When considering homebuilder stocks for client portfolios, advisors today are confronted with negative analyst assessments and industry outlooks for 2023 that are dubious at best.
Despite continued high home prices and still-brisk demand, climbing mortgage interest rates have sown fear among investors, especially those worried about recession in 2023. Prices of some major names in the industry are still down more than 20% for the year after recovering a bit since the June market low. And a few—Pultegroup (PHM), KB Home (KBH) and Meritage Homes (MTH)—have had a robust fourth quarter.
Still, the outlook for the industry remains gloomy, even by its own measures; the National Association of Homebuilders Housing Market Index is at it’s lowest level in nearly a decade.
Amid this gloom, equities forecasters may be conflating the current transition to a more normal residential real estate market—where price-to-ask will replace bidding wars—with an actual downturn. More fundamentally, naysayers are failing to fully consider how critical long-term market factors will affect an industry that has outperformed in the last two mild recessions.
Not Actually High
Regarding rates, older advisors are more aware of the reality that current mortgage rates aren’t historically high. The 2% to 3% rates that prevailed in early 2022 were an anomaly, as was the 14% rate I got on my first home in 1980. According to Freddie Mac, the average U.S. rate for 30-year fixed-rate mortgages in mid-December was 6.52%, well below the 50-year average of 7.76%. So, when considered with a long view, the current national case of rate shock is really one of whiplash.
Sure, the late-2022 surge in interest rates—in mid-October, 30-year fixed hit 7.37%, a multi-decade high—has pushed some buyers out of the market, but it has pushed some sellers out along with them. But since October, there have been signs that rates are starting to roll over, and declines in the coming months may be steep, following substantial recent declines in inflation. And despite higher rates, home prices remain well above pre-pandemic levels.
It shouldn’t be surprising that demand for housing remains high amid sustained high demand for labor, a factor largely unrecognized by the recession-is-imminent crowd. While high employment continues to buoy sales, prices are less affordable than they’ve been in decades. But prices will probably settle down soon, offsetting the effects of higher mortgage rates, so affordability may not remain a builder-industry challenge for long. Projections for home prices next year range from a decline of 20% (KPMG LLP) to an increase of 1.2% (National Association of Realtors).
These outlooks indicate that the current state of flux will eventually settle down as the market moves toward equilibrium, as opposed to a herky-jerky environment of the pandemic economic aftermath and escalating rates. Equilibrium will bring more clarity and certainty for investors—and less opportunity than now, while homebuilder stock prices are still depressed from the bear market.
Demographic Realities
Integral to any assessment of homebuilder prospects over the next two or three years is consideration of a chronic housing shortage sustained by long-term demographic trends that aren’t going away.
Last year, Freddie Mac estimated the deficit of homes at 3.8 million homes, but only 1.12 million new units have gone up each year since 2011. Homebuilding increased significantly after the Fed rate cuts, spiking in 2021 and the first half of 2022. But this was a case of too little, too late. There just aren’t enough places in this country for people to live.