The sharp rise in bond market yields is spilling over to one of the most rate-sensitive corners of the equities market: housing stocks.
As rates jumped in recent weeks, housing stocks have taken a big hit. The SPDR S&P Homebuilders ETF has fallen 22.7% this year as climbing mortgage rates have raised concerns about demand for housing and related products.
Caught up in the selloff are homebuilders such as D.R. Horton DHI, Lennar LEN, and Toll Brothers TOL, all down at least 25% this year. Home furnishing retailers and remodeling companies Wayfair W, Sherwin-Williams SHW, Fortune Brands FBHS, and Masco MAS fell as well.
However, for investors looking for opportunities to put money to work, a number of housing-related stocks are considered undervalued by Morningstar analysts, including Horton, Lennar, and Toll. “I think that this is an opportunity for all the names that have sold off,” says Brian Bernard, Morningstar’s equity research director for industrials.
Housing demand rallied when the Federal Reserve cut rates during the coronavirus recession, prompting many people to try and take advantage of lower rates to purchase a home.
But this year interest rates have jumped. The yield on the 10-year U.S. Treasury has jumped to 2.47% from 1.51% at the end of 2021, and mortgage rates have followed. The average 30-year fixed rate mortgage rose to 4.42% on March 24 from 3.11% at the end of last year--the fastest rate of change since 2018, when the 30-year rose to 5% from 4% in less than a year.
With lower affordability and higher prices, markets are concerned about demand for homes softening.
Are Home Builder Stocks a Good Buy?
“There are a few factors feeding into it, but really the concern is affordability, and that’s a function of the fact that real home prices right adjusted for inflation are at all-time record highs,” Bernard says. “It's not surprising that we’re seeing a selloff [in stocks], we saw the same thing happen in 2018.’’
“All that optimism we had in the past about the housing market being undersupplied and millennials buying homes--the market has forgotten about that and is focusing on those concerns,” Bernard says.
The near-term housing outlook may not be as bad as investors fear. The U.S. is still facing a supply shortfall of about 3.5 million units, according to Bernard. Housing starts rose 16% to 1.6 million in 2021. He sees that as roughly the average amount of new homes to be constructed on an annual basis through the rest of this decade.
Homebuilder stocks showed record profit margins in 2021 as a result of strong demand. While Bernard sees recent margins as abnormal and expects them to normalize, the lack of supply should be a tailwind for homebuilders’ margins even if demand slows.
“It will take time for housing supply to catch up with demand, so gross profit margins could remain elevated relative to historical averages for a couple of years,” Bernard says. Homebuilders D.R. Horton, Lennar, and Toll Brothers currently trade as undervalued 4-star rated stocks.
Housing Related Stocks
Home furnishing and remodeling companies like Wayfair, Sherwin-Williams, and Fortune Brands were pulled lower on the fallout as investors bet on a drop in demand for their products. Even with the market's concerns shares in some companies were treated unfairly, Bernard says.
Masco offers plumbing supplies and paint through its Behr brand. About 90% of the company’s products are used for repair and remodeling projects, a market that historically has been ``much more stable’’ than residential housing construction, Bernard says. As a result, even during a recession, demand for Masco’s products may remain resilient.
“Even if you are pessimistic about the future path of housing it's kind of unfair to have some of these players getting hit just as hard when their future prospects are likely much better even if demand does soften for homebuilder,” Bernard says.