Establishing a Strong Foundation

E*TRADE Securities2

04/27/18

Spring has finally sprung and with it comes the highly anticipated spring housing market. Traders, economists, and homebuyers and sellers are keeping a close eye on a slew of factors and figures, including tax law changes and mortgage rates. For economists, the housing market is a significant indicator of the health of the overall economy, while prospective buyers and sellers are looking for the best deals at the right time.1 For curious investors, it’s a good time to check in and look for opportunities in the sector.

The lay of the land

Many are saying the sector’s hot, hot, hot.2 Consider that last week the US Commerce Department issued its monthly report on the housing market, which included some indications that the market may be starting to build momentum:

·  There were an estimated 1.32 million homebuilding starts in March, which beat most forecasts for the month and could also mean an increase in supply to meet demand.3

·  There are also signs that building activity will remain strong, as building permits for March were 2.5% higher than February. 3

These numbers may signal the potential for growth in the homebuilding and supply sectors. In the beginning of the year, we noted a resurgence of homebuilding stocks, such as D.R. Horton (DHI), KB Home (KBH), LGI Homes (LGIH), and Toll Brothers (TOL), all of which were trading near long-term highs. Since then, however, several publicly traded builders have experienced losses year-to-date.4 These include experienced companies with the scale to address supply and demand gaps in the housing market despite the increased cost of building materials. Translation: Some investors may be looking at these stocks as bargains. The high demand for housing may also bode well for suppliers that do not directly participate in the market but provide building materials, such as Lowe’s (LOW) and Home Depot (HD).5 However, not all entities involved in the market have been clear leaders year-to-date.

March housing market overview

Rising tide did not lift all boats

There is one number investors may want to watch if they’re interested in the housing growth story: single-family homebuilding. According to the March housing report, homebuilding for single-family homes, which represents a significant share of the housing market overall, fell 3.7%, while the multi-family housing segment surged 14.4%.6

So what could this mean for the housing sector? In short, all may not be as rosy as it may appear. In fact, there are more than a few signs that this sector could cool: The decrease in single-family construction starts can increase prices for homebuyers, who have benefitted from the strong labor market but have not seen corresponding wage increases.7 According to one survey, some builders pointed to tariffs on Canadian lumber and other imported construction materials implemented by the White House as a contributing factor to housing affordability concerns.8

Mind the mortgage makers

Furthermore, observers aren’t seeing a lot of prospective buyers applying for mortgages. Per the Mortgage Bankers Association (MBA), total mortgage application volume in the final week of March decreased by 3.3% from the previous week. This could be in part due to increasing interest rates driving up mortgage costs. Rising rates may also further dampen supply because homeowners may not want to sell their current homes in an environment when financing their next purchase will be more costly. Nonetheless, Mike Fratantoni, chief economist for the MBA, stated that the negative trend would be short lived: “The job market continues to strengthen, which should power demand through the spring season.”9

If mortgage applications do start to pick up, expect large mortgage originators to benefit from increased demand for loans, which they may be increasingly able to issue at higher rates.10    

Core/Satellite  

While the headlines may lull some into thinking this housing market is a sure thing, the reality is far from that perception. In life as in investing, sure things are scarce. That’s why many investors adopt a core/satellite approach, keeping the core of their portfolio properly diversified and focused on their long-term goals, and satellite portions dedicated to timely investment ideas.

 

1. Mutikani, Lucia. “U.S. Consumer Confidence, housing data highlight economy’s strength,” Reuters, 24 April. 2018 https://www.reuters.com/article/us-usa-economy-housing/u-s-consumer-confidence-housing-data-highlight-economys-strength-idUSKBN1HV1U3

2. Danziger, Pamela. “Real Estate Market Is Hot, Except At The High-End: Disruption Coming In the Luxury Home Market,” Forbes, 17 April. 2018. https://www.forbes.com/sites/pamdanziger/2018/04/17/real-estate-market-is-hot-except-at-the-high-end-disruption-coming-in-the-luxury-home-market/#4cf456133b5a

3. Riquier, Andrea. “Housing starts rebound as buyer demand buoys builders,” MarketWatch, 17 April. 2018. https://www.marketwatch.com/story/housing-starts-rebound-as-buyer-demand-buoys-builders-2018-04-17

4. Suttmeier, Richard. “How To Trade Homebuilders KB Home, Lennar And Toll Brothers, Which Are In Bear Market Territory,” Forbes, 20 April. 2018. https://www.forbes.com/sites/investor/2018/04/20/homebuilders-kb-home-lennar-and-toll-brothers-are-in-bear-market-territory/#30094da212d3

5. Harry, Joseph. “Home Depot Vs. Lowe’s: Quality Vs. Value,” Seeking Alpha, 9 April. 2018. https://seekingalpha.com/article/4161730-home-depot-vs-lowes-quality-vs-value

6. “Monthly New Residential Construction, March 2018,” The U.S. Census Bureau and the U.S. Department of Housing and Urban Development, 17 April. 2018. https://www.census.gov/construction/nrc/pdf/newresconst.pdf

7. Chandra, Sho. “Home Prices in 20 U.S. Cities Rise by Most Since Mid-2014,” Bloomberg, 24 April. 2018. https://www.bloomberg.com/news/articles/2018-04-24/home-prices-in-20-u-s-cities-rise-at-fastest-pace-since-2014

8. “US housing starts total 1.319 million in March, vs 1.262 million starts expected,” CNBC, 17 April. 2018. https://www.cnbc.com/2018/04/17/us-housing-starts-march-2018.html

9. Olick, Diana. “Weekly mortgage demand drops as homebuyers are rattled by the stock market,” CNBC, 4 April. 2018. https://www.cnbc.com/2018/04/04/weekly-mortgage-demand-drops-as-homebuyers-are-rattled-by-the-stock-market.html

10. Domm, Patti. “Here’s why the interest rate that affects mortgages and other loans is near 3 percent and headed higher,” CNBC, 23 April. 2018. https://www.cnbc.com/2018/04/23/the-interest-rate-that-affects-mortgages-is-at-3-percent-and-headed-higher.html