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Housing to Recover on Supply-Demand Balance

Zacks Equity Research

2016 had been reasonably good for the housing market, and this year is expected to maintain the trend, courtesy of healthy demand-supply balance, modestly rising prices, historically low mortgage rates, escalating rent costs and easy availability of loans. Again, there are signs of increased inclination of home purchases among millennials, a generation that had to some extent refrained some from entering the market.

For that matter, there are plenty of reasons to be optimistic about the broader housing sector over both the short and the long term.

Below, we discuss some of the key factors driving the sector and what investors can expect going ahead.

Higher Demand, Low Inventory Boost Sales

Steady economic growth along with favorable demographics, historically low interest rates and the attractiveness of owning versus rent are driving demand.

Although GDP growth in the fourth quarter of 2016 was slower than the preceding quarter, average growth in the second half of the year significantly improved from the disappointing 1.1% increase in the first half. The composition of growth in Q4 was also somewhat better than the Q3 gain. The final quarter of 2016 saw solid consumer spending, a pickup in business investments along with a rebound in home construction.

Per the National Association of Realtors or NAR, 2016 was the best year in a decade for existing home sales, even after the decline in December, courtesy of the ongoing affordability tensions and historically low supply levels.

On the other hand, a shortage in buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing. The convergence of healthy demand and low inventory levels is boosting new home sales and is expected to continue for some time.

Total housing inventory of existing homes was 10.8% lower at the end of December, per data released by the NAR. This marks the lowest since the NAR began tracking housing supply in 1999. Inventory has dropped for 19 straight months. At the current sales pace, the December inventory represents a 3.6-month supply, which is down from 3.9 months in November.

Healthy Demand-Supply Balance to Lift Price

The past year saw inching up of prices every month with the largest gains coming in the later half. Although gains may decelerate to a certain extent, we expect prices to continue to ascend. The median of existing home prices in December was $232,200, up 4% from a year ago. The price hike marked the 58th consecutive month of year-over-year gains in the sector.

Higher rates may impact the housing demand. However, the supply-side dynamics of the U.S. housing market support higher home prices.

We believe prices will continue to scale higher despite decelerating sales growth as demand for homes is like to grow on high consumer confidence and low unemployment. Improving labor markets, declining unemployment rates, low mortgage rates and limited home supplies are driving home prices, thereby boosting homebuilders’ top line.

Although the recent bump up in interest rates has raised concerns over outlook of home prices in 2017, the rates should remain reasonable, in our view, keeping housing affordable. Modest hikes in interest rates in the context of an improving economic environment can be a positive for the housing sector.

After all, the underlying driver for the higher move in interest rates is increased economic growth expectations. A booming economy boosts income as well. Thus, if the rise in income offsets the increase in mortgage payment, housing will do just fine.

Some analysts are of the opinion that the hike largely follows the euphoria of Trump’s election as U.S. president. Probably, builders are hopeful that Trump will follow through on his pledge to ease some regulations that are marring housing affordability and business for small enterprises.

Trump’s Growth Plan

President Donald Trump aims to double economic growth through an ambitious stimulus program featuring tax cuts, deregulation and higher infrastructure spending. Although this may face varied obstacles, we expect the plan to help the economy grow at a faster clip in 2017.

Although the U.S. inched up 1.6% in 2016, down from 2.6% seen in 2015, the economy grew at an average annual rate of 2.6% from 2010 to 2015. Improving economic growth supported by a better employment picture generally boosts housing activity and provides a basis for stronger demand.

Meanwhile, the U.S. economy added 227,000 jobs during the month of Jan 2017, significantly higher than 157,000 added last December. This also exceeds the consensus estimate of 174,000 job additions. Additionally, these are the best monthly job gains since September. Job addition is yet another signal that Trump has taken over a healthy economy.

With a fall in the unemployment rate, rising wages and decent consumer confidence, the U.S. economy looks quite strong despite rising pressure elsewhere.

Millennials Take Interest

Millennials, born after 1980, are anticipated to continue to make up a large and growing portion of the buyer section, although many disagree with this view. This is due to the fact that millennials occupy the largest adult generation and make up the greatest percentage of the workforce.

According to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends study, millennials accounted for 35% of all buyers, up from 32% in 2014.

Land as Native Strength

The well-stocked supply of land, plots and homes of large homebuilders like Lennar Corp. (LEN), D.R. Horton, Inc. (DHI) and Toll Brothers, Inc. (TOL) provide them with a strong competitive position to meet the demand in future quarters, thereby growing sales and home closings. D.R. Horton carries a Zacks Rank #2 (Buy) and Toll Brothers holds a Zacks Rank #3 (Hold).

Toll Brothers has secured some of the most sought-after urban locations in the country – New York City, Northern New Jersey, Philadelphia and Washington D.C. to name a few – where land is scarce and approvals are not easy to come by.

Interestingly, homebuilders like PulteGroup, Inc. (PHM) and Lennar are moving away from a land-heavy acquisition strategy to acquiring land with a shorter two- to three-year average life to improve returns. Pulte also focuses on investing in land in closer-in locations where demand is more sustainable. PulteGroup sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Smaller homebuilders too have realized the importance of land investments to support growth. KB Home (KBH) and Beazer Homes USA Inc. (BZH) are stepping up land investments to strengthen their position in an improving housing market.

Conclusion

Though they admit to rising labor shortages and land/labor costs, homebuilders in general expect the housing market to continue its measured recovery this year in tandem with steady economic growth.

Overall, the positive trends in supply and demand fundamentals have led to incredible hikes in home prices and are likely to provide some resiliency in the face of moderately rising interest rates in 2017.

Investors could also take advantage of the opportunities in the near term and cash in on any sudden surge in the homebuilding sector.

Check out our latest “Housing Industry Outlook” here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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Toll Brothers Inc. (TOL): Free Stock Analysis Report
 
Lennar Corporation (LEN): Free Stock Analysis Report
 
KB Home (KBH): Free Stock Analysis Report
 
D.R. Horton, Inc. (DHI): Free Stock Analysis Report
 
Beazer Homes USA, Inc. (BZH): Free Stock Analysis Report
 
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