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Homebuilder sentiment ticks up in April with opportunity ahead

Brent Nyitray, CFA, MBA

Starts, permits, sales, and prices as spring selling season begins (Part 3 of 5)

(Continued from Part 2)

The National Association of Homebuilder Sentiment Index: A closely watched measure of future building activity

The National Association of Homebuilders Sentiment Index measures homebuilders’ confidence. It gauges builder perceptions of current and future sales of single-family residences and asks builders to characterize the sales as “good,” “fair,” or “poor.” It also asks the builders to rate the traffic of prospective buyers as “high to very high,” “average,” or “low to very low.”

An index level of 50 is considered neutral. The index peaked at 71 during the height of the housing bubble—late 2005—and bottomed at eight in early 2009. While the index has been steadily rising in the years since it bottomed, it has begun to accelerate.

Homebuilder sentiment crashes from post-bubble highs

The index came in at 47—a increase from 46 in March. This follows the biggest drop recorded in February. Lousy weather in the South and the Northeast depressed traffic. Shortages of lots and labor contributed to the drop in sentiment.

Builders are in a good position right now, with tight inventory. They’re able to increase margins (virtually every builder reported higher gross margins) and were able to drive revenue by increasing prices. Most market watchers expect home prices to moderate next year, but that would require extra supply. In the Northeast, that may be possible, as the foreclosure pipeline is still full. In the red-hot West Coast markets, builders still seem to be cautious about overbuilding.

A shortage of skilled labor has been a problem for the homebuilding industry as well as the mortgage industry. Since the bubble burst, employment in these sectors dropped so dramatically that many skilled workers found jobs in other sectors of the economy. Skilled construction workers absorbed into the energy and trucking sectors.

Implications for homebuilders

Shortages of construction materials, lots, and skilled labor may mean that gross margins for the builders like Lennar (LEN), D.R. Horton (DHI), PulteGroup (PHM), and Toll Brothers (TOL) have peaked. Virtually every builder reported record or close to record gross margins, as prices have risen faster than input costs. From what the report has to say, those days may be over.

That said, volumes should increase as the economy recovers and more pent-up demands get released. At some point, demographics will take over. Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves. As the job market improves, the first-time homebuyer should reappear, which would create a wind at the back of the homebuilders. Investors who are interested in trading the homebuilding sector as a whole should look at the S&P SPDR Homebuilder ETF (XHB)

Continue to Part 4

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