Purchase applications fall despite a bond rally, hurting builders



The MBA Purchase Index falls 2.8% for the week ending May 16

The MBA Purchase Index decreased 2.8% last week despite a strong bond market rally. More and more builders are noticing a drop in traffic, and the previously unaffected Lennar (LEN) and KB Home (KBH) recently disclosed drops in traffic during their first quarter earnings conference calls. Last quarter, PulteGroup (PHM) did note that the first-time homebuyer was pulling back due to higher rates. D.R. Horton (DHI) saw the same thing. Pulte and D.R. Horton are more geographically diversified than KB Home or Lennar, and they focus more on the first-time homebuyer.

MBA Purchase Index

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Unlike the MBA Refinance Index, the MBA Purchase Index is driven by seasonal factors. 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. The real estate cycle starts picking up in late winter, and the selling season peaks in the summer, lasting until late fall. We’re exiting the seasonally slow period. For mortgage bankers, this could be a tough season, as they won’t have refinance activity to fall back on. Indeed, many of the big mortgage bankers have announced job cuts in their mortgage units.

Ever since rates bottomed last year, the MBA Purchase Index has declined much less than the refinance index. 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 impact purchase activity the way they affect refinance activity. Despite the rise in rates, housing remains highly affordable.

Implications for homebuilders

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We’re wrapping up earnings season for the builders, and so far, most have reported good earnings. Average selling prices are rising, but volumes are decreasing. That said, there’s still restricted supply. While housing is rebounding, 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 November, the number rose above 1 million starts for the second time since 2008. The spring selling season is underway, and we hope to get more color on how things look when the builders start reporting in a few weeks.

Homebuilders like Lennar (LEN), D.R. Horton (DHI), Toll Brothers (TOL), PulteGroup (PHM), and Standard Pacific (SPF) have leveled off, but we’re still very early in the housing recovery. This is because the 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. Investors interested in trading the builders as a sector should take a look at the S&P SPDR Homebuilder ETF (XHB).


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