Mark Elias/Bloomberg Construction workers set floor trusses in place that will support the second story of a home at a development in Doral, Florida.
In a rocky October for stocks, few companies have fared worse than those in the housing sector. Buffeted by a string of reports showing falling home sales and dwindling new construction, the SPDR S&P Homebuilders Index XHB, -1.54% has fallen roughly 12% month-to-date, and 24% on the year.
These data have caused some analysts to downgrade the sector, but several others see a perfect buying opportunity.
Housing bears have plenty to point to, as a combination of rising interest rates, a dearth of buildable land, and rising input costs have kept a lid on new-home construction, existing home sales, and the sort of consumer spending that results when families change homes.
Recent economic data has also been dismal. The number of new homes under construction, which remains well below prerecession levels, fell in September by 5.3% causing Jennifer Lee, senior economist for BMO Capital Markets to write, “the overall trend in housing has clearly slowed/plateaued/leveled off.” On Friday, the National Association of Realtors announced that existing home sales had fallen to a three-year low.
But some observers argued that the market reaction to negative news has gone overboard.
“As far as home builders go, we think the sector is ludicrously cheap,” wrote analysts at Bespoke Investment Group, in a Thursday note.
They noted that home builders are trading at their lowest levels relative to the S&P 500 since 2014, when housing starts remained barely above the nadir of the real estate bust.
Meanwhile, though mortgage rates are rising, they are still historically very low, leaving home price affordability in line with levels seen between 1990 and the start of the housing bubble in 2004. And that’s helping to maintain healthy demand for homes, even if home builders haven’t thus far been able to meet it with supply, a yearslong mismatch that has left the U.S. with a cumulative shortfall of 4.6 million homes.
But despite the litany of headwinds that should be diminishing buyer enthusiasm, they keep showing up. So far this year, the “traffic of prospective buyers” component of the closely-watched sentiment index from the National Association of Home Builders has averaged 51, a high that was only matched one year during the frothiest period of the bubble.
Also see: Construction hiring is booming—and there still are plenty of available jobs
And mortgage lenders from Maine to Ohio have told MarketWatch that it’s not rising rates that’s keeping customers on the sidelines, it’s a dearth of anything to buy. And with so much catch-up to do from the postcrisis years, there are likely still many prospective homeowners in America.
And there is reason to believe this demand will remain robust for years to come, according to Steven DeSanctis, analyst with Jefferies.
He pointed out that the largest age cohort in America is now in its late 20s, which has driven new household formation to its highest rate in more than three years.
“The millennial generation is finally starting to marry, start families and look for homes,” DeSanctis told MarketWatch. “The demand is there, and it’s not going away any time soon.”
It will still pay to be strategic in terms of which housing related stocks to buy. DeSanctis suggests looking at mobile-home manufacturer Skyline Champion Corp. SKY, -7.10% as a company that can avoid the hurdle of the short supply of buildable land.
Focusing on regions like the Southeast and Southwest, where supply constraints are much less severe, is a good strategy too, he said. Howard Hughes Corp. HHC, -0.12% is one such play, according to DeSanctis. It is down heavily on the year, but benefits from large exposure to markets in Houston and Las Vegas, where input constraints are less of a concern. DeSanctis argues these names have been unfairly swept up in the broader housing rout.
To be sure, not all analysts are convinced. JPMorgan analysts in late September downgraded five builder stocks, saying that they expected the housing recovery “to remain fairly tepid in 2019, while rising new home inventory and declining affordability should result in a slower rate of home price appreciation next year. As a result, we expect builder fundamentals to moderate over the next two years, which include a continued softer order growth rate in 2H18 and gross margins peaking over the next 12 months.”
The wild card in the debate over the housing sector is the broader macroeconomic picture. DeSanctis said that housing stocks will typically do very poorly in the lead up to a recession, but he argues that most data describing the financial health of potential home buyers says we’re not close to a cycle peak for the sector.
“We’re just now seeing acceleration of economic growth.” he said. “Unemployment is down dramatically, consumer confidence is up, and that’s the time when people are willing to make big purchases like a home.”
Read: Buyers are ‘fatigued,’ ‘burned out,’ but kept house-hunting even in August, real-estate agents say
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