Rising interest rates may increase mortgage costs, but luxury homebuilder Toll Brothers CFO Marty Connor says there are reasons his stock is a buy.
The Federal Reserve Bank may taper its quantitative easing (QE2) program later on this year. The Fed has been buying $85 billion a month in government and mortgage bonds as part of QE2. This has helped to keep bond prices higher and interest rates lower as bond prices and rates are inversely related.
Higher interest rates should be negative for housing since it means higher monthly mortgage payments for homeowners. However, Fed Chairman Ben Bernanke thinks buyers are willing to bet that their home values will grow faster than their mortgage rates. Speaking to the press after yesterday’s Fed meeting, the Fed chief said:
“People are more optimistic about housing. They expect house prices to continue to rise. And you see that for example in a survey question in Michigan survey. And that compensates to some extent for a slightly higher mortgage rate. And in fact in terms of monthly payments on an average house, the change in mortgage rates we've seen so far is not all that dramatic. So yes our forecast, our projections do factor that in.”
Bernanke isn’t the only one to think the housing market will improve further. John Paulson, the hedge fund manager controlling $18 billion, increased his position in several mortgage insurers in the beginning of the year. It’s so far been a profitable bet for Paulson, an investor who wagered against the housing market when it was at its highs several years ago.
Data out today show the home market has indeed improved. Existing home sales for the month of May were up 12.9% versus last year to its highest level since the housing crisis of 2008. Shares of homebuilders have also had a good run so far in 2013. The SPDR S&P Hoembuilders ETF (XHB) which tracks the S&P Homebuilders Select Index, is up 11%. However, one company in that index, luxury-focused Toll Brothers, is down almost 4%.
Selling homes at an average of $550,000 (more than twice the national average), Toll Brothers customers pay a lot more in dollar terms when rates go up. But, one-fifth of their customers pay cash for their homes with the rest of buyers putting an average of 30% down in cash.
Are the upper ends of the homebuying spectrum more immune to rate hikes and will that affect the luxury market?
We ask Toll Brothers CFO Marty Connor to talk numbers with Talking Numbers. Though shares are down this year and more so today as the market worries about higher interest rates, Connor believes the drop in share price represents a buying opportunity.
On the other side, Talking Numbers contributor Enis Taner, Global Macro Editor at RiskReversal.com, has a different point of view on homebuilders.
Who is right? Watch the video above to hear Connor give his reasons on why Toll Brothers is a buy and get Taner’s take on the homebuilders ETF, the XHB.