builders catering to entry-level buyers have the potential to make gains in the current stage of housing recovery.
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A return in seasonality to the housing sector, strong demand trends, and low resale inventory have benefited the performance of home builders through the first half of 2023.

Public builders have consistently outperformed analyst expectations for both revenue figures and profits per share, and executives during earnings calls have expressed optimism in the short-term future for the newly built single-family sector.

The optimism is a stark contrast to the sentiment at the end of 2022, when higher mortgage rates, low existing- and new-home sales, and declining single-family starts brought talk of a recession and clouded the sector with uncertainty heading into the new year.

According to Bill Smead, chief investment officer for Smead Capital Management, fear of a repeat of the Great Financial Crisis led many analysts to underestimate the strength of the housing sector and provide bearish projections for the sector.

However, due to strong market fundamentals, measured approaches from builders, and a resurgence of demand, the sector has performed very well in the first half of 2023. Single-family starts have trended positive since January—increasing by 1.6% month over month in April—as stronger new-home sales have encouraged builders to meet demand by building more homes.

“With the Fed tightening credit, [many] automatically assumed this was going to be a total disaster, the next 2006, the next total Waterloo for the industry,” says Smead. “That led to microscopic price-to-earnings ratios nine months ago. It laid the groundwork for [builders] to perform better this year once people realized how incredibly profitable this business is even when things go against them.”

Strong performance has helped the S&P Homebuilders Select Industry Index rise over 17.5% year to date, outperforming the S&P 500’s 12% return during the same period. Several individual home builder stocks, including the nine largest public companies on the 2023 BUILDER 100 list (D.R. Horton, Lennar, PulteGroup, NVR, Meritage Homes, KB Home, Taylor Morrison, Century Communities, and Toll Brothers), have year-to-date stock returns greater than 20%.

Data tracked by Zonda has shown the rebound of new-home sales after declines ending 2022. After decreasing 5.8% month over month on a nonseasonally adjusted basis in January, new-home sales increased 2.2% in February, 1% in March, and 5.4% in April, according to Zonda’s New Home Market Update.

“Spring selling season—March, April, May—of 2023 has turned out to be healthy for the home building sector. The demand conditions have improved sequentially in the first quarter of 2023 compared to the fourth quarter of 2022,” says Natalia Gluschuk, vice president and senior credit officer at Moody’s Investors Service. “On a year-over-year basis, however, the declines in demand have continued, but at a narrowing rate compared to the previous quarters.”

In addition to the strong spring selling, builders are benefiting from new-home sales taking market share from the existing-home market. Many buyers who purchased homes with interest rates around 3% are reluctant to give up their low rates, contracting existing home supply.

Builders found success in the early months of 2023 offering price cuts and incentives to bring prospective buyers off the sidelines. Recently, many public builders have reported a pullback in incentives and even price increases in several regions after successfully finding the market.

According to data from Zonda and the NAHB, new-home sales account for roughly 30% of the housing market, when historically newly built single-family homes have had a market share between 10% to 15%.

Smead says the cooling of lumber prices also has driven down building costs, another positive for the sector.

A tailwind cited by many home builders that is likely to promote housing demand moving forward is the demographics of the U.S. Smead says there are an estimated 92 million millennials, primarily between the 27- to 42-year-old bracket, who are beginning to get married, have children, and become homeowners.

The demographic shift is being experienced by builders in real time: Tri Pointe Homes reported 59% of buyers in the first quarter that used the builder’s mortgage company were millennials, and an additional 9% were Gen Z.

Moving forward, Smead says inflation and whether the economy falls into a recession will be two factors to watch that could impact the performance of the housing sector for the duration of the year.

Gluschuk says it will be important to observe demand trends following spring selling season, the behavior of mortgage rates, home price trends, and the unemployment rate.

“Historically, housing has led the economy out of recessions. If we go into recession, that would likely lead to the 30-year mortgage rate coming down quite a bit and would lay the groundwork for housing to lead us out of the recession,” Smead says. “If we don’t have a recession, the problem is going to be inflation.”

Gluschuk says Moody’s forecast for the remainder of 2023 projects a “meaningful drop” in single-family starts toward 0.8 million units and new-home sales to fall to 513,000 units, a level comparable to activity during 2015 to 2016. Moody’s projects prices will fall between 10% and 15% and, as a result, the rated home builder group’s revenue will decline 20% to 25% compared with 2022.

“Our forecast from early in the year, which took into consideration the normalization of sector trends, remains intact,” Gluschuk says. “Following a reset year of 2023, we expect stabilization of sector conditions in 2024. We expect a 2% rise in new single-family home starts in 2024, and a 2% increase in new single-family home sales. We project new-home prices will continue to weaken in 2024 and decline 3% to 5%. Home building revenue in 2024 is likely to remain generally in line with 2023 levels.”