What Are Home Builder Stocks?

Home builder stocks encompass some of the most dynamic offerings on the market, comprising powerhouses like PulteGroup, Inc. (NYSE:PHM), D.R. Horton, Inc. (NYSE:DHI), and Lennar Corporation (NYSE:LEN). Over recent months, the companies in this sector have witnessed a substantial surge, with many experiencing a 40% to 80% uplift from their October lows. This upward trend emerged when the housing industry sentiment was at its nadir, sparking curiosity among investors about the potential for a short-term correction in the housing stock market.

Current market signals present a mixed bag of fortunes. The Pending Home Sales Index recorded a 5.2% dip in March, with pending transactions taking a sharp 23.2% hit from the same month in the previous year. NAR Chief Economist, Lawrence Yun, pointed to a scarcity of housing inventory as a significant driver of increasing housing prices, with 28% of houses selling above their listing prices. However, this shortage also poses a considerable hurdle for sales.

Data suggests that real estate investors are stepping back, with Redfin recording a striking 48.6% drop in home purchases during Q1. This figure represents the most significant year-on-year decline ever documented by the firm. The culprits? Rising interest rates and decreasing rent prices have contributed to cooling investor enthusiasm. Moreover, a 17.4% year-on-year dip in homebuying demand was observed for the four-week period ending May 25.

Luxury home builders are not immune to the impact of climbing interest rates. According to data from the real estate tracking firm Knight Frank, luxury home prices suffered a Q1 decline for the first time since the financial crisis, drawn from information across 46 leading markets. Following a 3% increase in the final quarter of the previous year, luxury home prices slid by 0.3% in Q1 2023. This dip aligns with Redfin's report of a 38% drop in luxury home sales during the three-month period ending November 30, marking the most significant recorded decline.

For those intrigued by the potential to short some promising housing stocks, especially given the recent elevation in share prices, the home builder stocks ETF SPDR S&P Homebuilders ETF (XHB) is heavily shorted right now, with almost 12 million shares in short positions.

Home builder stocks endured a turbulent 2022, rewarding shorts with significant gains. Existing home sales declined for an unprecedented 12 consecutive months through January 2023, leading potential buyers to increasingly abandon deals. Consequently, the market value of the 21 Largest Home Builders in the USA saw a significant reduction.

Nonetheless, some encouraging signs suggest the presence of sound housing stocks to buy. Record-low inventory and rising orders, alongside declining mortgage rates, contribute to a more affordable housing market than has been witnessed in a considerable period.

The housing market has encountered difficulties in recent times, due in part to soaring raw material prices and rising mortgage rates which impacted housing sector stocks throughout 2022. New home sales for January 2023 clocked in at a seasonally adjusted annual rate of 670,000, down a significant 19.4% from the January 2022 estimate of 831,000. Housing prices have also begun to stabilize, with the median sales price of new houses sold in January 2023 dropping almost 1% year-on-year to $427,500. Furthermore, housing starts, an indicator of new construction activity, declined 4.3% month-over-month in January for single-family housing - the primary sector for homebuilding.

However, numerous positive developments suggest the worst may be over for the housing market. Retail inflation in January showed a decrease, sitting at 6.4% compared to 7.5% in the same period the previous year. This decrease has given the U.S. Federal Reserve confidence to slow the pace of interest rate hikes, with the most recent increase standing at 0.25%, down from multiple rate hikes of 0.75% last year. The average 30-year fixed-rate mortgage in the U.S. hovered at around 6.6% in 2022, dropping from November highs of approximately 7.1%. This reduction could render new home financing somewhat more affordable. Meanwhile, a considerable undersupply of homes remains, with estimates indicating that the country may be short of anywhere between 1.5 million to 5 million homes. This scenario suggests housing players might still have reliable demand visibility, with volumes and revenues likely to rebound as the economy picks up and inflation eases.

Within this theme, Installed Building Products has been the strongest performer, with its stock rising by about 34% year-to-date. Conversely, Home Depot stock has underperformed, declining by about 6% year-to-date.