Analysts Not Worried About Rates For Builders

NEW YORK ( TheStreet) -- Homebuilder stocks have made many investors happy this past year with the homebuilder index delivering a 48% total return. However, that has changed since May 15 when the group began to slide, losing 10% in value over six weeks. The concern over rising rates has caused many to sell those positions over fears of slowing orders but these analysts seem to agree that the group has more life left in it.

Goldman Sachs ( GS) just initiated coverage on the group and splits its opinion. Analyst Eli Hackel thinks there will be modest upside (13%) to the homebuilder stocks over the next 12 months, but doesn't believe that all home builder stocks will rise equally. He advises buying builders that are exposed to markets with the best growth potential, which seems like good common sense. He also suggests buying the higher end because these people will have better access to getting mortgages and selling the lower end of the market. Those buyers will have more difficulty in obtaining a mortgage in this new tightened environment. Hackel does not believe rising rates will slow down the housing rally.

Jay McCanless of Stern Agee mentions higher interest rates in his recent research, but he too believes it won't hurt the overall trend. He thinks the negative psychological effect of rising rates will pull down homebuilder stocks temporarily and he sees this as a buying opportunity. However, the two analysts disagree on which homebuilder stocks are buys. McCanless' top picks include D.R. Horton ( DHI), Meritage Homes ( MTH), Pulte Group ( PHM), and Ryland Homes ( RYL). He also has buy ratings on the newly public Taylor Morrison ( TMHC)and NVR ( NVR).

Hackel's top picks also include Meritage, but he likes Ryland and Toll Brothers ( TOL). Unlike McCanless, he thinks Pulte is a sell along with Hovnanian ( HOV). Hackel believes that first-time homebuyers have too much risk associated with them and suggests there could potentially be regulatory changes to first-time buyers. College graduates making more than $120,000 tend to be common purchasers of high end homes, look less likely to be unemployed, and are more likely to buy a home like a Toll Brothers home.

Meritage Homes seems to be the analysts' favorite. Michael Rehaut of J.P.Morgan gives the stock an overweight rating as well, along with Ryland, KB Homes ( KBH), Beazer ( BZH), Taylor Morrison and M/I Homes ( MHO). Rehaut thinks there is still upside potential in the builders and believes the housing industry fundamentals will continue to improve over the next 18 months. He is aware of the pullback in builder stocks when rates rise and noted that this has happened six times since 1987. However, the group strongly rebounds after the rising rate period. It is this rebound that causes Rehaut to be positive. In addition, he points to the supply and demand picture, which Hackel also wrote about.

Both analysts say that the U.S. market needs over 900,000 new homes a year. Approximately 300,000 are demolished each year and the current level of new housing starts is below 30-year averages. Builders have been reluctant to build due to the number of distressed homes in the market. Why buy a new home when you can get a bargain-priced used one? The number of distressed homes has declined 15% in 2012 and that is helping to create the current shortage. Typical demand for U.S. households is about 850,000 a year, so you can see the shortage of new homes in the market.

Another positive point is that order rates are rising and the builders don't book these transactions until the homes are actually closed. Ryland has a 45% order growth outlook for 2013 and Meritage's outlook is for 28% order growth. The more solid homebuilders were also able to take advantage of the crisis to do land grabs and pick up land at fire sale prices. If the Obama administration begins to push the banks to give more mortgages, then the homebuilders will continue to benefit. It seems the only thing that could hold the builders back now is how tight the banks remain on those strict mortgage requirements.

--Written by Debra Borchardt in New York.

>To contact the writer of this article, click here: Debra Borchardt.
Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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