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Is the Slump in Starts & Permits a Real Threat to Housing?

Zacks

New residential construction in the United States decreased more than expected in April 2018 as lesser starts of apartment buildings overshadowed a modest improvement in single-family structures. Notably, this is the second time in the last four months that housing starts has toppled.

Per the latest jointly released report from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, construction of new homes fell 3.7% in April to 1.29 million units (seasonally adjusted annual rate) from the prior month. That was well below the expected 1.31 million units and followed an upward revision to the March figures.

The downside was mainly due to 12.6% drop in apartment starts. This was offset by a 0.1% gain in single-family homes which followed a 0.8% decline in March. The report also showed sharp declines in the Midwest, Northeast, and West United States, while starts increased in the South.

Moreover, residential building permits, an indicator of construction activity, fell 1.8% in April to an annualized rate of 1.35 million units from March, below the expected 1.36 million units.

Does This Downfall Matter?

Although April starts and permits tumbled from the March figure, the larger picture is still overwhelming. Housing starts were up 10.5% from April 2017 buoyed by a 7.2% increase in single-family homes, and a 19.1% surge in apartments. Again, permits were 7.7% above the April 2017 rate of 1.26 million units helped by a 7.9% surge in single-family and 6.4% growth for buildings with five units or more.

The National Association of Home Builders released a separate report on Tuesday showing a surge in homebuilder confidence in the month of May. Builder confidence increased two points to 70 in May from a downward revision of 68 in April, reinstating builders’ confidence in the current housing market. Importantly, the reading was above the 50 mark, in the first five months of 2018, indicating a favorable outlook. Moreover, this is the fourth time in 2018 that the index has reached 70.

Notably, current single-family home sales increased two points in May but the indices measuring buyer traffic and sales expectations in the next six months were unchanged at 51 and 77, respectively.

Despite mounting confidence among homebuilders, higher lumber price is hurting homebuilders’ margins. Tariffs on Canadian lumber by the Trump administration and other imported products have raised construction cost. Also, lack of supply and robust demand continue to push prices higher, thereby hurting affordability.

Then again, stable single-family starts underscore the solid residential construction pace that will probably support economic growth given upbeat homebuilders’ confidence in the market’s progress. As the economy continues to improve and the millennial generation comes of age, pent-up demand for homes will continue to be released.

Economists are of the opinion that second quarter will register higher growth as the industry starts to feel the impact of the Trump administration's $1.5 trillion income tax package on their paychecks.

Higher Rates Raise Concern

Mortgage rates, which loosely follow the yield on the 10-year Treasury, started the year at around 4% but began rising thereafter. Higher inflationary expectations and upbeat economic growth have already driven the benchmark treasury yields to 3%. The yields went on to score even higher on May 15 to touch the highest level in seven years at 3.08%.

Evidently, the industry is down 20% year to date, comparing unfavorably with 1.3% growth for the broader market (S&P 500) as rising rates are bothering investors since the start of this year.

For the upcoming period, if we delve deeper, the homebuilding industry falls within the top 5% of the Zacks Industry Rank and a good industry rank supports growth. Again, the industry’s three-five year expected earnings per share (EPS) growth rate of 17.7% is better than the broader market’s 9.7% rate, raising optimism about the industry’s earnings potential.

Currently, notable homebuilders like KB Home KBH, Century Communities, Inc. CCS, Lyon William Homes WLH and M.D.C. Holdings, Inc. MDC sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Toll Brothers, Inc. TOL, Beazer Homes USA, Inc. BZH and Meritage Homes Corporation MTH carry a Zacks Rank #2 (Buy).

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