uploads///MR NAHB

Homebuilders note momentum pause as buyers digest rate increases

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Nov. 20 2020, Updated 2:53 p.m. ET

The National Association of Homebuilder Sentiment Index is a closely watched measure of future building activity

The National Association of Homebuilders (NAHB) Sentiment Index measures homebuilders’ confidence. It gauges builder perceptions of current and future sales of single-family residences and asks builders to characterize the sales as “good,” “fair,” or “poor.”  It also asks the builders to rate the traffic of prospective buyers as “high to very high,” “average,” or “low to very low.”

An index level of 50 is considered neutral. The index peaked at 71 during the height of the housing bubble—late 2005—and bottomed at eight in early 2009. While the index has been steadily rising in the years since it bottomed, it has begun to accelerate.

Homebuilder sentiment the highest since the height of the bubble years

The index came in at 58—the highest reading since July 2005, and only the third time since the bust that more homebuilders considered conditions to be more “good” than “poor.”

Given the strength of first quarter earnings, this report isn’t a surprise. Lennar (LEN), KB Home (KBH), Toll Brothers (TOL), Ryland (RYL), and Meritage (MTH) all reported strong earnings. The NAHB is forecasting a 29% increase in housing starts this year.

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NAHB Chief Economist David Crowe noted that momentum has shifted: “Following a solid run-up in builder confidence over the past year, we are seeing a pause in the momentum as consumers wait to see where interest rates settle and as the headwinds of tight credit, shrinking supplies of lots for development and increasing labor costs continue.”

Increasing labor costs have been a theme for the builders, as skilled construction workers found new careers after the bubble burst. Many ended up in the energy and trucking industries. The tight credit continues to be a vexing issue for consumers, builders, and the government. The U.S. taxpayer bears the credit risk of 90% of all newly originated mortgages and backstops 50% of the current mortgage market. The private label market is still only a shadow of its former self. While the new QM rules out of the CFPB were intended to increase credit availability, they seem to be having the opposite effect.

Implications for homebuilders

The homebuilders like Lennar (LEN) and Meritage (MTH) are in a better position than the smallest construction firms in that they have easy access to credit. In contrast to homebuyers, the bigger homebuilders have exceptionally easy access to credit. Last Fall, Toll Brothers (TOL) priced a senior convertible bond offering amazing terms—a 50 basis point coupon, a conversion premium of 50%, and a 20-year maturity. Those terms were unheard of—even in the go-go credit days of the housing bubble, no one was issuing 20-year paper with a negligible coupon at a 50% conversion premium. Old-timers on convertible bond desks were shaking their heads at that one.

In spite of the sentiment index, some builders reported that the increase in interest rates has had a negative effect on orders. PulteGroup (PHM) and Beazer (BZH)—both geographically diversified builders with a focus on the first-time homebuyer—reported decreased traffic.

The increase in consumer sentiment is starting to drive more business for homebuilders. Housing starts have been so low for so long that there’s some real pent-up demand that will unleash as the economy improves. The Homebuilder ETF (XHB) rallied on the news. As the job market improves, the first-time homebuyer should re-appear, which would create a wind at homebuilders’ backs.

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