Home Builders Stocks Will Be a Value Buy but Haven’t Hit Bottom Yet
The yield on the 30-Year treasury hit 5.25% on Tuesday for the first time since mid-2007. Rising yields will continue to push up average mortgage rates — the last thing the already struggling housing sector needed.
In Monday’s column, I highlighted moribund housing market which faces headwinds, from near record low housing affordability to rising foreclosure rates.
In today’s column, I take a deeper look at the new home builders and related industries. It has been a tough slog for home builders over the past several years. Lennar (($LEN) is a good proxy for the industry as it is the second largest home builder in the land, behind only D.R. Horton ($DHI) in annual homes built and sold.
As you can see from the chart above, the stock is down some 55% from its all-time highs in mid-September 2024. Ironically, this is exactly when the Federal Reserve started to bring down its key interest rate by a cumulative 175 BPS to date.
Back in the housing boom years of 2020 through 2020, houses were flying off new home builders’ lots as fast as they could be completed. These properties were able to be sold without offering much if any incentives like mortgage rate buy downs and free upgrades. Back in 2022, Lennar’s incentive costs were around 2% of home building revenues and the builder’s profit margins peaked at just over 29% in mid-2022.
Times have changed drastically since then. Mortgages that troughed below 3% following COVID now average around 6.7% on the standard 30-Year mortgage. Housing affordability has plunged while new home inventory levels have soared. Incentive costs at Lennar are now around 13% of home sales and margins have dropped into the mid-teens. Taking incentives into account, Lennar’s average home sales price is now back to 2017 levels.
Now, there will be a time when home builders are going to be a great value buy. We are not there yet. I would like to see margins bottom, incentives drop and new home inventory levels fall before moving into the sector. Some insider buying in these stocks would be a nice vote of confidence as well. That largely isn’t happening.
I also expect this fragmented industry to continue to consolidate as well. Both Beazer Homes ($BZH) and Taylor Morrison ($THMC) have been acquired in recent months. I could see smaller builders like Century Communities, Inc. ($CCC) or LGI Homes, Inc. ($LGIH) making logical buyout targets if this trend continues. I also expect luxury home builders like Toll Brother ($TOL) to continue to perform better than mass market builders like Lennar in this K-shaped economy.
Companies dependent on housing like Home Depot ($HD) will likely face continued headwinds for the foreseeable future. I have very little exposure to these names or home builders in my portfolio currently after being heavily weighted in these areas following the pandemic.
Ending on a brighter note, the subdued levels of housing construction would normally heavily impact construction employment, especially with a substantial drop in multi-family construction and with office building construction being at 14-year lows. Fortunately, the huge surge in construction around AI data centers and other AI-related infrastructure is mitigating the impacts to construction employment for the time being.
At the time of publication, Jensen had no positions in any securities mentioned.
