These are the worst of times for the housing industry, but also the best of times. How could that be?
The Fed's aggressive rate hikes in 2022 spiked the 10-year treasury, and along with it, mortgage rates, to new multi-year highs. By Sept 2022, the 30-year fixed mortgage rate had jumped above 7% for the first time in over a decade. This ground the housing market to a complete halt. No one wanted to buy with mortgage rates that high, nor did anyone want to sell either.
It led to massive layoffs in the mortgage industry and many real estate agents are struggling to get by as sales have slumped.
By the fourth quarter of 2022, the rates came back down into the 6s, where they have remained in 2023. And home buyers, and sellers, have now had time to adjust to higher rates.
The spring season, where the vast majority of home buying, and selling, takes place, has been steady despite the higher rates. This has been a surprise to many.
But the housing market is predicated on two main components:
1) Mortgage rates
2) Unemployment rate
While mortgage rates are now double a year ago, the unemployment rate, nationwide, remains low, at 3.5%. People have jobs so they will buy a home. It's as simple as that.
Location, Location, Location
All real estate is local. You may live in a city where home prices are down 10% off of recent highs. Home prices are falling in the West and some areas of the South and Southeast. These areas saw strong gains during the pandemic. In Florida, home prices are up 40% to 50% in many major cities. The air is slowly staring to deflate out of that bubble.
Or you may live in a city where home prices are on the rise. Crain's Chicago Business recently reported on a house in the Chicago suburb of Lincolnwood, that received 64 offers. Homes in the Northeast, especially in Massachusetts and New Jersey, are also receiving multiple offers this spring and prices are on the rise.
Even the home builders will tell you that they have some communities where sales are strong, and they have pricing power, and others where it is not and they are offering more incentives.
No Housing Crash
Many future home buyers have been waiting for "the big one." They believed that mortgage rates over 6% would cause the housing market to "crash" with prices coming down, virtually nationwide, and housing would be affordable to first time buyers again.
But it hasn't happened. Even in cities where prices are down 10%, a "crash" simply hasn't materialized. And the reason it hasn't is because of the inventory levels.
Nationally, home inventory remains near multi-year lows. Unlike in 2008, when inventory had been on the rise for over 2 years, and where over a million homes were waiting for buyers, in 2023, there are around 400,000 nationally on the market.
But let's take a look at a specific state example: Illinois. In April, sales in the state of Illinois fell 30.2% year-over-year to 10,600 statewide from 15,193.
Year-to-date, through April, sales are down 26.7% to 36,322 from 49,568 in 2022. Remember, in early 2022, the housing market was still booming as rates remained under 3%. The Fed only started raising rates in March.
Inventory in Illinois, however, continues to fall. It was down 23.6% to 17,186 in April from 22,492 last year.
Want to Buy a Condo Near Wrigley Field? Good Luck!
Is it really high rates that are driving the lower sales or is it the lack of inventory? Home buyers have fewer and fewer homes to choose from.
Zillow recently put out some data on the most searched neighborhoods and Chicago's Lake View neighborhood, home to Wrigley Field and the Chicago Cubs, made the top 10 list, with over 20,000 daily searches for properties. No telling how many people were simply "dreaming" and like to look at real estate or how many might be actual prospective buyers.
But currently, according to Redfin, there are just 244 properties available on the market in Lake View. It is one of Chicago's most dense neighborhoods, with a lot of condos and townhomes. That's a big disparity. 20,000 searches, but just 244 listings.
But this is the reason that home prices have remained elevated in many locations. There simply isn't enough inventory to push prices down. It's still a seller's market. And this is a frustration for many buyers who have been waiting on the sidelines. Your dream Wrigleyville condo may have to wait.
How to Invest in the New Housing Normal
1) Real Estate Brokerages, Home Depot, and Furniture Retailers
There are winners, and losers, in this housing market, as I said above. The losers have been those on the services side. Any of the mortgage lenders and those in real estate brokerages like Redfin and Zillow. With sales remaining depressed, there's no reason to buy these companies at this time.
The home remodeling companies are hanging on, helped by the professional builders more than mom and pop putting in a new kitchen. But even the king, Home Depot, is seeing some slowing from consumers now. The home remodeling companies are still pricey, even though their stocks have come down off of 2022 highs. I am on the sidelines.
And then there are the furniture retailers. They were big beneficiaries of the staycation phenomena during the pandemic. Not only did we need a grill but also new outdoor furniture and we might have bought a couch for the family room as well. But that buying has most ended. And with home sales down over 20% year-over-year, which is when many buy new furniture, the furniture retailers are seeing slowing sales or a return to "normal."
But I don't believe that their sales have completely normalized yet so I'm mostly on the sidelines with these stocks as well. Eventually, there will be some really cheap buys in that group, but you have to have patience.
2) Homebuilders Back Again?
That leaves the homebuilders. They saw big cancellations last fall as mortgage rates spiked and buyers were scared to buy with rates at those levels. Sales also plunged as buyers stayed away from the sales centers.
But the 2023 spring season has shown stabilization, and even a return of demand, in some markets. The builders learned lessons from the housing bust of 2008-2012. They learned not to overbuild. In this cycle, as demand soared during the pandemic, they did not overbuild. When sales dropped off a cliff in 2022, they didn't have much inventory on hand they had to discount.
The homebuilder stocks have been some of the best performers of 2023 but they are still cheap, on a P/E basis. And they have demand from both the Millennial buyer, the largest generation in American history, and the Baby Boomer buyer, who is finally retiring and moving to their dream home in one of the sunshine states.
Top 3 Homebuilder Stocks to Buy Now
The homebuilders are in the Top 3% of Zacks Ranked Industries, ranked 7 out of 251 and as a group, remain cheap. Many have forward P/Es under 10 even with the stock rally this year. Here are our top three stocks to consider adding to your portfolio today:
Stock #1: Unique luxury homebuilder with strong demand, stable sales, and high margins. Cash-paying customers unaffected by rates. Raised dividend, cheap stock, and high growth potential.
Stock #2: Mid-cap homebuilder operating under a popular name in sought-after states. Despite lower margins and earnings, its high dividend yield and commitment make it an intriguing investment opportunity.
Stock #3: Top-tier homebuilder with a diverse portfolio and solid market cap. Despite expected earnings decline, its high gross margin, share performance, and attractive valuation make it a compelling opportunity.
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All the Best,
Tracey Ryniec heads up our popular portfolio recommendation services Insider Trader and Value Investor.
¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.