Two of the housing market's biggest foes are finally retreating: mortgage rates and inflation. And it's putting the already-hot homebuilding market once again into focus for 2024.
So far this year, the SPDR S&P Homebuilders ETF (XHB) has gained over 48% — and the rally in homebuilder stocks is expected to continue, albeit in a "calmer" fashion, as BTIG's Carl Reichardt, managing director and homebuilding analyst, wrote in a note to clients.
"We expect public builders to continue to gain market share of both new home sales and the overall transaction market in 2024," Reichardt wrote. "But we also do not expect a repeat of 2023's share price performance."
Market dominance has been the major advantage for homebuilders. Data gathered from BTIG shows that the 20 publicly traded homebuilders control nearly 2 million lots, which at today’s average new home sales price of $487,000, could pull in roughly $975 billion in future revenue.
The smaller private homebuilders won't be as lucky. There are about 12,000 firms that are facing higher capital costs and constraints, Reichardt noted.
Read more: How to buy a house in 2023
"Builders like [DR Horton, PulteGroup, and MDC] are able to consolidate trade and labor availability, further putting pressure on smaller builders and creating potential M&A opportunities," Buck Horne, director at Raymond James & Associates, wrote in a separate note.
Despite the high costs of labor and land — especially in larger metro areas — many builders are still planning to grow their footprint. On its recent earnings call, Toll Brothers (TOL) CEO Douglas Yearley noted plans to expand communities by about 10% in 2024, aiming to be ready with inventory when a drop in rates coincides with "spring selling season."
Still, the housing market is battling an affordability crisis that may not change as much as buyers would like.
"We believe the next few years of the US housing market will look not dissimilar to what we’ve been seeing this year — relatively sluggish transaction volume," Reichardt wrote.
Creative lending solutions and spec homes
One of the most effective ways the homebuilders have been able to stay on top is by offering mortgage rate buydowns. That’s when the builder upfronts the costs to lower the rate on the loan.
Read more: 5 strategies to get the lowest mortgage rates in 2023
For instance, Lennar (LEN) is offering a "fixed mortgage rate of 4.75%" in Colorado. That’s way lower than the average contract interest rate for 30-year fixed-rate mortgages backed by the FHA at 6.84%. The approach has been paying off for builders to attract first-time homebuyers, who are the most budget-conscious.
D.R. Horton (DHI) reported that 60% of its buyers used a mortgage rate buydown in the third quarter of this year. Through its buydown program, it has offered mortgage rates that are 100 basis points lower than the prevailing rate, Horne noted.
These are expensive costs, however. UBS housing analyst John Lovallo said the firm remains "cautious" looking at builders' returns going into 2024, pointing to Federal Reserve Chair Jerome Powell's "higher for longer" comments as evidence these buydown incentives might have to continue.
"We expect margins to remain above historical levels but maybe trend down," Lovallo said in an interview with Yahoo Finance Live.
For now, margins remain strong enough to build spec houses, houses that don't have a buyer yet — at least for Toll Brothers and other large public homebuilders. Especially for certain types of locations and houses. Reichardt sees larger homebuilders leveraging "their capital and scale advantages at entry-level price points and can best do so in urban fringe markets and, increasingly, in smaller tertiary cities."
Through stock prices, profitability, costs, and the housing market's dynamics, one thing remains clear: There's no sign that the homebuilding narrative will stop being dominated by the Fed.
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Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv.
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