Should Homebuilders Fear Higher Rates?

A big reason homebuilder confidence hit a high yesterday not seen since January 2006 is that builders have the product homebuyers want and need. Low inventory has been a big problem all year, and builders represent a solution to that problem. That’s why the builders I talk to aren’t as worried buy higher mortgage rates. Buyer traffic and offers for their homes continues to be strong because their new inventory relieves pent up demand.

That’s the case in San Francisco and the Bay Area anyway, and yesterday’s NAHB builder confidence report suggests this is also a broader U.S. trend, saying:

“Builders are seeing more motivated buyers coming through their doors as the inventory of existing homes for sale continues to tighten,” noted NAHB Chief Economist David Crowe. “Meanwhile, as the infrastructure that supplies home building returns, some previously skyrocketing building material costs have begun to soften.”

In the NAHB confidence index, 50 is dividing line between positive and negative sentiment, and the broad index was up six points to 57 in July. Drilling down to specific components of the index and geographic regions, it July results are as follows:

All three HMI components posted gains in July. The component gauging current sales conditions rose five points to 60 – its highest level since early 2006. Meanwhile, the component gauging sales expectations in the next six months gained seven points to 67 and the component gauging traffic of prospective buyers rose five points to 45 – marking the strongest readings for each since late 2005.

All four regions also posted gains in their HMI scores’ three-month moving averages. The Northeast showed a four-point gain to 40 while the Midwest reported an eight-point gain to 54, the South posted a five-point gain to 50 and the West measured a three-point gain to 51.

Here’s a table of the broad index dating back to 1985, which shows were currently at the best level since January 2006. This table is a good proxy for overall economic conditions leading up to and through the bust.

NAHB_July2013

New construction (aka Housing Starts) is another leading indicator of the housing economy and it came in today well below expectations. The drop was driven mostly by a drop in multi-family starts, and single family starts barely dropped (full stats here). Below is a chart showing a recovery but some caution is warranted.

HousingStarts_June2013

Which again brings up the rate spike we’ve had during 2013 and especially since April–and whether it will hurt home building and housing recovery overall. Wall Street interpretation of Bernanke’s June comments is that housing can sustain rates in the low 5s. Meaning that people can still afford homes with rates at those levels. I agree that borrower demand shouldn’t fall much with rates in the low 5s (and it’s worth noting that we’re still about .5% below that as of today) because a look at the numbers reveals borrower affordability isn’t steeply impacted by higher rates.

Consider someone earning $225,000/yr with no other debt buying a $1,000,000 single family home with 20% down. If rates rose 1%, their debt-to-income ratio would rise 3% from 27% to 30%.

Now let’s cut it in half: consider someone earning $100,000/yr with no other debt buying a $500,000 single family home with 20% down. If rates rose 1%, their debt-to-income ratio would also rise 3% from 31% to 34%.

Each borrower is different, but a 3% jump in an affordability ratio due to a rate rise doesn’t crush a budget. Just something to consider that’s often lost in the chatter about homebuilder stocks rising and falling.
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Reference:
An Unexpected (But Welcome) Consequence Of Rising Mortgage Rates

$XHB, $ITB, $IYR, $TLT, $TBT