Credit: Shutterstock photoGrowing demand, an improving economy and encouraging housing data are undoubtedly building on homebuilders' hopes. Yet, supply shortage, burdensome mortgage underwriting standards, cut-throat competition and cost inflation amid moderating home price increases could hold back the recovery this year.
It would be prudent to take a closer look at these dampeners before investing in this space. Below, we discuss the impact that these can have on the sector in the coming months and years.
Rising Labor, Land and Material Costs
Rising building materials and labor costs are threatening margins as they limit homebuilders' pricing power. Both labor and construction material costs are rising proportionally with increasing housing starts and there could be significant inflation going forward. This could eat into homebuilders' margins considering that home price increases are moderating.
Rising construction, labor and material costs have hurt gross margins of the likes of Lennar Corporation ( LEN ), KB Home ( KBH ) and D.R. Horton, Inc. ( DHI ) in the past few quarters.
Supply Constraints
Several years of production deficits during the housing downturn resulted in a limited supply of both rental and new homes in the country. At present, a shortage of buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing ones.
New home inventory for sale was 206,000 units at the end of May, a 4.5-month supply at the current sales pace, down from April levels. The supply of existing homes is also tight, with an available supply of just 5.1 months, also down from April levels. Analysts expect prices to flare up if the supply picture does not improve.
Increasing Competition & Incentives
Many homebuilders are increasing incentives to drive volumes as the competitive environment heats up. Higher incentives and cost inflation amid moderating price increases are hurting homebuilders' margins. Most homebuilders expect increased cost and pricing pressure in 2015 - the major headwinds to the housing industry.
Slowing Economy in Oil States
Low oil prices can affect consumer confidence and eventually slow down the economy and thereby home demand in an energy driven state like Texas. Lennar witnessed slower order growth in its Houston segment in both quarters of the first half - mainly across higher price points - hinting at a slowdown in Houston's economy. Pulte Group, Inc. ( PHM ) also witnessed some slowing demand trends in Texas/Houston particularly at higher price points.
However, it is noteworthy that another homebuilder, D.R. Horton, witnessed consistent performance in Texas (including Houston) in the last reported quarter. A smaller homebuilder, Meritage Homes Corporation ( MTH ), saw declining orders in Texas in the first quarter, but average sales prices remained strong in the region. Meritage, however, saw healthy sales trends in Houston in the first quarter and did not witness any major decline in demand. Despite the mixed views, we cannot rule out a decline in home demand and prices in the Houston/Texas region in the future.
Bottom Line
As you can see there is a long way to go for these homebuilders even though the economy paints a picture of recovery. But what about investing in the space right now -- will the opportunities outweigh the risks to lure in short-term investors?
Check out our latest Housing Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
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PULTE GROUP ONC (PHM): Free Stock Analysis Report
MERITAGE HOMES (MTH): Free Stock Analysis Report
LENNAR CORP -A (LEN): Free Stock Analysis Report
KB HOME (KBH): Free Stock Analysis Report
D R HORTON INC (DHI): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
