Surging US mortgage rates halt rally in homebuilder stocks

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A powerful rally in the stocks of US homebuilders has gone into reverse, as investors worry that a rapid rise in mortgage rates is starting to threaten demand for new houses.

Shares in DR Horton, Lennar and NVR have dropped more than 16 per cent since their peak in July. Those of PulteGroup, which had surged 86 per cent in 2023 until August, are down by a similar amount.

Rapid rises in mortgage rates had at first propelled homebuilder stocks, because they made current homeowners holding cheaper fixed-rate loans less willing to sell their properties. Buyers sought out newly constructed houses as an alternative.

But higher rates are finally having an effect. Mortgage rates have risen sharply in recent months, rising from 6.48 per cent at the start of the year to a 23-year high of 7.79 per cent last week, according to Freddie Mac. Homebuilders have said that the recent jump had begun to price more homebuyers out of the market.

“At this point it’s come down to a macro call,” said John Lovallo, an analyst at UBS. “We’ve taken our estimates down and our price targets down a bit, just in recognition of what’s going on in the market with rates.”

Single-family housing starts increased 8.6 per cent in September from a year ago, but some economists said that the recent uptick in activity would be shortlived. Homebuilder confidence this month dropped to its lowest level since January as higher rates drove some buyers away and raised construction costs, the National Association of Home Builders said.

“We don’t think this bounce in housing activity will persist,” said Oren Klachkin, financial market economist at Nationwide. “Builders won’t have an incentive to break ground on new projects so long as demand remains subdued, and we don’t see a sustained turnaround until credit becomes less restrictive and affordability improves.”

New home sales in September increased 12.3 per cent from August, the Census Bureau said on Wednesday, while existing home sales plunged to the lowest level since 2010.

Yet applications for 30-year fixed rate mortgages fell to the lowest level since 1995 last week. Zillow senior economist Jeff Tucker said the housing market had slowed dramatically over the past month and a half. “We have seen demand for new homes start to dry up.”

PulteGroup announced on an earnings call on Tuesday that it expects to deliver fewer homes than it had expected for the fiscal year due to higher interest rates.

One way for homebuilders to boost sales is by offering a “buy-down”, which provides buyers with a lower mortgage rate on a property than is available in the market.

PulteGroup said it has been able to offer a 5.75 per cent loan on a 30-year fixed rate. The group said 80-85 per cent of its buyers have received an incentive towards interest rates.

But the increased use of incentives might weigh on company margins, said Jade Rahmani, an analyst at Keefe, Bruyette & Woods. 

“New homes are now unaffordable unless the home builders can figure out another trick up their sleeve, which might be cutting prices further, which will mean their gross margins are impacted,” Rahmani said. 

Although mortgage rates are expected to remain elevated through 2024, Goldman Sachs said in a research note on Monday that it expected them to fall just below 7 per cent by the end of next year.