Wall Street Bullish on Homebuilders Despite Slowdown in Sector

Wall Street Bullish on Homebuilders Despite Slowdown in Sector

Wall Street Bullish on Homebuilders Despite Slowdown in Sector© Reuters. Wall Street Bullish on Homebuilders Despite Slowdown in Sector

(Bloomberg) — The pullback in the once red-hot housing market isn’t scaring investors away from homebuilding stocks — it’s all normal, they say. And normal is good enough for now.

Construction starts, mortgage applications and existing home sale data this week all pointed to signs of cooling amid the rise in mortgage rates from record low levels. Still, since the start of the third quarter, the S&P Supercomposite Homebuilders Index has risen nearly 17%, outperforming the S&P 500’s 13% rally in the same period.

“I actually don’t think there’s anything quite wrong at this point,” Tom Shapiro, president of GTIS Partners, which has investments in roughly 80 homebuilding projects across the country, said in an interview with Bloomberg Television on Wednesday. 

The slowdown in housing may actually be a return to normalcy, after posting “incredibly high housing numbers” in the last two years, Shapiro added. 

Construction starts fell in July to the slowest pace since early 2021, with residential starts dropping by nearly 10% to a 1.45 million annualized rate, according to government data released Tuesday. Despite the gloomy results, investors see a silver lining. 

“If you look at the housing data we saw in starts, the month we just produced was the average of 2020 including the pandemic — it would have been the best month of any month from 2009 to 2019,” said Cole Smead, president of Smead Capital Management. “Return on equity is going to stay higher even with a pullback.”

Despite record inflation and tighter monetary policy sparking concerns of an impending US recession, investors say the housing market is not heading into a 2008-like collapse. 

“I just don’t see this being anywhere near a GFC situation,” Shapiro said. “We just don’t have the supply we had.”

The global financial crisis more than a decade ago was sparked by the collapse of the housing market, which was fueled by low interest rates, excess unregulated lending and a glut of inventory. 

While the homebuilding sector has been resilient in the face of a slowdown, the US mortgage industry is grappling with signs of deterioration. Even though there isn’t the same systemic risk facing the sector as there was prior to the financial crisis, some lenders have already stopped operating or scaled down dramatically.  

Mortgage applications continue to drop amid higher interest rates, but Mark Zandi, chief economist at Moody’s Analytics, told Bloomberg Television on Thursday that he expects rates on a 30-year fixed loan, the most common mortgage for a home buyer, to remain around 5.5%. And that’s where they should be in the long run when there’s full employment and inflation is on target, he added.

“The big publicly traded homebuilders have been very cautious,” Zandi said. “They knew that those good times when mortgage rates were at record lows wouldn’t continue, so I think they’ll manage through pretty well.”

Investors will get a fresh read on the performance of homebuilders next week when Toll Brothers (NYSE:) reports its third-quarter results, providing insight into the higher end of the housing market, which may also start to show signs of slowing, according to Bloomberg Intelligence analyst Drew Reading.

“Even with 18% of buyers who pay in all cash, it’s not immune to the broader housing market slowdown,” said Reading. “The so-called mortgage rate lock-in effect could remain a headwind to the higher end.”

©2022 Bloomberg L.P.

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