Bank of America on Thursday downgraded homebuilders Lennar, Toll Brothers and KB Home. New home demand has dropped over the last three months after two years of unprecedented growth. Affordability is down, with the average monthly mortgage payment up 50% in some markets. Loading Something is loading.
Jumping mortgage rates are contributing to lower demand for newly built homes, and while a bottom in the slump may be in sight, Bank of America said Thursday it was downgrading three homebuilding stocks.
The rating cuts for Lennar, Toll Brothers, and KB Home were published on the same day Freddie Mac reported a 5.5% average rate on a 30-year fixed-rate mortgage, a two-month high. The benchmark rate is up from 3.1% at the end of 2021 and 2.87% a year ago.
“New home demand has reset lower over the last three months following two years of unprecedented growth,” research analyst Rafe Jadrosich said in the BofA note. Earnings for homebuilders and industry data indicate a sharp deceleration in demand in June and July on the back of “worsening affordability” and lower consumer confidence.
The investment bank sees a downside to homebuilder estimates and it’s modeling, on average, per-share earnings 14% below consensus in 2023. Homebuilders have offset supply-chain bottlenecks and input cost inflation through price increases. “Going forward, we see risk that prices will begin to hit a ceiling and builders will reintroduce sales incentives as worsening affordability pressures demand,” said Jadrosich.
Lennar was cut to an underperform rating from neutral, Toll Brothers was moved down to neutral from buy, and KB Home was reduced to neutral from buy. The ratings reflect valuation and relative positioning for different trends including a faster slowdown in West and Mountain markets than the national average and demand for speculative home sales that are outpacing built-to-order.
The average monthly mortgage payment for a new home in some key metro markets is up 40%-50% in the last six months and affordability was at the lowest levels since 2006, with entry-level buyers priced out, BofA said.
“We acknowledge July could be the trough; however, we expect overall demand to remain weak,” with mortgage rates up substantially year-to-date and with home prices elevated. “Favorable demographics and migration trends are tailwinds, but buyers no longer feel the same urgency as the prior two years and will be more patient,” the firm said.
Bank of America did upgrade DreamFinders to neutral from underperform and raised its price objective on the stock to $12 from $10.50. The company is concentrated in Florida and has high exposure to the build-to-rent segment, which BofA expects to outperform.
“DFH controls 100% of land through options, which better positions it in a slowing market,” it said.
The S&P 500 Homebuilding Select Industry Index has lost about 28% this year.
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