Last year was a rough one for real estate.
The Federal Reserve was mashing the interest rate hike button to combat inflation.
And those higher rates pushed people out of the market.
Today I’m going to use our Stock Power Ratings system to show you that a real estate market revival is upon us.
And I’m zeroing in on a particular branch of real estate: homebuilding.
You see, when interest rates rocket up, it hikes the overall price of entry. Even when home prices go down — as they have in recent months — higher interest rates mean your mortgage is more expensive.
In 2021, it was a different story.
Housing was a hot market as more Americans moved away from large, urban areas into less pricy, more rural parts of the country.
And interest rates were in a completely different ballpark. The average mortgage rate was 2.65% in 2021. Freddie Mac reports that number hit 6.32% in March of this year!
To illustrate how much of a jump that is, let’s do some simple math. A 30-year fixed rate mortgage at 2.65% for a $300,000 home comes out to a $1,209 monthly payment. That number soars 53% to $1,861 at the 6.32% rate!
With that in mind, you’d think the expectation is that homebuilder stocks would push lower.
But that’s not the case…
Homebuilder Stocks on Fire
Homebuilding stocks have been in a resurgence since late 2022, despite the interest rate environment.
We can compare the performance of the SPDR S&P Homebuilders ETF (NYSE: XHB) — an exchange-traded fund (ETF) tracking homebuilding stocks — with the S&P 500:
In the last year, XHB (the green line in the chart above) has consistently out-returned the broader market (the orange line). XHB’s return is 5.4% while the S&P 500 is down 8.7%.
Homebuilder stocks outpaced the market even when mortgage rates were at their highest.
And they’ve climbed higher since late 2022.
One rationale for the resurgence of this market segment in late 2022 was that mortgage rates cooled from a red-hot 7% in October to around 6% to start 2023.
That’s logical, but I don’t think it’s the main reason why homebuilder stocks have performed so well.
For that, we have to dig a little deeper.
Here’s Why Homebuilder Stocks Are Higher
To better understand homebuilder stock outperformance, it’s important to look at the real estate sector in totality.
A bulk of total home sales — around 80% to 90% — are people selling their existing homes. The remaining sales are new home construction.
Existing home sales were well above 5 million on a rolling average in the first two quarters of 2022.
But existing home sales dropped to around 4 million from November 2022 through February 2023 due to exorbitant rates.
If you bought your $100,000 home before the pandemic with an interest rate of 3%, you simply can’t sell and buy something comparable with an interest rate of 6%. (Remember how much that monthly payment jumped in my example above?)
That’s the same scenario millions of homeowners looking to sell and move are facing.
The existing home market has compressed, but there are still people out there looking to buy.
With over 1 million existing homes off the table, these buyers are turning to homebuilders. That demand for new homes is the main reason why homebuilder stocks have outperformed in a market where they shouldn’t.
How You Can Profit From This Trend
Since I don’t see this trend stopping anytime soon, I used our Stock Power Ratings system to evaluate homebuyer stocks.
I ran the 35 stocks held within XHB through an “X-ray” of our system. Here’s what I found:
XHB Stocks Average a “Bullish” Rating
The average overall rating of all 35 holdings of XHB was 71 out of 100. That‘s a “Bullish” indicator for us — meaning we expect the ETF to beat the broader market by 2X over the next 12 months … which it already has.
Two-thirds of the stocks scored 70 or higher on the Stock Power Ratings system … which is “Bullish” or better.
Of the rest, 12 were rated “Neutral” and only two were “Bearish” or below:
I wrote about one of these stocks recently. Click here to read that report.
Bottom line: Mortgage rates aren’t likely to fall by an impactful amount while the Fed keeps fighting off inflation.
This doesn’t give existing homeowners much reason to sell their homes because buying would be cost-prohibitive.
Homebuilders and new construction are the next option for would-be homebuyers.
Our Stock Power Ratings system tells us that homebuilder stocks should continue strong outperformance and can help you profit from this real estate trend.
Stay Tuned: The Size Factor
Adam designed his Stock Power Ratings system around six factors to help us find stocks that are well-positioned to outperform.
Tomorrow, he’ll show you how the size factor works, and why it’s shaping up to be a critical metric as stocks become more bullish.
Matt Clark, CMSA®
Chief Research Analyst, Money & Markets