by In the second half of 2022, homebuilders across the country struggled as high mortgage rates drove cancellations by buyers soaring. In response, many builders quickly ramped up their incentives, including offering “mortgage interest surrender.” While builders in fast-correcting markets like Reno and Austin had to go much further and cut the prices of new community homes by 10%, 15%, or in some cases as much as 20%.
Those incentives and price cuts are now working: New home sales are rising again and builder cancellation rates normalized this spring.
“Rate cuts turned reluctant borrowers into eager buyers… The post-pandemic housing environment is not the post-apocalyptic wasteland many predicted last fall,” Deutsche Bank researchers wrote in a report published last week.
There is growing optimism on Wall Street that incentives, such as buying off mortgage rates, will give homebuilders a housing edge not only in 2023, but as long as mortgage rates remain high. Not to mention, builders face limited competition as existing housing supply remains tight amid the so-called “lock-in effect”. After all, if homeowners were to sell and buy something new, they would trade their 2% or 3% mortgage rates for a 6% or 7% handle.
Simply put, companies like Deutsche Bank think the next step in the housing market is one where new construction is crowded, while the existing/resale market remains limited.
That builder enthusiasm has translated into a rush among investors to buy homebuilder shares, including a 55.9% year-to-date increase in PulteGroup’s share price. It is followed by Toll Brothers (+46.9% this year), DR Horton (+25.7%) and Lennar (+24.2%).
Check out this interactive chart on Fortune.com
During the Pandemic Housing Boom — a period of seemingly limitless housing demand — builders including KB Home, PulteGroup, and NVR reaped huge profit margins while rapidly driving up prices. Those fat profit margins gave builders the breathing space to squeeze margins (i.e. by lowering prices and/or buying off aggressive rates) to “find the market.” According to Deutsche Bank, many builders offer mortgage rates of 5.0% to 5.5% because they pay lenders for so-called “mortgage interest surrender.”
In Deutsche Bank’s eyes, there is still more room for homebuilder stocks as the US housing market remains “underdeveloped”.
“We [have] quickly turned from cautiously optimistic to resolutely optimistic about new housing developments,” Deutsche Bank researchers wrote in their latest construction report. Stocks should generally be moving higher, but we see opportunities for stock selection.”
In the report, Deutsche Bank researchers outlined their “target price” outlook for some homebuilders. See below.
DR Horton – DHI: Target price of $150 from Deutsche Bank (trading at $114.01 as of Friday close)
Meritage – MTH: Target price of $200 from Deutsche Bank (trading at $129.67 as of Friday close)
Pulte-PHM: Target price of $95 from Deutsche Bank (trading at $71.99 as of Friday close)
Tri Pointe – TPH: Target price of $42 from Deutsche Bank (trading at $32.38 as of Friday close)
Toll Brothers – TOL: Target price of $94 from Deutsche Bank (trading at $74.29 as of Friday close)
Taylor Morrison – TMHC: Target price of $50 from Deutsche Bank (trading at $46.70 as of Friday close)
KB Home – KB: Target price of $49 from Deutsche Bank (trading at $48.74 as of Friday close)
NVR, Inc. – NVR: Target price of $4,400 from Deutsche Bank (trading at $5,818 as of Friday close)
Lennar-LEN: Target price of $105 from Deutsche Bank (trading at $114 as of Friday close)
This story was originally on Fortune.com
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