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Home prices expected to drop, but homebuilders remain strong

image of new home in the process of being built

Some economists and housing analysts say home prices will likely decline soon, just as existing home inventory is rising. According to November 22 data from real estate platform Redfin, median sale prices are declining in several U.S. metro areas, including Austin, San Antonio and Fort Worth in Texas, along with Portland, Oregon.

However, that forecast hasn't dimmed enthusiasm for homebuilders' stocks, including PulteGroup Inc. (NYSE: PHM), Toll Brothers Inc. (NYSE: TOL), D.R. Horton Inc. (NYSE: DHI) and Lennar Corp. (NYSE: LEN). As a group, homebuilders have been rising along with the rest of the broad market. The SPDR S&P Homebuilders ETF (NYSEARCA: XHB) is up 15.28% in November, its best month since June. 

Decline in home prices "likely"

In a recent media interview, Redfin CEO Glenn Kelman commented on Morgan Stanley's forecast of a 3% decline in home prices in 2024. That drop, Kelman said, "seems not just possible, but likely."

Morgan Stanley analysts recently wrote, "We think we are poised for an improvement in affordability that we have only seen a handful of times over the past 35 years."

Analysts foresee home prices to fall modestly as the pace of housing activity picks up versus this year, with new home sales outpacing existing sales. In addition, Morgan Stanley analysts predicted that "the strong fundamentals of existing homeowners will prevent sizable corrections."

More homes owned without a mortgage

Those strong fundamentals include the number of homeowners who own their residence outright, without a mortgage. That number reached 40% in 2022, according to data from Bloomberg. Of those homeowners, more than half are at retirement age. '

That's likely to, somewhat, mitigate one of the biggest concerns about the current housing market: People with mortgages at rates close to 3% are understandably reluctant to sell and take out another mortgage that's nearly 8%. That rate discrepancy has slowed down rates of moving and trading up to a newer or larger home. 

Meanwhile, home sales fell to a 13-year low in October, while home affordability becomes more difficult for many Americans. In October, a Redfin report found that 2023 is on pace for the fewest home sales since 2008 as mortgage rates reached 8%.

No uptick in home sales expected

Although analysts forecast a decline in home prices simultaneous with a drop in interest rates, Redfin analyst Chen Zhao told the Wall Street Journal that she doesn't expect home sales to pick up next year.

"We're in for a fairly prolonged freeze," she told the Wall Street Journal.

In August, Morgan Stanley forecasted that home prices would decline by 2% but later revised that estimate higher.

Builders offering below-market-rate mortgages 

So while all that is going on in the existing home market, big homebuilders such as Lennar, D.R. Horton, PulteGroup and Toll Brothers are offering below-market-rate loans. That's not something that's been common in prior housing market cycles.

For example, in Santa Fe, New Mexico, PulteGroup is developing new communities, offering a 30-year fixed rate of 5.75%. In Texas, Toll Brothers is offering a 30-year fixed rate of 4.99% for qualified buyers. 

Those four homebuilders are consumer discretionary stocks. Large caps D.R. Horton, PulteGroup, Lennar and NVR Inc. (NYSE: NVR) are tracked in the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY)

Despite homebuilders' stocks performing well, the most recent homebuilders sentiment data show lower confidence for the fourth month in a row. Even as the builders offer lower rates, affordability remains a problem, so prices are also being slashed. 

Homebuilders continue to be pessimistic

Those price cuts may be contributing to growing pessimism. The National Association of Home Builders data revealed that price cuts are more common in the Western U.S., especially versus the Northeast. However, declining mortgage rates could offer some green shoots to the industry. 

"While builder sentiment was down again in November, recent macroeconomic data point to improving conditions for home construction in the coming months," said NAHB Chief Economist Robert Dietz in the builder sentiment release.

In particular, he added, the 10-year Treasury rate moved back to the 4.5% range for the first time since late September, "which will help bring mortgage rates close to or below 7.5%."

NAHB forecasts approximately a 5% increase for single-family starts in 2024 as it expects inflation and interest rates to ease in the coming months.

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