Homebuilder opportunity: Mortgage purchase applications fall, but still strong
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The Mortgage Bankers Association (MBA) index of purchase activity measures application activity, not loans made. The Mortgage Bankers Association samples roughly 75% of all mortgage activity in the U.S., and its indices are key indicators for the real estate finance market and home builders alike. The purchase index is released weekly, along with the mortgage applications composite index.
Housing economists use the MBA applications data to forecast many economic variables, like existing home sales and new home sales. Originators use the data to benchmark their own activities. Mortgage REITs use the refinance data to forecast prepayment activity, which is a critical factor in mortgage-backed security returns. Homebuilders also use the purchase index to forecast existing and new home sales. The purchase index tends to lead home sales by four to six weeks.
The MBA Purchase Index fell 3% for the week ending June 28
The MBA Purchase Index fell by 3% last week, which is surprising given that the 30-year mortgage rate actually fell 12 basis points. One question that’s been in the minds of those in the real estate industry is how will the increase in rates affect homebuyers? Will it discourage them, or will it get them off the fence (given that now both prices and rates are going up)? So far, at least according to KB Home (KBH) and Lennar (LEN), the jump in rates is getting buyers off the fence.
Unlike the MBA Refinance Index, the MBA Purchase Index is driven by seasonal factors. The real estate cycle starts picking up in April, and the selling season peaks in the summer, lasting until late fall. This year, we haven’t seen much (if any) drop in the index, which bodes well for the summer selling season. The purchase index somewhat understates the true activity going on in the market, as professionals who are cash buyers have been responsible for a large chunk of the buying. The index won’t count their activity.
Ever since rates bottomed in late April, the MBA Purchase Index has remained relatively stable. This steadiness is largely because homebuyers tend to be less interest rate–sensitive than refinances, which are 100% interest rate–driven. Higher interest rates aren’t expected to make that big of a dent in purchase activity. Lennar, the big homebuilder, said it has yet to see any effects of the increase in interest rates on its second quarter earnings conference call.
Implications for homebuilders
Generally, earnings for homebuilders like Lennar (LEN), Toll Brothers (TOL), KB Homes (KBH), Standard Pacific (SPF), and Ryland (RYL) were very good. Each reported increases in revenues and earnings, and some of the West Coast–based homebuilders, like KB Homes (KBH), reported 50% to 80% increases in backlog. It’s important to remember that these numbers are coming from an extremely depressed base. Prior to the housing bust, we only rarely observed a housing starts number below 1 million—usually at the lowest point of a recession. In March, we rose above 1 million starts for the first time since 2008. During expansions, it isn’t unusual to see housing starts numbers above 2 million.
The homebuilder ETF (XHB) has been up smartly over the past 12 months, but we’re still very, very early in the housing recovery. This is because first-time homebuyers have been absent due to tough credit conditions and a difficult labor market. As those circumstances change, the market will release a lot of pent-up demand , which should drive homebuilder earnings for quite some time.