global economic pressure are not expected to have any major impact on U.S. homebuilding activity, there are other factors that can pull it back. Land and labor shortage has become a valid concern and so are tedious underwriting standards. And you can’t wish away competition that can at times get fierce and ignore cost inflation.

It would be prudent for investors to take a closer look at these dampeners before investing in this space. Below, we discuss the impact that these can have on the sector in the coming months and years.

Labor/Land Shortages

Several years of production deficits during the housing downturn resulted in a limited supply of both rental and new homes in the country. At present, 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 labor market has tightened with limited availability arresting the rapid growth in housing production. Labor supply is expected to remain tight through the rest of the year. Also, capital constraints for land and land development have left entitled lands in short supply while increasing demand has driven land prices higher. Moreover, the regulatory environment for mortgages remains challenging.

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.

Rising Labor, Land and Material Costs

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are resulting in higher wages while land prices are inflating due to limited availability. There could be more inflation, going ahead. This is eating into homebuilders’ margins considering that home price increases are moderating.

Rising land and labor costs - mainly the latter - have hurt gross margins of the likes of Lennar Corporation (LEN - Analyst Report) , KB Home (KBH - Analyst Report) and D.R. Horton, Inc. (DHI - Analyst Report) in the past few quarters.

Slowing Sales Trends in Texas/Houston

Texas’ economy is dependent on the oil complex and the volatility in the energy sectorhas in the recent past hurt the region’s overall economic growth and, in turn, home sales. Though Texas’ markets like Dallas and San Antonio are doing well, bucked the trend, Houston suffered in particular, mainly at higher price points, in the wake of the oil slide. However, lower-end demand remained more or less steady in Houston.

Pulte Group, Inc.’s (PHM - Analyst Report) Texas segment accounts for around 15% of its homebuilding revenues. Orders declined 9% in this market in 2015 and were flat in the first quarter of 2016.Houston accounts for around 9% of Lennar’s homebuilding revenues. The company’s orders declined 12% in the Houston segment in fiscal 2015 and 4% in the first half of 2016 due to lower demand.

Interestingly, Pulte management said at the first quarter conference call that demand trends in Houston improved as they moved through the quarter. Meritage Homes Corporation (MTH - Snapshot Report) , a smaller homebuilder, also said that its sales in Houston exceeded their expectation in the first quarter. With oil prices on the rise again, demand trends could improve in Houston.

Bottom Line

As you can see, there is some catching up to do for these homebuilders even though the economy paints a picture of recovery. But what about investing in the space right now – will the opportunities outweigh the risks to lure in short-term investors?

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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