Key releases that could affect your REIT and homebuilder portfolio (Part 4 of 6)
Mortgage rates are the lifeblood of the housing market, which is why the Fed began conducting quantitative easing (or QE) in the first place. Lower rates allow homeowners to refinance, which increases their disposable income and helps stimulate economic growth. Lower rates enable first-time homebuyers to move out of an apartment and into a house, which means higher consumption (and benefits for home improvement retailers like Home Depot and Lowe’s). Consumption accounts for some 70% of the U.S. economy.
Mortgage rates drop as the ten-year yield falls
The average 30-year fixed-rate mortgage fell 2 basis points to 4.15%, as the ten-year yield fell 5 basis points, and TBAs rallied. With the refinance boom over, originators are overstaffed and cutting prices to drive business. We’ve seen a number of small originators go out of business, as they found themselves unable to compete in a purchase-driven mortgage market. The purchase market is fundamentally different from the refinance market in that it’s driven by relationships and not price. We heard from the biggest banks in the mortgage business, and every one reported 30% to 40% drops in origination activity. Margins are getting squeezed as bankers compete for business.
Recently, the FHFA issued new loan level pricing adjustments for conforming loans. Loans with FICO scores above 680 and loan-to-value ratios above 80% will see higher rates. Not only that, but the FHFA also increased the guarantee fee for conforming loans by 10 basis points. Mel Watt put these increases on hold.
Effect on homebuilders
Homebuilders, like Lennar (LEN), Toll Brothers (TOL), PulteGroup (PHM), and D.R. Horton (DHI), have been reporting decent earnings, but it appears that traffic is increasing in the previously dormant East Coast and Midwestern markets, as the West Coast probably moved too far too fast. An alternate way to invest in the sector is through the S&P SPDR Homebuilder ETF (XHB). Given that the economy could have depressed household formation numbers, there’s real pent-up demand for housing.
Housing starts have been below historical averages for the past ten years. With low mortgage rates and increasing demand—and a strengthening economy—homebuilders now have the wind at their backs. The builders that have exposure to the red-hot West Coast market did very well. For homebuilders, the top-down macro picture looks good.
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