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Can Builder Confidence Recover From November's Sharp Plunge?

The confidence level among the nation's homebuilders plunged eight points in November, the sharpest one-month drop since 2014. The November reading is also the lowest since mid-2016 as rising prices and borrowing costs are coming in the way of buyers’ affordability, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index.

Following the latest reading, the SPDR S&P Homebuilders ETF XHB dropped 0.4%, while Invesco Dynamic Building & Construction ETF PKB fell 0.9%. Meanwhile, homebuilding stocks have already been thrashed this year in anticipation of slower growth in housing and higher costs for construction companies. The Zacks Homebuilding industry has lost 34.7% this year, whereas the broader S&P 500 Composite market has gained 2.2%. Major homebuilders such as D.R. Horton, Inc. DHI, KB Home KBH, PulteGroup, Inc. PHM, NVR Inc. NVR and Lennar LEN have lost 31.9%, 40.6%, 24.9%, 31.6% and 35.1%, respectively, this year.


Key Takeaways

Homebuilder sentiment fell eight points in November to 60 from October and all three indices — present sales, future sales and buyer traffic — registered a fall. In the words of NAHB Chief Economist Robert Dietz, “While home price growth accommodated increasing construction costs during this period, rising mortgage interest rates in recent months coupled with the cumulative run-up in pricing has caused housing demand to stall.”

Current sales conditions fell seven points to 67. Buyer traffic plunged eight points to 45 (the lowest since August 2016) and sales prediction over the next six months dropped 10 points to 65. Regionally, the HMI reading was dismal for South and West, declining 2 points and 3 points to 68 and 71, respectively. However, Northeast and Midwest ended on a positive note, increasing two points and one point, respectively.

Affordability Taking a Toll on Housing

Challenges like inventory shortage are prevailing in the U.S. real estate market and creating upward pressure on prices in several parts of the country, thereby affecting affordability. In addition to this, rising mortgage rates in recent months has been making the operating backdrop tough for homebuilders.

According to Freddie Mac’s latest Primary Mortgage Market Survey, the 30-year rate remained unchanged from last week, averaging 4.94% for the week ending Nov 15, 2018. Notably, this is still an increase from last year’s rate of 3.95% and the highest since February 2011.

Meanwhile, higher home borrowing rates have kept many potential buyers on the sidelines. Mortgage applications in the United States dropped 3.2% in the week ended Nov 9, after a 4% drop in the previous week, per the report from the Mortgage Bankers Association. Moreover, refinance applications decreased 4.3% and applications to purchase a home fell 2.3%.

Apart from rising mortgage rates that are expected to pose serious threats to the construction market, higher input costs are also compressing homebuilders’ margins at a time when political pundits are seriously considering a national infrastructure revamp.

Construction material prices increased 7.9% year over year and 0.5% month over month in October, according to an Associated Builders and Contractors (“ABC”) analysis of information provided by the U.S. Bureau of Labor Statistics. Prices for nonresidential construction inputs also increased 0.5% month over month and more than 8% year over year.

Is Recovery Due in the Near Term?

Despite the sharp fall in builders’ sentiment, an important economic indicator, the reading remains in the positive territory as any reading above 50 signals improving conditions. Homebuilders indicated continued consumer demand for new homes. That said, the recent market data related to sales, permits, starts and existing home sales revealed a decelerating growth rate, which raised apprehensions about housing recovery. Moreover, labor shortage, trade-driven material price increases, limited land availability along with increases in new and existing home sale prices have been making things worse.

Notably, the Federal Reserve hiked the funds rate for the third time this year in September to 2-2.25% in response to a strong U.S. economy and signaled a gradual pace of rate hikes, going forward. It was the eighth hike since late 2015. The central bank maintained its forecast of the fourth rate increase before the year end and three more in 2019.

The Fed is expected to raise interest rates in December. However, the recent housing slowdown may influence the extent to which the central bank will actually extend its interest rate hikes since late 2015.

Economist Dietz also stated, “Recent policy statements on economic conditions have lacked commentary on housing, even as housing affordability has hit a 10-year low,” said Dietz.

Homebuilding biggies, like Lennar and KB Home, have also trimmed their expectations recently. KB Home slashed its guidance for fourth-quarter fiscal 2018 revenues and average selling prices. Lennar has also adjusted both deliveries and new order guidance for the fourth quarter of fiscal 2018, to reflect the impact of Hurricane Florence and the sluggishness that it has been currently experiencing.

The only thing that is positive for the homebuilding industry is robust economic growth and a solid job market that provide the basis for demand.

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