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Homebuilder Sentiment Is Approaching Post-Bust Highs

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Homebuilder sentiment

The National Association of Homebuilders Sentiment Index (XHB) measures homebuilders’ confidence. It gauges how builders view current and future sales of single-family residences. It asks builders to characterize the sales as “good,” “fair,” or “poor.”

It also asks the builders to rate the prospective buyers’ traffic 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 in late 2005. It bottomed at eight in early 2009. While the index has been increasing steadily in the years since it bottomed, it has started to accelerate.

NAHB Housing Market Index

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Homebuilder sentiment rebounds

The index came in at 58—an increase from 54 in October. Builder sentiment peaked last summer. It had fallen to the mid-40s over the winter and through the spring. However, sentiment has picked up and is approaching post-bust highs

Right now, builders are in a good position because inventory is tight. Builders are able to increase margins. Nearly every builder reported higher gross margins. Revenue is driven by increasing prices.

Most market watchers expect home prices to moderate next year. However, that would require extra supply. In the northeast, that may be possible because the foreclosure pipeline is still full. In the red-hot West Coast markets, builders are still cautious about overbuilding.

A shortage of skilled labor has been a problem for the homebuilding and mortgage industries. Since the bubble burst, employment in these sectors dropped so dramatically that many skilled workers found jobs in other economic sectors. Skilled construction workers were absorbed by the energy sector and the trucking industry.

Implications for homebuilders

Shortages of construction materials, lots, and skilled labor may mean that gross margins for the builders like Lennar (LEN), D.R. Horton (DHI), PulteGroup (PHM), and Toll Brothers (TOL) have peaked. Most builders reported record or close-to-record gross margins. Prices have increased faster than input costs. Those days might be over.

Volumes should increase as the economy recovers and more pent-up demand is released. At some point, demographics will take over. Housing starts have been low for so long that there’s pent-up demand that will unleash as the economy improves.

Investors who are interested in investing in the homebuilding sector should look at the S&P SPDR Homebuilder ETF (XHB).

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