Why Did Builders Feel Better in February?
Greetings! Thanks for reading The Sunday Morning Post. Thanks to everyone who read and responded to last week’s article about Silicon Valley Bank. I’m developing some more thoughts on the topic, but I’ve been in Florida this week on vacation with my family so stay tuned for more in future articles. Have a great week, everybody!
A key statistic that tracks homebuilder sentiment ticked up in February for the second straight month. This was the first two-month streak of improving sentiment since 2021. February’s reading was also the highest mark since September. Why are homebuilders feeling more positive? And will it last? Let’s dig into the data.
Factor #1: New Home Construction on the Rise
First and foremost, builders are feeling better because things are being built. New housing starts ticked up in February to 1.45 million homes, beating analyst estimates that only 1.31 million new homes would be newly under construction. That is a pretty sizable beat, and it was good for a 9.8% month-over-month increase in new construction according to the U.S. Census Bureau and HUD.
One layer down in the data shows that this jump in activity is being fueled by the construction of multiunit rental units while single-family home construction remains relatively flat: single-family home starts were up 1.1% to 830,000 on a seasonally-adjusted basis, but multifamily construction was up a whopping 24.1% to a total of approximately 608,000 units. So even though single-family construction still makes up a larger portion of all new housing starts, the growth in housing starts is mostly coming on the multifamily side of things.
This matches what I have seen over the past couple of years with a lot of builders I work with — they have been transiting from the construction of single-family homes for sale to the construction of rental units either to sell or to retain as a source of long-term income for themselves. A lot of homebuilders who remember the lessons of the 2008 housing crash have been trying to diversify their revenue lines into rental properties instead of relying on just on sales.
Factor #2: Interest Rates Remain High, but Eased Down
After peaking above 7.00% in the fall, the average 30-year fixed mortgage rate dropped back to the low 6’s in early February (it has since increased back to 7.00% but then declined back to 6.60% by the end this past week). Supply chain issues finally settling out may also be providing some optimism to homebuilders, but interest rates are a real driver of activity as both homebuyers (for their mortgage on the property) and homebuilders (for the financing of construction itself) are both pretty interest-rate sensitive. High rates in the fall and the early part of the winter had a significantly chilling effect on the market, but as rates have eased it has provided some hope that rates may have crested. Note: may have. A slight easing down of rates, I believe, is one of the reasons homebuilders were feeling more optimistic in the February survey.
The problem of high rates, however, leads to another variable particularly unique to this moment in time that provides some positive tailwinds to homebuilder activity: the problem of low inventory and what I have written about before, so-called Golden Handcuffs…
Factor #3: Low Inventory
With rising wages, a tight labor market, and strong consumer spending, the economy is relatively strong despite fears about inflation and other factors out there right now. In an economy like this, there are going to be qualified buyers, and many of them remain frustrated at a striking lack of available inventory. There are just not many homes on the market. Why? Well, we are still recovering from a period of under-building in the early 2010s following the Great Recession, but I believe a major variable is that current homeowners are simply staying put. Why move and give up a 3.00% interest rate (or better; or no mortgage at all) to buy into a market with higher prices and a much higher interest rate? The financial benefits of simply staying where you are are too much for many people to give up. This phenomenon is a major drag on the housing market because there are just fewer homes available with such less turnover.
Why is this good for homebuilders? If you can’t find what you want, build it! In other words, absent existing homes available to buy, people are hiring builders instead. This puts homebuilders in the sweet spot right now where the economy is strong enough that there are still qualified buyers despite higher interest rates, but these would-be buyers cannot find homes to buy so they are looking to build instead.
What Comes Next
There are plenty of pitfalls out there for the housing sector, not the least of which is that inflation remains stubbornly high, which provides a catalyst to the Fed to keep increasing interest rates. As I’ve written about many times before, certain markets are more perilous than others, most notably the COVID-migration cities in the west that absorbed an exodus of people out of the tech centers and other big cities from 2020 to 2022.
But at least among the builders I talk to, which, admittedly, is not a representative sample as these builders are mostly working in the northeast, they are all very busy. The biggest impediment to their continued success is usually a lack of available labor. One builder told me recently he could do ten times as many jobs as he is doing now if he just had a reliable team of workers and that he has to actually turn away a fair amount of good work.
Will the increase in new housing starts continue? It’s impossible to say because there are just so many variables at play. I think the number one variable remains rates, but from a homebuilders perspective, rising rates also creates this unique situation of planting existing homeowners where they are and pushing would-be buyers into the new construction market instead. So from a homebuilder’s perspective, the year ahead should be still full of mostly blue skies. It is no wonder, then, that the homebuilder sentiment index is on the rise after a dismal 2022.
Addendum: Dissecting Lennar Corp’s earnings
Lennar Corp is a Florida-based home construction company and the second-largest homebuilder in the country behind only DR Horton. Lennar Corp (LEN) released its latest earnings this past week and presented a bullish case for the home construction market. Among the highlights:
Earnings Per Share of $2.12 versus a $1.55 estimate.
Quarterly revenues of $6.49 billion versus a $5.99 billion estimate.
An increase in projected homes sold in Q2 from 16,000 to 17,000 versus analyst estimates of 15,881
A comment in the earnings call that, “In January and early February, lower interest rates energized sales.”
A comment by CEO Bruce Gross that they are experiencing “no disruption” in the wake of the collapse of Silicon Valley Bank.
With such a rosy picture, Lennar Corp stock was up 3.70% on the week and is up 12.52% for the year so far. I can say from being down here in Florida for the past week, new construction is everywhere. It almost makes you worried a bit, as the developments have the look and feel of some of the cookie-cutter places that became poster children for the housing bust in 2008. There are rows and rows of new homes being built right along the highway, for example, from Kissimmee to Orlando. It made me feel uneasy to see them earlier in the week. Is anyone going to want to live that close to the highway in a cookie cutter development, I thought. But nonetheless, at the current moment in time, life is good for these homebuilders. We’ll see where they are in a year.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank. © Ben Sprague 2023.