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Is the Tide Turning for Homebuilding ETFs?

Homebuilding stocks have been on a roller coaster ride in the past year, as the supply chain disruptions and higher rates have affected the demand and supply of homes. However, recent trends suggest a potential rebound amid a sparse housing market.

Some analysts believe that the pain is over for this sector, and that 2023 will be a strong year for homebuilders. Here are some reasons why homebuilding stocks could be a good investment in the coming months.

Against the above-mentioned backdrop, investors may tap housing ETFs like iShares U.S. Home Construction ETF ITB and SPDR S&P Homebuilders ETF XHB. Both ETFs added 8% and 5.1% past month, respectively.

Homebuilder Sentiment Enters Positive Territory

The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) reports a 5-point increase in builder confidence for newly built single-family homes in May, up to 50. This uptick, noted for the fifth consecutive month, brings the sentiment out of negative territory for the first time since July.

A dearth of existing homes for sale is propelling homebuilders into the limelight despite prevailing market challenges. NAHB Chairman Alicia Huey attributes this to new home construction playing a larger role in the market. Many homeowners, whose loans stand well below current mortgage rates, are choosing to hold onto their properties, resulting in a stark scarcity of existing homes for sale, as quoted on CNBC.

New homes listed for sale in March constituting 33% of the total, a significant rise from the 12.7% average recorded between 2000-2019. This trend, as NAHB’s chief economist Robert Dietz suggests, is likely to persist as potential buyers continue to scout for new construction due to limited available housing inventory, the CNBC article quoted.

Yet, this boon does not come without its challenges. Even though lumber prices have been dropping since March, builders are grappling with supply shortages in building materials and tightening credit conditions for residential real estate development and construction, a ripple effect of the recent banking crisis and increasing interest rates.

Despite these hurdles, the index's three components saw improvement. Current sales conditions and sales expectations for the next six months rose 5 and 7 points to 56 and 57 respectively, while buyer traffic saw a modest increase of 2 points to 33.

Slight Decline in Mortgage Rates

The mortgage rates may decline in the medium term as the Fed might act less-hawkish (or even pause in rate hike) ahead on cues of cooling inflation. Relatively lower interest rates make mortgages more affordable and boost the purchasing power of homebuyers. According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage was 6.35% as of May 11, 2023, down from a 52-week high of 7.08%.

Softening in New Home Price Inflation

Incentives offered by homebuilders, such as buying down mortgage rates, have also attracted buyers. However, as demand intensifies, these incentives seem to be waning. The percentage of builders reducing home prices fell from 30% in April to 27% in May.

Upbeat Long-Term Earnings Trend

The homebuilding industry has a projected an average earnings growth rate of 16.8% for the upcoming 3-5 years, compared to 10.7% for the S&P 500. Companies like D.R. Horton DHI, KB Home KBH and Lennar Corporation LEN reported impressive earnings this reporting season, defying the challenging housing market conditions.

Bottom Line

The housing market is still undersupplied, especially in the entry-level and affordable segments, where many homebuilders are focusing their efforts. This means that there is still strong demand for new homes, especially from first-time buyers and millennials.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

KB Home (KBH) : Free Stock Analysis Report

Lennar Corporation (LEN) : Free Stock Analysis Report

D.R. Horton, Inc. (DHI) : Free Stock Analysis Report

SPDR S&P Homebuilders ETF (XHB): ETF Research Reports

iShares U.S. Home Construction ETF (ITB): ETF Research Reports

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Zacks Investment Research