The effects of the pandemic on the global supply chain and industrial manufacturing have been widespread. Manufacturing bottlenecks became all too common, leading to supply shortages, which drove prices of goods higher. The housing market was acutely affected by labor and material shortages. Together, tight housing supply and building materials inflation caused a run-up in home prices. Prior to the pandemic, inventories within the market remained low and, according to a Freddie Mac article in February 2020, the U.S. suffered from a severe housing shortage.
The pandemic created a perfect storm within the housing market, as homebuilders noticed the strong demand for new homes and worked to satisfy it. In an effort to pass on the higher costs of building materials, new home prices increased rapidly. Additionally, the trend shift to working from home supplemented the already-robust demand for houses, while mortgage rates continued their steady decline throughout the second half of 2020.
Fast forward to 2022, supply-and-demand dynamics continue to drive home prices even higher. Supply constraints, including labor availability and extended lead times for materials, have made it difficult for homebuilders to keep pace with record demand. This week’s chart examines the performance of homebuilders over the last few years, as mortgage rates steadily declined through the end of 2020 but have since risen beyond pre-pandemic levels early in 2022. Included in this week’s chart are the S&P Homebuilders Select Index, which seeks to track the underlying performance of the homebuilders sector, and the U.S. 30-year fixed mortgage rate average.
Prior to the pandemic, the U.S. was facing a supply-and-demand imbalance within the housing market. There simply was too much demand for too few homes. Mortgage rates fell dramatically in the first half of 2020, after initially spiking above 4.00% during the first quarter. According to a Freddie Mac report in November 2020, “weaker consumer spending data … drove mortgage rates to a new record low.” This proved to be a strong growth catalyst for homebuilders as lower mortgage rates spurred demand for new homes. Many saw near-record levels of revenue. You would have to look back prior to the 2008-2009 financial crisis to see stronger earnings.
Mortgage originations and housing starts accelerated during 2020. U.S. home prices, tracked by the Case-Shiller Index, followed suit and prices exceeded levels recorded during the peak of the housing bubble in 2006. As a result, homebuilders thrived. From the start of 2020 through the end of 2021, the S&P Homebuilders Select Index gained roughly 92%, more than double its performance in the five previous years.
However, 2022 has been a different story for the broad sector. The S&P Homebuilders and the S&P Home Furnishings subsectors are the worst performing sectors year-to-date. At the same time, mortgage rates have risen dramatically. The rise in rates, coupled with ongoing material shortages and workforce absenteeism, has dented the outlook for new home construction. Moreover, an increase in the 30-year fixed mortgage rate will crimp demand for refis and new mortgages, as higher rates mean higher payments.
Homebuilders continue to maintain pricing power, although some are expected to struggle with higher costs associated with supplies and labor. Many companies are hiking prices for new homes in an effort to offset their realized cost inflation. Improvements in the global supply chain during the second half of 2021 have reversed course, with homebuilders highlighting the disruptions that continue to affect material availability. In theory, the growing supply of new homes in the U.S. should temper pricing, although many of the new homes are being pricing well above average market values. For most of the major contractors in the sector, the average selling prices for their new homes continue to climb.
The effects of dramatically higher mortgage rates have yet to be fully realized. The housing market remains red-hot and although performance has considerably lagged for the homebuilders’ stocks, they continue to provide guidance for growing orders and inventories. It remains to be seen, but I believe the rise in mortgage rates may soon stifle demand within the market and residential builders will be faced with repricing much of their new home inventory.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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