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2 Homebuilding Stocks Bolstered by Housing Market
Stock Analysis & Ideas

2 Homebuilding Stocks Bolstered by Housing Market

As disruptive as the COVID-19 pandemic was to the economy, it was a boon for a few industries. The stay-at-home orders made everything-from-home a new norm, making it necessary for families and individuals to have more space at home. This helped the real estate and related sectors.

This boom was further fueled by the drop in mortgage interest rates, and inevitably led to a consistent price rise. According to mortgage loan company Freddie Mac, the rates fell sharply to 2.68% in December 2020.

However, the economy has come a long way since then and is now slowly getting back to the pre-pandemic situation. Mortgage rates are back up at their highest since 2011, at 5%.

Struggles in the Homebulding Space

That was the demand-side discussion. When it comes to looking at the supply side, homebuilding has been juggling a lot of balls throughout the pandemic. U.S. homebuilders have been scrambling to navigate supply chain constraints, sky-high prices of harvested wood or lumber, and considerable labor shortages.

The U.S. housing market has managed to get so hot that homebuilders have been struggling to keep up with the demand. Lack of inventory has been impeding the efficient growth of the housing market.

Nonetheless, things started to look up when the government Census data revealed that there was a 6.8% growth in new constructions in February as compared to January, 22% higher year-over-year. This was significant because this marked the fastest growth in new home constructions in 16 years, bringing some relief for homebuyers facing the issue of spiraling home prices and limited inventory.

This brings us to the question of whether this spike in new constructions could effectively bring down prices and boost sales further.

Housing Bubble in the Making?

In March, sales of existing homes declined 2.7% sequentially, and 4.5% year-over-year, according to the National Association of Realtors, which expects a 10% year-over-year decline in 2022.

This highlights the fact that home sales are returning to pre-pandemic levels, and the growth in new constructions is yet to make a mark in bringing the supply-demand balance.

The data was revealed mid-April, a month after Lennar (NYSE: LEN), one of the U.S.’s largest public home builders, upped its guidance for the full year, prompted by strong revenues in its first-quarter report.

The company was upbeat that the momentum in the housing market will continue despite supply issues, high building costs, and rising mortgage interest rates affecting home affordability.

Prices and Demand Both on the Rise

So, why is the housing market expected to be hot when mortgage prices are on the rise, and supply constraints are likely to remain for some more time?

A big chunk of millennials are starting or expanding their families, growing their careers, and looking to own homes to accommodate their changing lifestyle.

“The millennials are in their family formation years. Their families are growing and they need more space. They need a good school district. Those are reasons that people typically buy a new home,” observed Wedbush analyst Jay McCanless.

These reasons are expected to keep the demand high. Homebuilding costs should further fuel higher prices, because of the supply constraints, even though there is an improvement in new home constructions.

In this regard, we can safely say that the outlook for the construction companies as well as homebuilding materials providers seems to be bright this year.

Here are two stocks that are poised to make the most of the high-demand period.

Builders Firstsource

Builders Firstsource (NYSE: BLDR) manufactures and supplies building materials, and provides construction services to real estate agencies, sub-contractors, and individual consumers.

In its last reported quarter, Builders FirstSource’s earnings per share surged 116% year-over-year, the fourth consecutive quarter with a triple-digit growth rate.

Following its hard-to-beat earnings report, Truist analyst Keith Hughes reiterated a Buy rating on the stock and raised his price target to $90 from $76.

“Future estimates will remain volatile given rapid changes in lumber prices, but near-term trends in housing remain very good,” opined Hughes.

The stock enjoys a Strong Buy consensus rating, based on seven Buys and one Hold. The average BLDR price target is $96.

Lennar

Lennar deals in construction as well as real estate-related financial management services. Its optimism about its prospects in the coming months, as discussed earlier, is quite upbeat.

Earlier this month, JPMorgan analyst Michael Rehaut reiterated a Buy rating on the stock, but lowered the price target to $89 from $108.

The analyst does not think that any “material or sustained rebound” in the homebuilding stocks is likely to be discussed this earnings season.

Moreover, his price target slash is solely based on investor concerns for the broader housing market, which will inevitably have a trickle-down effect on Lennar’s stock prices. Otherwise, the analyst remains optimistic about Lennar’s fundamentals.

Wall Street altogether has a Moderate Buy rating on the stock, based on six Buys, five Holds, and one Sell. The average LEN price target stands at $104.50.

Parting Thoughts

All in all, we are looking at an interesting phase in the real estate market, especially the homebuilding area.

New constructions still have a long way to go before they can catch up with the soaring demand. This is for two broad reasons; new construction takes time to complete, and building permits continue to be very slow, having dropped 1.9% sequentially in February, per Census.

Moreover, mortgage-rate hikes will take time to impact demand. Supply shortages are here to stay for at least a few more months, which will impact building costs, putting a limit on inventory.

The hope is that consistently high demand, notwithstanding soaring prices and higher mortgage rates, will help pull up inventories. This will have a major hand in bringing the prices down.

Until then, some stocks are expected to take full advantage of the situation, giving investors an opportunity to cash in.

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