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Homebuilders Stumble on Fed Policy Plan of Faster Rate Hikes

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Yesterday, at its policy meeting, the Fed went ahead with its highly anticipated move of hiking the interest rates by 25 basis points. While the policy makers were happy about a strong U.S. economy, the rate hike raised eyebrows in the housing market.  

Shares of home builders — PulteGroup, Inc. (PHM - Free Report) , Lennar Corp. (LEN - Free Report) , Toll Brothers, Inc. (TOL - Free Report) , D.R. Horton, Inc. (DHI - Free Report) — tanked 6.67% 4.01%, 4.32%, 4.25%, respectively, following the news release, on concerns that increasing interest rates might ruin the affordability of home buyers in the form of higher interest cost on home mortgages. Each of these stocks carries a Zacks Rank #3 (Hold).  You can see the complete list of today’s Zacks #1 Rank stocks here.

Fed Raises Interest Rates

Against the backdrop of declining employment rates and faster-than-anticipated increase in interest rate beyond the 2% threshold level, the fed funds rate was pulled up for the second time this year.

Moreover, the dot plot of the Fed the policy makers hinted at a step up in the pace of rate hike, with two more upward moves for the balance of the year compared with the previous plan of one more. The Fed also sees three rate hikes in 2019.

Rising Interest Rate to Impact Affordability

Mortgage rate, which loosely follows the yield on the 10-year Treasury, started the year at around 4% but began rising thereafter. Mortgage rates are surging in proportion to U.S. government bond yields in anticipation of higher rates of inflation and further monetary tightening by the Fed.

There seems no respite for mortgage rates as the Fed continues with its aggressive policy moves. High mortgage rates dilute demand for new homes, as mortgage loans become expensive. This lowers the purchasing power of buyers and hurts volumes, revenues and profits of homebuilders.

The rise in interest rates looks all the more unwelcoming for the industry, which is already facing higher house demand and constrained supply.  This phenomenon might pinch first-time homebuyers the most.     
Consequently, higher mortgage rates may impact affordability at a time when millennials are trying to make their dream come true of owing a house. Nevertheless, higher interest rates will only act as a dampener in this case.

High Input Prices Pose Another Concern

High input prices, which include raw material, wages and land cost, have caused an escalation in the end prices of house and at the same time shrink margins of homebuilders.

Median price of existing homes was higher for the sixth straight year in 2017. April median sales were up for the 74th consecutive year.

This shows continued pain for both hombuilders as well as buyers.

Already Soft Sales

Home sales have not been really encouraging so far this year, which to a certain extent reflects the struggles of the industry. Per the most recent data for the month of April, sales of new U.S. single-family homes were down in three of the last four reported months.

Sales of newly constructed single-family homes, accounting roughly 10% of all U.S. home sales, dropped 1.5% sequentially in April, along with a downward revision in sales for three months prior to that.

The Pending Home Sales Index, a forward-looking indicator based on contract signings, decreased 1.3% sequentially to 106.4 in April, marking the fourth consecutive month of decline. The index is also down 2.1% year over year.

Housing starts and building permits also fell in two of the last four reported months.

Year to date, the industry has fallen by 13.5% compared with the 4.3% growth in S&P 500 Composite.

Bottom Line

Nevertheless, a strong U.S. economy and favorable employment picture should offset some of the weakness in the housing industry.

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D.R. Horton, Inc. (DHI) - free report >>

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