Link’s Favorite Long-Term Themes: Housing

Last week we learned that the Fed is likely to cut interest rates in September. As of August 26, markets are estimating a 70% chance for a 25bp cut and a 30% chance of a 50bp cut. Regardless, the coming path for rates is lower, ultimately supportive for cyclical segments of the economy. Fixed Income markets have started the easing cycle for the Fed, with the 10-year Treasury yield 90bps lower than its 2024 high of 4.70%, and the 2-year Treasury yield over 100bps lower than its 2024 high of just over 5%. As a result, this has aided mortgage rates lower.

The current 30-year fixed mortgage rate of 6.50% is the lowest in 15 months, and well below the peak of 7.80% in October 2023. Monthly mortgage payments have followed the decline in mortgage rates – U.S. monthly mortgage payments recently declined for the first time in four years.^[1] Coming interest rate cuts will benefit those looking to enter the housing market and improve dynamics.

Chart 1: New Home Sales Rise as Mortgage Rates Fall^[2]

We have spoken about housing being one of our favorite themes in 2024, which is ever more true with pending interest rate cuts. As rates have declined over recent months, housing activity has started to pick up, and it seems that some are looking to get ahead of declines in rates. New home sales in July came in at 739K, growing 10.6% m/m and coming just short of the best number since early 2022. Existing home sales also rose, 1.3% m/m, ending four straight months of declining sales.

Home prices continue to rise amid high demand and low levels of supply. With record-low mortgage rates in 2020 and 2021, many Americans received 2-3% borrowing rates and are essentially “locked in” to their mortgages. As of June, 91% of U.S. mortgaged homeowners have a rate below 6%, 82% have a rate below 5%, and 62% have a rate below 4%. Not to mention, nearly one in every four mortgaged homeowners has a rate below 3%.^[3] To see real movement in the housing market, mortgage rates will need to fall below 6%, and possibly even 5%. On the bright side, housing inventory has improved every month thus far this year. Total housing inventory in July was up 19.8% y/y.^[4]

Home affordability has also been a large concern for Americans looking to become homeowners. Existing home prices have risen for 13 straight months and were 4.2% higher in July than the previous year. To qualify for a median-priced existing home, a household income of $110,000 is needed – almost double the needed income of just $59,000 for the same home three years ago.^[5] Home prices hit a record high in June at an average sales price of $426,900^[6], and now nearly 10% of all U.S. homes are worth north of $1,000,000.^[7] Rising home prices, a strong economy, and healthy consumer are all impacting home prices and keeping demand well-anchored even with near 7% mortgage rates.

Chart 2: Nearly 10% of all U.S. Homes are Worth Over $1 Million^[8]

How We Are Exposed to This Theme

The U.S. is over five million homes short, and housing has been underproduced and underdeveloped for much of the past 14 years. We believe lower interest rates will greatly improve the housing market, improving supply/demand dynamics, and enticement movement across the country. The number one way we are positioned for improving development is through D.R. Horton (DHI). DHI is focused on construction in the Sunbelt region and has a skew toward first-time home buyers. The company delivered 2,814 homes in the previous quarter, up 11.5% y/y, and raised its full-year deliveries guidance by 100 homes to a projected 10,650-10,750. Management noted that average construction times are back to normal and improved in the second quarter. Lower mortgage rates, and thus an improved supply/demand dynamic will benefit the company.

Builders FirstSource (BLDR) is the largest U.S. supplier of building products and is the second way we are positioned for an improved housing market. The company is a technology-focused manufacturer and offers exposure to the housing sector outside of traditional home builders. Management noted that lower home affordability has affected its financials and smaller and cheaper housing starts are impacting its dollar sales per start, despite strong operating performance. BLDR has a diversified revenue stream: 28% manufactured products, 25% windows, doors, and millwork, 24% lumber and lumber goods, and 23% specialty products and services. Its CEO, David Rush, commented on the company’s outlook, stating, “While near-term market dynamics are challenging as starts have lost momentum, we remain focused on executing our strategy in the weeks and months ahead, and we are well positioned for growth as long-term housing tailwinds remain intact.”

A few other names we own with housing exposure include Home Depot (HD), Lowe’s (LOW), and Sherwin Williams (SHW). HD has struggled as consumers have limited big-ticket spending and do-it-yourself (DIY)/home improvement projects have slowed since Covid-19. Its acquisition of SRS Distribution earlier this year has provided strong tailwinds for the company, improving HD’s gross margins by 35bps last quarter and estimated to contribute $6.4 billion to revenues this year. HD maintains a ~17% market share in the $1 trillion home improvement market and will be a beneficiary of lower borrowing costs.

LOW has experienced many of the same hardships as HD. Big-ticket items have been avoided and DIY projects have slowed. In its second-quarter earnings call, the company said it is focused on improving the online experience and its pro segment. LOW increased its dividend by 5% and discussed new innovative partnerships with Apple, Nvidia, OpenAI, and others to help customers design their dream kitchen through the help of artificial intelligence. Its management team stated, “We are hopeful that lower rates are going to have a dual impact of, one, relieving pressure on consumers, and then secondly, driving existing home sales activity.” As the housing market looks to bottom, LOW should benefit from a rebound in housing-related activity.

SHW holds a nearly 70% market share in the paint store industry and maintains exposure to the housing sector. The team discussed slowing DIY projects, which HD and LOW have experienced as well, but CEO Heidi Petz mentioned on its earnings call that new residential returned to growth in the second quarter, and they are seeing improving single-family starts turn to completions, a positive for the company. New home sales surprising to the upside in July is hopefully the beginning to a new trend in housing.

Chart 3: June CPI Report Was a Turning Point for Housing-Related Stocks^[9]

Looking Ahead

In summary, declining mortgage rates and more balanced supply/demand dynamics in the housing market will lead to improvements for companies exposed to housing. Markets are projecting interest rates to decline by 200bps by the middle of next summer which would be a benefit for lower mortgage rates. Housing has been underdeveloped for over ten years in the U.S., and with millions of Americans looking to become first-time home buyers, a crack below 6% will entice many to enter the market.

Stephanie Link’s TV Schedule:

Sources

^[1] Source: Redfin. As of August 22, 2024.

^[2] Source: FactSet. As of August 26, 2024.

^[3] Source: Redfin. As of June 14, 2024.

^[4] Source: CNN. As of August 25, 2024.

^[5] Source: CNN. As of August 25, 2024.

^[6] Source: CBS. As of July 23, 2024.

^[7] Source: Redfin. As of August 16, 2024.

^[8] Source: Redfin. As of August 16, 2024.

^[9] Source: FactSet. As of August 27, 2024.

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