One of the direct effects of rising interest rates is that they make borrowing more expensive for both home buyers and home builders. Higher interest rates increase the monthly payments and the total cost of mortgages, which can reduce the affordability and attractiveness of homeownership for potential buyers. This can lower the demand for new and existing homes, leading to lower sales and prices. According to a report by CNN Business, mortgage rates have skyrocketed to their highest level in 14 years, which has dampened activity in the housing market and caused home prices to decline for seven consecutive months in 2022. That is bad news for home buyers, but also for home sellers who want to cash out their equity. As a result, some people may opt to rent instead of buy, or postpone their purchase until interest rates fall again. This can create a vicious cycle of low demand and low supply, which can further depress the housing market.
For the Builders', higher interest rates increase the cost of Construction Loans, which are short-term loans that home builders use to finance their projects. Construction loans typically have variable interest rates that adjust according to market conditions, so when interest rates rise, so do the interest payments that home builders have to make. This can reduce their cash flow and profitability, as well as their ability to secure new loans or refinance existing ones. According to a blog post by Bridgit, interest rate hikes can exacerbate supply chain issues and drive-up prices for building materials, which can further increase the cost of construction and lower the profit margins for home builders. This is especially challenging for small and medium-sized home builders, who may not have enough financial cushion or bargaining power to cope with rising costs. Some home builders may decide to cut corners on quality or design, or delay or cancel their projects altogether. This can reduce the supply of new homes in the market, which can worsen the shortage of housing, especially in high-demand areas or segments.
Another effect of rising interest rates is that they can affect the supply of housing in the market. Higher interest rates can discourage home builders from starting new projects or expanding existing ones, as they face lower demand, higher costs, and more uncertainty. This can reduce the inventory of new homes available for sale, which can create a shortage of housing, especially in high-demand areas or segments. According to a report by Builders FirstSource, there is a significant national shortage of housing, especially workforce housing, and demand remains strong despite rising interest rates. This can create an opportunity for home builders who can provide affordable and quality housing to meet the unmet demand. However, this also requires home builders to have access to sufficient capital, land, labor, and materials, which may not be easy in a tight credit market and a competitive environment.
However, higher interest rates can also encourage some homeowners to stay in their current homes instead of selling them and moving to a new one. This can reduce the turnover of existing homes in the market, which can limit the supply of housing as well. According to a report by Marketplace, with 30-year mortgage rates topping 7%, many existing homeowners appear reluctant to sell only to risk taking on a new, more costly mortgage. This can create a bottleneck in the housing market, as fewer homes are available for sale or purchase. Some homeowners may decide to refinance their existing mortgages at lower rates instead of selling them or renovate or expand their homes to suit their changing needs or preferences. This can increase the value and quality of existing homes, but also reduce the mobility and flexibility of homeowners.
The Current Interest Rate Environment
Interest Rates are, simply, the rates at which money can be borrowed or lent in the Financial Market. They vary depending on the type, term, and purpose of the loan, as well as the economic conditions and monetary policy (Set by those Elected). Here are some examples of current interest rates from different sources:
- The Federal Reserve is the Central Bank of the United States that sets the target range for the Federal Funds Rate, which is the interest rate that Banks charge each other for overnight loans. The Fed holds interest rates steady at a 22-year high of 5.25% to 5.5% as of September 20, 20231.
- Mortgage Rates are the interest rates that Lenders charge Borrowers for Home Loans. They depend on various factors, such as the loan amount, term, type, credit score, down payment, and market conditions. The average interest rate on a 30-year fixed-rate mortgage rose to 7.88% APR as of October 5, 20232. The average interest rate on a 15-year fixed-rate mortgage jumped to 7.17% APR as of October 4, 20233.
- Loan Rates are the interest rates that Lenders charge Borrowers (Builders Included) for Unsecured Loans that can be used for various purposes, such as Debt Consolidation, Home Improvement, or medical expenses. They depend on the borrower’s creditworthiness, income, and loan amount. The average rate for personal loans was 8.61% as of July 20234.
- Credit Card Rates are the interest rates that card issuers charge cardholders for carrying a balance on their cards. They depend on the card type, features, and the cardholder’s credit history. The average annual interest rate was 21.7% on bank overdrafts and 20.76% on credit cards as of July 20234.
Home Builders I am Invested-In
These three Homebuilders have caught my attention. I value their Fundamental Assessment, high demand in their Products, and see a Competitive Advantage giving them an edge in the Stock Market.
Here they are, and some key points:
- Pulte Group (PHM) is one of the largest homebuilders in the United States, with operations in 40 markets across 23 states. It offers a variety of home designs, including single-family detached, townhouses, condominiums, and active adult communities. It also provides mortgage and title services through its subsidiaries. PHM reported a net income of $1.4 billion on revenues of $11.6 billion in 20221.
- D.R. Horton (DHI) is the largest homebuilder in the United States by volume, with operations in 90 markets across 29 states. It builds and sells single-family detached homes, townhomes, and condominiums, targeting first-time, move-up, luxury, and active adult buyers. It also provides mortgage, title, and insurance services through its subsidiaries. DHI reported a net income of $2.8 billion on revenues of $24.3 billion in 20222.
- Lennar (LEN) is the second-largest homebuilder in the United States by volume, with operations in 50 markets across 21 states. It builds and sells single-family attached and detached homes, townhomes, and condominiums, catering to entry-level, move-up, luxury, and active adult buyers. It also provides financial services, such as mortgage, title, and insurance, through its subsidiaries. LEN reported a net income of $2.4 billion on revenues of $22.5 billion in 20223.
These three companies are among the top performers in the Homebuilding Industry, which has been benefiting from strong demand, low inventory, favorable demographics, and low interest rates. However, rates are changing. They also face challenges such as rising costs, labor shortages, supply chain disruptions, and regulatory hurdles.
If you want to learn more about these companies or the Homebuilding industry in general, you can check out these sources:
