Homebuilder confidence has held and remained the same in recent months as new home sales dropped. Mortgage rates have been at the root of many problems afflicting the US housing market and now they are starting to take a toll on homebuilder stocks; things could get even uglier as rates consistently move between 7% and realtors see mortgage rates going as high as 8% even.
As part of Yahoo Finance's Real Estate: The New Reality special coverage this week, Wedbush Securities Equity Research SVP Jay McCanless describes the rate environment as having "gone from being pretty benign" at 2024's start to "much more negative now than we would've expected."
McCanless outlines how homebuilders are operating in this rate-sensitive housing market and where he sees demand going based on the younger generations of homebuyers.
"The group is carrying less debt than it was five years ago and especially ten years ago. They are building the homes certainly more efficiently than they were back then, but at the same time, it comes down to monthly payment and the builders, I think they've done a good job of trying to shrink the size of the homes that they're building, reduce the amenities that they're putting especially in some the starter homes," McCanless says. "But at the end of the day if the mortgage rate's gone up 100-something basis points like it has this year already, that's just going to reduce the size of the population that can potentially buy a home."
JOSH LIPTON: US homebuilders came in at 2024 on the back of a banner year, that was 2023. Low supply in the resale market fueling higher demand for new homes. However, as mortgage rates climb and expectations shift now for interest rate cuts, where does that leave the rate-sensitive homebuilding sector?
Here to discuss as part of our weeklong special, Real Estate-- The New Reality, we have Jay McCanless, Wedbush Securities Equity research Senior Vice President joining us now. Jay, it's good to see you. So maybe we'll start there, Jay. You know, the market obviously is repricing, rethinking, Jay, the Fed's path to cuts. Wasn't so long ago, Jay, it was six cuts. And now, increasingly, we hear people coming on the show and saying no cuts. Larry Summers says, maybe you should get ready for actually a hike. How does all this kind of impact and influence your coverage universe, Jay?
JAY MCCANLESS: Well, thanks for having me on. I think what we've seen-- we watched the 10-year rate, 10-year US Treasury rate and mortgage rates a little more closely than the Fed funds rate. And mortgage rates have been moving the wrong way. We're back above 7% now, solidly above 7%.
That means the builders have to do more buy downs on mortgage rates and have to do some other things to try and keep these homes affordable. So, yeah, the rate environment has gone from being pretty benign at the beginning of the year to being much more negative now than we would have expected. And that's why we're generally kind of neutral to bearish on the group at this point, not because of lack of demand. It's just what's going on with the rate environment.
ALEXANDRA CANAL: And you mentioned treasuries, A 10-year yield is above 4.5%. What risk does that have on the housing market?
JAY MCCANLESS: So I think for the housing market, certainly-- or not certainly, but typically, we'll make mortgage rates stay high, stay at levels that, just from an affordability standpoint, a lot of people can't make. We also think in parts of our other coverage, multifamily and in mortgage, the refinancing costs for some of these multifamily projects are going to go up. And I think that's a larger risk for some of the names we cover is that being able to refinance some projects right now may not be as possible as it was earlier this year when the 10-year was below 4 and 1/2.
JOSH LIPTON: I'm interested, Jay, you know, on the other hand, we've had some of your colleagues, you know, other financial analysts who cover these names, Jay. They come on and say, you know, investors should know that these homebuilders, it's a different kind of company than it used to be. They're more efficient than they used to be. Do you agree with that? Do the business models look different now?
JAY MCCANLESS: Yeah, fully agree. They're from the group that's carrying less debt than it was five years ago and especially 10 years ago. They are building the homes certainly more efficiently than they were back then. But at the same time, it comes down to monthly payment and the builders. I think they've done a good job of trying to shrink the size of the homes that they're building, reduce the amenities that they're putting, especially in some of the starter homes. But at the end of the day, if the mortgage rate's gone up, you know, 100 and something basis points like it has this year already, that's just going to reduce the size of the population that can potentially buy a home.
I think the builders also are looking at ways to bring those-- again, to bring the square footages down and find other ways to make these homes more affordable, doing attached product and some things like that. So yeah, I think these are better run companies and generally better balance sheets than they were a few years ago. But at the end of the day, can you make that-- can the buyer make that monthly payment? And I think it's becoming increasingly difficult for some of these builders to make that happen.
ALEXANDRA CANAL: And Jay, what do you expect when it comes to demand? Do you think demand will continue to stay high? Or do you think buyers are waiting to potentially see mortgage rates come down? Do they think-- do you think they just want to get into the market as soon as possible? What are your thoughts on the future demand outlook?
JAY MCCANLESS: Yeah. So from a demand standpoint, we feel like the demand is going to be pretty solid for a few years because you have the millennials, which are a fairly large population group in prime household formation years. The Gen Zs are right behind them, also starting to get into home ownership. So I feel like the demand side of this is a really good outlook for the builders and going forward.
But again, with rates having moved up and now with prices starting to accelerate again, we've seen home prices appreciate mid-single digits for most of this year. It's kind of both those things are working against those buyers. But yeah, the need for housing is probably as high as I've seen it in my years of covering this group. So once we can get some rates and/or maybe some home prices to come down a little bit in terms of what the builders are offering to consumers, then that'll help solve for that affordability challenge.
JOSH LIPTON: Any builders in your coverage universe, Jay, you still have a buy on here?
JAY MCCANLESS: Yeah. We have-- on the manufactured housing side, we have a buy rating on Cavco Industries. They're manufactured housing producer, national manufactured housing producer. We like that name from an affordability standpoint.
We also like a small cap name, Landsea. LSEA is the ticker on that one. And we're outperform rated on that one. They're a mostly coastal California as well as down into Texas and Florida builders. So those are two names we like on the long side.
ALEXANDRA CANAL: All right. Jay McCanless, thank you so much for your insights. We really appreciate it.
