What Will a Rate Hike Mean for Housing Stocks in 2017?
A thought that has been plaguing investors of late is whether a rise in interest rates will affect the housing market. Here, we should not ignore the fact that a raise in rates is indicative of a solid economy which in turn spells increased demand for housing.
Meanwhile, the Federal Reserve has raised the benchmark interest rate by a quarter percentage point to the range of 0.50% to 0.75% from 0.25% to 0.50%, citing improvement in the labor market and a strengthening U.S. economy. This marks the first interest rate hike of 2016 and the second since the 2008-2009 financial crisis following a raise at the end of 2015.
But with the Federal Reserve announcing a hike in the benchmark Federal Funds target rate, mortgage rates will probably rise in 2017 or after that. High mortgage rates dilute the demand for new homes as mortgage loans become expensive. This lowers purchasing power of buyers and hurts volumes, revenues and profits of homebuilders.
Will a Hike Really Matter?
Clearly, rising interest rates make for a difficult borrowing environment. This may impede home sales, which affects new starts and thereby homebuilders.
Coming to the numbers, U.S. homebuilding fell more than expected in November, plummeting from a nine-year high as construction activity dropped substantially. Although groundbreaking on new housing projects, or housing starts in short, surged 25.5% in October, it plunged by 18.7% in November from the prior month.
Single-family starts, which account for the largest share of the residential housing market, also fell to a seasonally-adjusted rate of 828,999 in November, down from 869,000 units in October, as per the Census Bureau New Residential Construction report for Nov 2016. Single-family starts rose to a nine-year high in October. Notably, housing starts figures largely vary month-to-month.
Nonetheless, the housing market remains strong. Post the election of Donald Trump as the U.S. president, mortgage rates have scaled to a new high. Even after that, homebuilder confidence soared to a reading of 70 in December, marking the highest climb since Jul 2005.
Some analysts are of the opinion that the hike largely follows the euphoria of Trump’s election as U.S. president. Probably, builders are hopeful that Trump will follow through on his pledge to ease some regulations that are marring business for small enterprises and housing affordability.
Housing experts also believe that the rapid growth in the economy and wages is driving an interest rate hike. Following the modest 25-basis point hike, the Fed has expressed its confidence in the U.S. economy and forecasts three hikes in 2017, up from the two projected in September. Also, a booming economy boosts income as well. Thus, if the rise in income offsets the increase in mortgage payment, housing will do just fine.
The SPDR S&P Homebuilders ETF XHB and iShares U.S. Home Construction ETF ITB, the two largest exchange traded funds focusing on homebuilders and related fare, are up 2.5% and 4.4%, respectively, so far this year.
The year 2016 has been more or less good for the housing market since the housing recession in 2007.
Positives like an improving economy, modest wage growth, low unemployment levels, low interest rates, positive consumer confidence and a tight supply situation raise optimism about the sector’s performance for the whole of 2017.
Improving labor markets, falling unemployment rates and a limited home supply are supporting a continued rise in home prices, thereby booting homebuilders’ top line.
Concerns
Although homebuilder confidence soared to a 11-year high in December, it barely moved the needle for homebuilders’ shares, D.R. Horton, Inc. DHI, KB Home KBH, Lennar Corporation LEN, PulteGroup, Inc. PHM and Toll Brothers Inc. TOL). Looking for the Best Stocks for 2017? Be among the first to see our Top Ten Stocks for 2017 portfolio here.
We should keep in mind that homebuilding stocks could be vulnerable to some near-term downsides. Mortgage rates may continue to rise anticipating rapid economic growth and inflation, thanks to Trump’s policies.
Thus, we should keep an eye on how the housing sector, which is getting stronger buoyed by support from the job market, performs post another hike in interest rate.