Housing Stocks Could Blow Over Soon for a Number of Reasons
Housing stocks overdone?

The outlook for the U.S housing market remains strong as continued job growth and wage increases have resulted in solid demand for homes.

Mortgage rates have not been affected since the Federal Reserve started increasing short-term interest rates in December 2015, keeping housing payments affordable for homeowners.

But some banks have expressed a bearish viewpoint on the stocks of homebuilders. Barclays cut ratings on homebuilder stocks Lennar (LEN) , PulteGroup (PHM) and TRI Pointe Group (TPH) to "equal-weight" from "overweight," while downgrading Toll Brothers (TOL) to "underweight" from "equal-weight."

"Our builder target prices are unchanged and show 7% average downside," Barclays wrote in a research report. "We view building product/distribution stocks as having a more attractive risk/reward."

The bank contends that expectations have run up ahead of themselves, and even though demand remains robust, decelerating indicators such as buyer traffic shows limited upside. Barclays offered some assurances for the industry, stating that the housing backdrop remains favorable with low inventory levels against encouraging household formations. But constraints such as land and labor pressures will prolong the sector's recovery.

Mizuho Securities analyst Haendel St. Juste downgraded both KB Home (KBH) and PulteGroup (PHM) to "underperform" from "neutral" based on concerns that full valuations will make it harder for the homebuilders to outperform, Barron's reported.

St. Juste put a $21 price target on KB Home despite "substantial improvement in gross margins." There's more optimism than there should be and lagging orders paired with a low community count mean limited upside, St. Juste wrote.

Pulte received a $22 price target, but the lack of expected margin growth and negative absorption rates suggest Pulte's current valuation is "unjustified," according to St. Juste.

St. Juste's two buy-rated stocks in the homebuilder sector are Lennar Corp and Toll Brothers Inc..

The key driver affecting the demand for homes is employment and with the addition of 200,000 new jobs every month, a "solid demand" of potential new home buyers is being created, said Torsten Slok, chief international economist for Deutsche Bank Securities.

"Housing demand should continue to be solid going forward," he said. "Despite the recent slowdown in some housing indicators, we still think the housing outlook is solid. If job growth begins to slow, then the first sector I would worry about would be housing."

The decline in affordability in some part of the U.S. has less of an impact than other economic factors, Slok said.

Since mortgage rates have been changed little since December 2015, the real risk factors which could hold back the sales of homes is the amount of available homes on the market and their affordability, said Greg McBride, chief financial analyst for Bankrate, the NewYork-based financial data company. 

"The shortage of inventory has kept prices on the rise, outpacing increases in household income, which further strain homebuyers and limit would-be buyers," he said. "I don't expect housing to stumble as long as we're seeing continued job growth, an increase in wages, and demand building from Millennials and the previously foreclosed re-entrants to the housing market."

The housing market is not demonstrating any signs of a slowdown, said Ralph McLaughlin, chief economist for Trulia, a San Francisco-based real estate company.

"In fact, recent data suggests otherwise as the pace of house price appreciation has quickened in four out of the five months we have data for in 2017," he said.

Even if mortgage rates were to rise in the future, they are not likely to affect homebuying nationally since the mortgage breakeven rate or "where the cost of buying would be the same as the cost of renting would have to be upwards of 8%," McLaughlin said.

"Rising mortgage rates might impact homebuying in a few select markets, such as New York, San Francisco and Honolulu, where the mortgage breakeven rate is only around 5% to 6%," he said. "The broader housing market is continuing to benefit from low unemployment and steady job growth."

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Editor's Pick: Originally published Jul. 11.

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