Interest rates

With interest rates rising, what is the outlook for homebuilder stocks?

Oyour theme of Housing stock, which includes stocks of homebuilders, building products companies and home improvement players, is down about 20% year-to-date, compared to the S&P 500, which remains down about 6% over the same period. The strong sale of real estate space comes against a backdrop of rising interest rates. The Federal Reserve voted last week to raise its benchmark rate by a quarter point while indicating that it was ready to raise rates in half-percentage-point increments if necessary in the coming months. Average 30-year mortgage rates also rose to nearly 4.2% from less than 3% a year ago, making it more expensive for homebuyers to finance their purchases. In addition, inflation in the United States has reached 40-year highs, which is also putting pressure on builders and home buyers.

Today, things actually remain robust on the demand side as the US continues to witness a very strong labor market with rising wages. Housing starts, which are an indicator of new home construction, rose about 6.8% to a seasonally adjusted annual rate of 1.769 million units in February. There is also a significant backlog of homes that have been approved for construction and have yet to start, as builders face material shortages and rising costs. Prices also remain elevated, with the median January new home price, the most recent data available, standing at $423,300, up 13.4% from a year ago. However, with rising interest rates, it is entirely possible that demand will slow in the future.

The valuations of some of the major homebuilder stocks in our chart look very reasonable. For example, DR Horton (NYSE: DHI) and Lennar (NYSE:LEN) are trading at less than 6 times 2022 consensus earnings, despite consensus revenue growth rates of 25% for both companies. That compares to the S&P 500, which trades at around 17 times forward earnings. However, this rate of growth may not be sustainable, given the cyclical nature of the housing market and concerns about high house prices. Cyclical stocks often tend to have low multiples when the industry peaks and this could also be the case with housing names.

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