US housebuilders: long-term investment case remains intact

US house prices continue to go through the roof. Across America, home prices — as measured by one closely watched benchmark, the S&P Corelogic Case-Shiller index — rose nearly a fifth in May from a year ago.

Yet that has done little for homebuilding stocks. The S&P Homebuilders Select Industry index is down 25 per cent so far this year, outpacing losses on the S&P 500 index. Shares in the country’s big builders — DR Horton, Lennar, NVR, PulteGroup and Toll Brothers — have all pulled back to trade at or just slightly above book value.

Higher house prices, it turns out, mean very little when affordability has been crimped by mortgage rates that have jumped 200 basis points since the start of the year.

As would-be buyers flee the market, construction groups are warning of a slowdown. Toll Brothers, which operates at the higher end of the market, is among them.

The company this week reported a 60 per cent year-on-year drop in purchase contracts during the July quarter. The cancellation rate of 13 per cent was up from 3.1 per cent just a year ago. It now expects to deliver 10,000 to 10,300 homes in its full financial year, down from a previous estimate of 11,000 to 11,500 homes.

Recent readings on construction starts and mortgage applications provide little solace. New home sales in July fell 13 per cent month on month and were 30 per cent lower compared with last year. The National Association of Home Builders’ index of builder sentiment fell in August for the eighth consecutive month.

Housebuilders will have to start offering discounts and other incentives to avoid an inventory pile-up. This will weigh on margins and profits in the near term.

For investors that take the long view, the investment case for homebuilders remains intact. America has a structural shortage of homes — to the tune of 3.8mn units, according to one estimate. The rock-hard foundation of the US housing market is suffering some cracks, but an outright collapse is nowhere in sight.