There are many macro and industry fundamentals that can move building-products equities. This article considers rates, mortgage spreads, recent affordability trends, starts, and home sale counts. Much of this data is on the FactSet workstation. These fundamentals cut across several industries, including homebuilders, suppliers, distributors, residential REITs, and commodities.
As an important caveat, these comments consider the overall market from a macro viewpoint. Ultimately, local and individual property factors will influence values.
As indicated in the following chart, the building products ecosystem rallied strongly through the pandemic in 2020 - 2021 and then dipped in 2022 due to rising interest rates and the prospect of recession. In the first three quarters of 2023, belief in a steady economy and still-strong home prices supported the stocks.
It wasn’t until the fourth quarter that the industry moved lower again over concerns of inflation and a “higher for longer” interest rate sentiment. In the past three weeks, however, with hopes of rates at least reaching a plateau if not a near-term peak, the industry has rallied strongly again. In the following chart, note the typically higher beta or volatility of the building products sub-industry (light gray line).
Source: FactSet
A key factor in recent months has been interest and mortgage rates, which remain near their highs of the past two decades. They peaked near 8% recently and pulled back slightly in the most recent two weeks.
Source: Freddie Mac
One variable that argues for slightly lower mortgage rates ahead is the relationship between average mortgage rates and the 10-year Treasury. This difference, which is usually in the 150 - 200 bps range (blue shaded area in chart below), remains quite wide. If rate volatility decreases, it is arguable that lenders could ease back on mortgage rates even if the underlying 10-year remained flat.
Source: Freddie Mac, FactSet
The supply side is giving mixed signals. Permits are holding their own near pre-Covid levels after declining through 2022. New home starts are in a slowing profile, however, and back to a more normal relationship to permits.
Source: FactSet, Census Bureau, NAR
Homes for sale on Zillow seem to be troughing after a decline from pre-Covid highs. There’s a widely held view that some supply continues to be kept off the market because many homeowners currently have low-interest mortgages they are unwilling to give up. The 65+ age cohort owns 33% of existing homes, up from 25% during much of the past few decades. More recent articles indicate that a trend of "retiring in place" may limit how much of this inventory comes to market.
Source: FactSet, Zillow
Higher mortgage rates and higher prices have made financing a home more expensive. Two ways to look at this are 1) considering how much mortgage payments have risen with the higher rates and 2) considering what percent of average household income equates to those payments.
The graphs below show tough affordability headwinds for the average buyer. Required monthly payments as a percentage of estimated household income are sharply higher. Assuming 20% down, those payments are above the 27% traditional limit of what mortgage lenders want to offer (red shaded area below). Buyers putting 15% or less down are in tougher shape.
Source: FactSet, St. Louis Fed, NAHB
Source: FactSet, St. Louis Fed, NAHB
Lumber is 25% - 30% of homebuilders’ costs, and prices remain on the higher end of historic levels and have ticked up ~$60/bf in the past month.
Source: FactSet, CME
Labor, another key cost, remains in tight supply in many markets, particularly the more skilled trades. Some believe the demand for skills in renewable energy projects, which are similar for many trades such as electrical and plumbing, is keeping homebuilding labor tight. And others believe that fewer people are entering the trades than leaving. These two trends—plus the higher interest-driven carrying costs for the builders—have added to homebuilding costs and support the idea that prices can only come down so much before supply is constrained.
Despite poor affordability statistics and constrained supply, new homes are selling.
Source: FactSet, US Census
Putting higher rates, concomitant pressure on affordability, limited starts and houses-for-sale counts, and continued solid demand, home prices have remained relatively high throughout 2023. One explanation might be high income home buyers supporting more expensive home prices in the mix.
Source: FactSet, Zillow, Case-Schiller, NAR
Two factors from the past are likely impacting today’s market and homebuilder profitability. First are the echo effects of the 2008 - 2009 global financial crisis and its aftermath. Many homebuyers at the time of the crisis didn’t want to or couldn’t pay their mortgages, which led to a large oversupply of homes on the market. The crisis left the builders with memories of lots of debt and acreage that couldn’t be developed.
Larger homebuilders survived in better shape than smaller ones, but this time around builders of all sizes—and banks—have been incrementally wary. Since the crisis, those larger homebuilders have also evolved into industrial enterprises operating with 75+ nationwide community developments with much more manufacturing-like operations. Land holdings currently are more frequently optioned rather than owned, providing flexibility and downside protection depending on the cycle.
Also continuing since the financial crisis is a supplier market characterized by more manufactured components and larger distribution centers helping builders avoid ‘parts’ inventory, less efficiently working house-to-house, and hiring specialized labor.
A key second factor in the current business cycle is that the Covid pandemic’s associated supply chain issues prevented inventories from building across the economy. That underrecognized phenomena in the current cycle has impacted not only the apparent resiliency of the broad economy but also inflation remaining high; supply simply did not have a chance to move to excess. According to many recent corporate transcripts, it has only been in the past couple quarters that the building supply firms have generally caught up to the market in most goods areas.
From the point of view of the homebuilders, a big supportive positive for prices is the structural undersupply of homes. Household formations (1.6 million/year) have been higher than the supply of new homes for a few years. Yet the biggest headwind for homebuilder activity is interest rates, both as the cost of builder financing for homes under construction and the impact on mortgage rates for buyers.
Challenged affordability may take a while to resolve, and transaction counts could remain low. A 1% - 1.5% decrease in mortgage rates with general rate stability could help, but ongoing cost inflation may keep housing prices from falling too much lest homebuilder margins get compressed. How this cycle and the general housing shortage across the country might further unfold are unclear.
Lee Li and Shreya Mehta contributed to this article.
This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.