Why High Interest Rates Are Actually Helping Homebuilder Stocks Such As Lennar & Pulte

Our theme of Housing Stocks, which includes the stocks of home improvement players, building supply companies, and home builders such as Pulte Group and Lennar
LEN
has fared well in 2023, rising by 38% this year so far. This compares to the S&P 500 which remains up by about 16% over the same period. Mortgage rates in the U.S. have soared to the highest level in more than twenty years, due to the Fed’s hawkish stance and the post-pandemic surge in inflation. The average interest rate for a 30-year, fixed loan stood at about 7.6% as of last week, compared to levels of under 3% in 2021. This is making home financing much more expensive compared to the pre-pandemic era. Interestingly, despite the surge in mortgage rates, the market for new homes remains strong and this is benefiting homebuilders.

The increased rates make it more likely for existing homeowners, who have locked-in mortgages at lower rates, to stay in their homes, reducing the incentive to sell. This has led to a decrease in the market for both upsizing and downsizing homes due to the lock-in effect. In September, existing home sales dipped by 2%, reaching a seasonally adjusted annual rate of 3.96 million units, the lowest since October 2010, according to the National Association of Realtors. This trend has proven advantageous for new home builders, as the overall housing market still faces a significant undersupply. September’s sales of new single-family homes reached a seasonally adjusted annual rate of 759,000, marking a 33.9% increase from the September 2022 estimate of 567,000. This marks the highest levels seen in about 19 months. Moreover, median sales prices for new homes have declined to $418,000, down from $477,700 in the same period last year. This trend could also be stimulating demand. Notably, new homebuilding activity has also seen an uptick, with U.S. single-family homebuilding rebounding by 7% in September. Single-family starts increased by 3.2%, while multi-family starts soared by 17.1%.

While the broader housing sector has fared well in recent years, LEN stock has seen extremely strong gains of 60% from levels of $75 in early January 2021 to around $120 now, vs. an increase of about 20% for the S&P 500 over this roughly 3-year period. However, the increase in LEN stock has been far from consistent. Returns for the stock were 52% in 2021, -22% in 2022, and 35% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 15% in 2023 – indicating that LEN underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Consumer Discretionary sector including AMZN, TSLA, and TM, and even for the megacap stars GOOG, MSFT, and AAPL. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could LEN face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

Demand for new construction is surging due to the housing shortage and a lack of availability of existing homes. Although it is difficult to gauge the near-term outlook for the theme, there remains a fundamental undersupply of homes, with a wide range of estimates projecting that the U.S. may be short of anywhere between 1.5 million to 5 million homes. ^[1] This might indicate that housing players may still have good demand visibility, with volumes and revenues likely to hold up. This could help companies such as PulteGroup and Lennar. Moreover, with inflation easing, input prices could also cool down, helping margins and profits for homebuilders.

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