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The Housing Market’s ‘Safe’ Bubble Sets Stage For Homebuilder Stock Price Gains

The housing markets’ symptoms of rising prices and bidding wars may look like the unhealthy one that led to the Great Recession. However, there are key differences that make this one “safe,” in that it is only at the beginning of its eventual bubble. Here is how this one is different:

Disclosure: Author holds PulteGroup PHM (previously, Pulte Homes) stock

  • There is a limited supply of houses for sale because: (1) Existing homeowners are not fully engaged in making a move, and (2) Homebuilders are hitting building constraints, including shortages in lots and lumber
  • Mortgage lenders have conservative requirements for qualified buyers: Good credit ratings, ample down payments and traditional mortgage terms

So, why the rising prices and bidding wars? Because the potentially qualified buyers outnumber the supply of homes.

Where does the housing market go from here?

Existing homeowners’ increasing equity balances for their older houses can incentivize a trade-up. Additionally, as COVID-19 effects wind down, postponed moves to downsize, upsize or relocate will pick up.

For homebuilders, the constraints will ease. Increased homeownership is viewed as desirable by most cities and communities, so more lots will become available. Lumber supply shortage is a short-term mismatch due, not to lack of timber, but of sawmill capacity. Additionally, with existing home prices rising, homebuilders can raise prices yet remain competitive while maintaining or improving profit margins.

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Mortgage lenders will follow their historical trajectory as buyer demand and rising prices continue. Through competition, expect progressively easier terms and requirements.

What about interest rates? If they rise, won’t that adversely affect the housing market?

Yes, and no. Yes, some buyers will see their house affordability figure drop. However, affordability is in the eye of the lender and the buyer, alike. In past rising markets, both have made adjustments to match buyer desires with lender needs and make the buy.

Then, there is the psychological factor. When rates start to rise, buyers, sellers and lenders ramp up their activity to lock in the rate today, thereby removing the risk of a higher rate tomorrow. Also, the current mortgage rate is at the bottom end of its historic range since 1965. There were several strong housing markets during that period.

The most likely cause of a housing market downturn is either a recession or a topped-out bubble. The characteristics of a bubble peak typically includes low or zero down payments, below market mortgage rates in first few years (to increase affordability), lower credit requirements, an ample/excess supply of existing and new houses for sale and homebuyer-investor speculation. Clearly, today’s housing market’s characteristics are far from those extremes.

The bottom line – This housing market looks like an early upsurge formation with a long way to go

Today’s housing market is sound. Likely this year will see activity increase and prices continue to rise – even if mortgage rates rise.

Besides owning a house, there are several investment routes for riding this trend. One that looks especially promising is stocks of homebuilders because they control the supply, pricing and marketing of the new, shiny, desirable houses.

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