In the second half of 2022, homebuilders across the country were scrambling as spiked mortgage rates caused buyer cancellation rates to soar. In response, many builders quickly ramped up their incentives, including offering “mortgage rate buydowns.” While builders in fast-correcting markets like Reno and Austin had to go much further, and slashed new community home prices by 10%, 15%, or in some cases even 20%.
Those incentives and price markdowns are working now: New home sales on the rise again, and builder cancellation rates normalized this spring.
“Rate buy-downs turned reluctant borrowers to enthusiastic buyers… The post-pandemic homebuilding environment is not the post-apocalyptic wasteland that many were predicting last fall,” wrote Deutsche Bank researchers in a report published last week.
There’s a growing optimism on Wall Street that incentives, like mortgage rate buydowns, will give homebuilders a housing market edge in not just 2023, but also as long as mortgage rates stay elevated. Not to mention, builders are facing limited competition as existing home supply remains tight amid the so-called “lock-in effect.” After all, if homeowners sold and bought something new, they’d be trading in their 2% or 3% mortgage rate for a 6% or 7% handle.
Simply put: Firms like Deutsche Bank think the housing market’s next move is one where new construction is busy, while the existing/resale market remains constrained.
That builder enthusiasm has translated into a rush among investors to buy homebuilder stocks, including a 55.9% year-to-date jump in the share price of PulteGroup. It’s followed by Toll Brothers (up 46.9% this year), D.R. Horton (+25.7%), and Lennar (+24.2%).
During the Pandemic Housing Boom—a period of seemingly unlimited housing demand—builders including KB Home, PulteGroup, and NVR achieved huge profit margins as they swiftly jacked up prices. Those fat profit margins gave builders the breathing room to reduce margins (i.e., cutting prices and/or aggressive rate buydowns) in pursuit of “finding the market.” According to Deutsche Bank, many builders are offering mortgage rates in the 5.0% to 5.5% as they pay lenders for so-called “mortgage rate buydowns.”
In the eyes of Deutsche Bank, there’s still more room for homebuilder stocks to run as the U.S. housing market remains “under-built.”
“We [have] quickly turned from being cautiously optimistic to decisively bullish on new residential construction,” wrote Deutsche Bank researchers in their latest builder report. “We expect solid demand for new housing to accompany a continuing normalization of margins and returns, and as book values grow, the stocks should generally move higher, but we see opportunity for stock selection.”
In the report, Deutsche Bank researchers outlined their “target price” outlooks for a few homebuilders. See below.
D.R. Horton – DHI: $150 target price from Deutsche Bank (trading at $114.01 as of Friday close)
Meritage – MTH: $200 target price from Deutsche Bank (trading at $129.67 as of Friday close)
Pulte – PHM: $95 target price from Deutsche Bank (trading at $71.99 as of Friday close)
Tri Pointe – TPH: $42 target price from Deutsche Bank (trading at $32.38 as of Friday close)
Toll Brothers – TOL: $94 target price from Deutsche Bank (trading at $74.29 as of Friday close)
Taylor Morrison – TMHC: $50 target price from Deutsche Bank (trading at $46.70 as of Friday close)
KB Home – KB: $49 target price from Deutsche Bank (trading at $48.74 as of Friday close)
NVR, Inc. – NVR: $4,400 target price from Deutsche Bank (trading at $5,818 as of Friday close)
Lennar – LEN: $105 target price from Deutsche Bank (trading at $114 as of Friday close)
This story was originally featured on Fortune.com
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