Home Builders Will Feel the Weight of Higher Mortgage Rates

Analysts expect that the builder received 6,589 new orders and delivered 7,297 homes to customers, with a 29.3% home builder gross margin.

Weekly measures of mortgage rates have been on an upward climb in the second half of the year, passing 7% in August and broadly gaining since then. The gains weighed on sales of existing homes, which make up the bulk of all home purchase transactions, in September.

The National Association of Realtors’ measure of completed transactions in September fell to its lowest monthly figure since late 2010, the trade group said last week. 

But don’t expect the increase in mortgage rates to hit new home sales the same way. Pending-home sales, a measure of deals for previously owned homes that have not yet closed, are expected to have fallen 1.5% in September to their lowest level on record. A comparable measure of new-home contract signings is expected to have increased 0.7% to a level about 20% higher than one year prior. Both reports are expected later this week. 

It isn’t that builders, the previous beneficiaries of buyer demand in a supply-constrained housing market, are immune from the impact of rising mortgage rates. Industry confidence measured by the National Association of Home Builders fell in October to its lowest level since January.

Rather, sales volume could come at the expense of builder margins. While homeowners with ultralow mortgage rates can choose not to sell instead of lowering prices or otherwise courting a buyer, builders turn to price cuts and incentives, such as mortgage rate buy-downs, to keep homes selling. 

Indeed, recent reports suggest more builders are offering incentives to get prospective buyers into homes. In a survey of builders by the Home Builders trade group, 30% said they cut home prices in October. A larger share, roughly three in five, said they provided buyer incentives more broadly. 

UBS
analysts John Lovallo, Spencer Kaufman, and Matthew Johnson lowered their 2024 builder estimates and price targets “to reflect the likelihood that ‘higher-for-longer’ interest rates will necessitate incremental rate buydowns and other incentives to sustain volume,” they wrote in a report last week. The analysts lowered their home building gross margin expectations by 1.4 percentage point on average.

New homes were beneficiaries of buyer demand earlier this year. As the steep increase in mortgage rates early in the pandemic kept would-be sellers in place, some home buyers turned to new-home construction, driving up industry sentiment—and builder stocks. Two exchange-traded funds tracking the home builders and related industries, the SPDR S&P Homebuilders ETF (XHB) and the iShares U.S. Home Construction ETF (ITB), hit 2023 closing highs on the first day of August. 

Builder sentiment—and stocks—have sunk since then as mortgage rates have gained. The two exchange-traded funds were down about 17% and 19% since their 2023 closing highs as of Friday’s close—though they remain positive on the year. 

The UBS analysts wrote they expect coming financial reports from builders to be of less importance to investors than commentary about buyer trends and the trajectory of builder gross margins. They remain positive on builders due to “a lack of existing home inventory, strong balance sheets and procurement/financing advantages relative to most private peers.”

Write to Shaina Mishkin at [email protected]