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Industry Outlook

Home shoppers are no longer in the "Should I rent or should I buy?" dilemma. Low mortgage rates, rising rent costs as well as easy availability of loans are driving the homebuilding sector.

This year, the industry experienced one of the strongest spring housing markets in a decade. Moreover, the sustained period of low mortgage rates has driven sales of homes. As measured by the National Association of Home Builders' Housing Market Index (HMI), home builder sentiment reads a "confident" figure of 63 out of 100.

With an improving economy, encouraging job numbers and affordable mortgage rates, homebuilding should gain further steam going forward. It might be a good idea for home shoppers to buy this fall or winter, rather than waiting for spring next year.

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 keys driving the sector and what investors can look forward to in the coming months and years.

Steady Economic Growth

The latest data revealing third-quarter gross domestic product or GDP numbers represented a significant improvement over the first half of 2016 and the best quarterly performance in two years.

GDP increased at a 2.9% annual rate, more than double the 1.4% recorded in the second quarter. This marks the highest improvement since the second quarter of 2015. From 2010 to 2015, the U.S. economy grew at an average annual rate of 2.6%.

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 departure of the U.K. from the European Union will not have any major impact on U.S. homebuilding activity.

Rising Demand, Low Inventory Boost Sales

Steady economic growth, along with increasing household formation, favorable demographics, low interest rates and the attractiveness of owning versus rent 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 6.8% lower at the end of September than a year ago, per data released by the National Association of Realtors.New home inventory for sale was 204,000 units at the end of September, a 4.5-month supply at the current sales pace, which is down from 4.6 months in August.

Mortgage Rates Low, Home Price Gains Moderate

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 has been maintained with rates going down further to 3.46% in September. 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 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 supplies are supporting a continued rise in home prices, thereby boosting 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 the 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 –New York City, Northern New Jersey, Philadelphia and Washington D.C. to name a few – 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 returns. Pulte also focuses on investing in land in closer-in locations where demand is more sustainable.

Smaller homebuilders too have realized the importance of land investments to support 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 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.