New-home orders dropped significantly at California-based builder
in its fourth quarter. It’s the latest illustration of how rising mortgage rates have weighed on builders.
Mortgage rates have retreated a bit, offering some optimism for investors—but analysts say it may be too soon to bank on an easy housing recovery.
(ticker: KBH) last week reported 692 net new orders in its fourth quarter—less than half of the 1,964 expected by FactSet consensus estimates, and about 80% fewer than the same quarter one year prior. The net decline was due to a combination of low gross orders and an increase in cancellations, KB Home CEO Jeffrey Mezger said on a conference call.
The quarter, which ended Nov. 30, reflects a point in time when the average 30-year fixed-rate mortgage was near or above 7%, according to Freddie Mac data—the peak of a climb from historically low rates that came as the Federal Reserve tightened monetary policy to control inflation.
“High mortgage rates and persistent inflation, together with an uncertain economy, have made home buyers more cautious since the middle of last year,” Mezger said in a statement. “In the fourth quarter, we prioritized delivering our large backlog and protecting our high margins over taking steps to stimulate additional sales during this seasonally slower time frame.”
KB Home isn’t the only builder that saw demand slow at the end of 2022.
(LEN), another public builder that recently reported earnings for the same period, said its new orders fell 15% to 13,200 homes in the fourth quarter.
“As a first playbook strategy, we detailed that we’re going to continue to sell homes and adjust pricing to market conditions and maintain reasonable volume,” Lennar Chairman Stuart Miller said during the company’s December conference call. That means the company’s margins, not its volume, is the “so-called shock absorber,” he added. Lennar’s gross margin on home sales fell to 24.8% in its most recent quarter from 28% in the year-ago period, according to FactSet.
(DHI), the nation’s largest public home builder, is set to post earnings on Jan. 24 for the quarter ended Dec. 31. Analysts expect it to report 14,890 new orders, a 31% decrease from the same quarter last year, and a margin of 23.5%, down from 27.4% in the first quarter of 2022, according to FactSet.
The impact of the late 2022 rise in mortgage rates was broad, weighing on existing-home sales and builder confidence alike. Existing-home sales in November, the most recent month for which data is available, fell for the 10th straight month. Builder sentiment, measured as an index by the National Association of Home Builders, fell every month in 2022, according to the organization.
“In this high inflation, high mortgage rate environment, builders are struggling to keep housing affordable for home buyers,” Jerry Konter, the National Association of Home Builders’ chairman, said in a statement last month. He added that 62% of builders reported using incentives to improve sales, while 35% cut prices.
Better news could be in stores in 2023, analysts wrote recently. The end of 2022 could have been the bottom for orders, a team of BofA analysts and strategists said. “Demand will likely remain weak in spring, but we think orders troughed in 4Q22,” wrote BofA analysts Rafe Jadrosich and Shaun Calnan and strategist Chris Flanagan in a note. Orders will improve sequentially in 2023, they are added.
Citi researchers also expect orders to improve. A Citi Research team led by Anthony Pettinari said it was “selectively positive” on builders, favoring it
(PHM). “The spring selling season should be weak, but a stabilization of 2H net orders should be a catalyst,” they wrote.
KB Home’s Mezger said the company expects year-over-year net orders to improve to a midpoint of 1,900 in the first quarter, with KB Home targeting a first-quarter decline between 50% and 60% from the “incredibly strong comparison” one year priors. In the first five weeks of the new quarter, net orders were down 72%, the CEO said.
One reason for optimism in the housing market: mortgage rates have trended down since rising above 7% in 2022. “Mortgage rates have declined from peak levels and are poised to move lower in 2023,” the BofA team wrote. Builder valuations are already accounting for lower prices and weaker demand, the analysts wrote, and builder margins could be helped by lower materials costs.
The team upgraded shares of
(TOL) to Buy from Neutral and shares of Lennar to Neutral from Underperform.
(NVR), another large home builder, is the analysts’ “top pick for builders,” the team wrote. “NVR is not immune to housing slowdown, but shares have historically outperformed weak housing markets due to its asset-light model,” they wrote.
The BofA team isn’t alone in expecting mortgage rates to fall. Following a Consumer Price Index report that showed inflation continued to cool in December, National Association of Realtors chief economist Lawrence Yun said mortgage rates could fall below 6%. “Inflation has been coming down. Mortgage rates will also, therefore, come down,” Yun said in a release.
Investors appear to be hopeful. the
SPDR S&P Home Builders
exchange-traded fund (XHB) and the
iShares US Home Construction
ETF (ITB), two ETFs that track home builders and related industries, have returned about 9.7% and 9.2%, respectively, so far this year, beating the
S&P 500 index.
But an easy housing market recovery isn’t guaranteed. “The seemingly perennial event known as the ‘Hope Trade’ for home builders has not disappointed,” Raymond James analyst Buck Horne wrote in a Jan. 9 notes. “Despite the growing optimism that the US economy can thread the needle, we still believe a ‘hard landing for housing’ is still the most likely path forward in 2023.”
The analyst upgraded shares of
to Outperform from Market Perform, and downgraded shares of
to Market Perform from Outperform. “For now, we believe the best most attractive risk/reward opportunity lies in moving up the price point curve towards Toll Brothers,” wrote Horne.
The recent fall in mortgage rates hasn’t remedied affordability concerns, the analyst wrote. “Despite the recent pullback in mortgage rates (to ~6.5%), payment/income ratios remained uncomfortably above prior 2006 peaks,” wrote Horne. “Home sales activity and buyer traffic remain shell-shocked entering 2023, and housing markets across the country remain in ‘price discovery’ mode.”
Home affordability, along with a weaker economy, is one of the reasons why RBC analyst Mike Dahl expects demand difficulties to persist, the analyst wrote in a note.
“Demand has remained depressed despite the pullback in rates,” wrote Dahl, adding that he expects the spring selling season “will bring disappointment along with further downside to prices.” He downgraded shares of DR. Horton, Lennar, and
Dream Finder Homes
(DFI) to Underperform from Sector Perform, and KB Home to Sector Perform from Outperform.
Write to Shaina Mishkin at [email protected]