Must-know update: The new home sales crater in March

Part 2
Must-know update: The new home sales crater in March (Part 2 of 3)

Why have the gross margins probably peaked for the homebuilders?

Affordability has been falling

The homebuilders like PulteGroup (PHM), D.R. Horton (DHI), Lennar (LEN), and Toll Brothers (TOL) may have finally raised the prices too much. Average selling prices for all the builders have been increasing. This has allowed the builders to report tremendous gross margins over the past year as prices have risen and costs have remained contained. On the other hand, mortgage rates have increased over the past year by about 75 basis points. This has made homes less affordable as well, and it appears that the double whammy of increased prices and increased rates probably means that the builders have pushed the price increases about as far as they can.

Mortgage RatesEnlarge Graph

Signalling weaker earnings ahead?

Homebuilders like Lennar (LEN) and KB Home (KBH) reported decent first quarter earnings, however they are on November fiscal years, and the March numbers will be in their 2Q reports. NVR recently reported and their numbers missed Street expectations. Does this mean the rest of the builders like D.R. Horton (DHI) and PulteGroup (PHM) will miss their quarters as well? These numbers do not bode well.

Gross margins have probably peaked

Even though the builders reported big increases in average selling prices, most have reported that traffic is down. NVR reported basically flat orders, and it is in the Washington, D.C. area, which is a hot market. What this report signifies is that gross margins have probably peaked for the builders and they will have to get promotional (a euphemism for offering discounts) in order to move inventory.

Second, nearly every builder has mentioned that skilled labor is hard to come by, and wages are rising. Between increasing costs and lower selling prices, we can probably say that gross margins have peaked, maybe for this cycle. That doesn’t necessarily mean earnings will fall, but what it does mean is that the builders will have to increase volume to grow the top line, not just raise prices.

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