Homebuilders caught in middle of tale of two housing markets
Mortgage rates remain elevated throughout February and reaching a two-month high, according to Freddie Mac's latest reading. Shares of homebuilder Toll Brothers (TOL) rise after topping fiscal first-quarter earnings estimates on Tuesday. What is Toll Brothers' guidance forecasting for US housing market hopes?
John Lovallo, UBS US Homebuilders & Building Products Equity Research Analyst, explains patterns in housing demand and how homebuilders are managing to maintain resiliency amid mortgage rate and inventory pressures.
"It's been a tale of two markets. The new home market has been very good, and we can talk about that. It's the existing home market, because there's no supply of inventory on the ground, which has been much more sort of locked in place, if you will," Lovallo tells Yahoo Finance.
For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.
Editor's note: This article was written by Luke Carberry Mogan.
Video Transcript
BRAD SMITH: Toll Brothers showing positive early signs for this year's housing market, raising its guidance after home deliveries rose 6% from a year ago. This comes after mortgage rates ticked up last week, according to data from Freddie Mac, hitting the highest level in two months.
For more on the state of homebuilders, we're joined by John Lovallo, who is the UBS US homebuilders and building products equity research analyst there. Woo. John, thanks so much for taking the time here today. First and foremost, I mean, let's just dive into these earnings from Toll Brothers because if we're trying to get a read on the rebound efforts that we're trying to see within the housing economy, what is the read through that we get from Toll Brothers here? On the super-luxury side, I might add.
JOHN LOVALLO: Sure. Hey, Brad. Thanks for having me.
I think the read through is much broader than just the super luxury. Toll's done a very good job of mixing their portfolio down to basically cover most price points across the spectrum.
I think the read is very positive. Order growth was up 40% year over year. Gross margin was well ahead of expectations by 90 basis points, and EPS beat meaningfully. And on top of that, they took their outlook up for deliveries, margins, EPS, and EPS actually went up by 10%.
And so what does this tell us? I think it says that demand for housing remains resilient, right? And I think Seana at the onset had mentioned, you know, Is the worst over for this market? And, you know, look, I think it's been a tale of two markets. The new-home market has been very good, and we can talk about that. It's the existing-home market, because there's no supply of inventory on the ground, which has been much more sort of locked in place, if you will.
SEANA SMITH: Right, John. That's great to point out, and I totally agree with you. When we talk about, though, I think one of the things, obviously-- and I know you've covered it extensively-- has just been the inability or lack thereof to meet that strong demand, right? People who own homes right now, many of them locked in to 4%, 5% below mortgage rates. They're simply not moving. Because of that, we have this massive disconnect between inventory and what we're seeing demandwise. Are home builders-- I guess do you see them at all closing that gap this year, and what does the incentive picture look like as they're trying to draw more people off the sidelines and be able to purchase their homes?
JOHN LOVALLO: Yeah, it's a great question. Look, I think I would tell you at the onset that we would prefer lower rates any day over higher rates. It's better for the market. It's better for the stocks. However, what I would tell you is that in this sort of high 6%, low 7% mortgage range, it's sort of Goldilocks for the home builders because they have the ability to buy down mortgage rates and offer this financing that can allow folks to get into homes. And you couple that with the fact that people who own homes today, as you mentioned, Seana, are not moving. They're kind of locked into place. And so the demand that is out there-- and it is resilient-- is all being funneled toward this new-construction market, and the public builders are gaining a tremendous amount share though. So for the public builders that we cover, it's a pretty good environment.
BRAD SMITH: How well are the homebuilders doing, from what you've monitored, at attracting those first time-home buyers, especially the millennial cohort?
JOHN LOVALLO: Doing incredibly well, Brad. I mean, look, this was a big concern for a number of years that this generation was different. They didn't want to buy homes. They didn't want to own big-ticket items. Look, I think that as life goes on and life events like marriage and child rearing occur, we're finding that this generation is very similar to prior generations, and they want to own a home. And the public buildings--
BRAD SMITH: Of course we want to own a home, John. My goodness. Are you kidding me? I don't know. It must have been the Great Financial Crisis or just the wild inflation around student tuition. I don't know. Just throwing things out there.
JOHN LOVALLO: Yeah. Yeah. So the builders have done a very good job of getting out there, building smaller footprints, more affordable price points, maybe a little further away from city centers but making the math work for this buyer.
SEANA SMITH: John, when it comes to those incentives-- circling back to what you just said a minute ago. I think the question out there is, How long are these homebuilders going to leave some of those incentives in place? If you were to be or if one of these homebuilders were to be the first to remove an incentive, how big of a hit they could potentially see as a result of that. How do you see the whole incentive game playing out here over the next couple of years?
JOHN LOVALLO: I think it's important to keep in mind that homebuilders are underwriting or penciling these deals to a return, right? And so the toggle point is sort of gross margin. And so what they'll do is they'll go into the market, kind of gauge demand. If demand is good, they can raise prices, to some extent. If it's not, they will offer these incentives.
I think as we move into the spring selling season, at least here in the early days, there's going to be a reluctance to pull back on incentives because they want to get their footing in this all-important spring selling season.
Now as we progress over the next month or two, if that demand remains resilient-- and by the way, Toll said that January and February were a better-than-normal seasonality for them-- in fact, very, very strong months. If that continues, I think you will see the opportunity for builders to pull back on the incentives, and that will be accretive to margins and, frankly, to returns at the end of the day.
BRAD SMITH: John, who's your top pick among the homebuilders going into the spring selling season?
JOHN LOVALLO: You know, our top pick is still DR Horton. That's ticker DHI. We think that, you know, they're the largest by volume by a margin of 15%. There's a lot of advantages to size and scale, both locally and nationally. And they attract the right part of the market, in our opinion, which is that first-time, entry-level buyer, which is really driving the demand in today's homebuilding market.
SEANA SMITH: John Lovallo, always great to talk to you. Thanks so much for joining us here on the results from Toll Brothers, also what we're seeing play out more broadly within the homebuilding space. John, thanks so much.
JOHN LOVALLO: My pleasure. Thank you.
