Homebuilder stocks experienced a significant surge in July, driven by a softer-than-expected inflation report for June that sparked optimism about potential mortgage rate declines this year. Market expectations have already priced in an interest rate cut for September, with a cumulative reduction of around 100 basis points anticipated by year-end. With only three Federal Open Market Committee (FOMC) meetings remaining in 2024, there is already an assumption of at least a 50 basis point cut being factored into current market expectations.
For homebuilders, this is undeniably positive news. Lower rates typically lead to reduced Treasury yields, from which mortgage rates are derived. While other elements, such as demand for mortgage-backed securities, also play a role in determining the ultimate trajectory of mortgage rates, a series of rate cuts could encourage hesitant homebuyers to return to the market. This would be a welcome development for many homebuilders, who have had to offer incentives to clear their inventory amid slowing demand.
Despite these bullish signals, recent dips in several homebuilder stocks warrant attention. Investors now face a critical question: Is this a buying opportunity, or could the anticipated rate cuts be a false signal?
Opportunity or Head Fake?
For those inclined toward optimism, the recent dip presents a potential buying opportunity. Investors might find it worthwhile to consider homebuilder stocks, particularly given the possibility of rate cuts.
Lennar Corp. is a prime example of a homebuilder stock that has exhibited considerable volatility this year. The stock has experienced five instances of daily movements exceeding 5% in the past 12 months. Although Lennar has generally been on an upward trajectory, driven by expectations of rate cuts boosting consumer demand for housing, the stock currently trades about 10% below its March 2024 high. For investors, this dip could represent a buying opportunity.
Lennar’s stock reached an all-time high of $178.76 this year, reflecting a robust year-over-year growth of nearly 40%. If positive demand trends translate into reduced inventories and increased building permits in key markets, another push to new highs seems plausible.
However, caution is warranted. The impact of any potential rate cuts on demand remains uncertain, and not all analysts are convinced of Lennar’s prospects. Goldman Sachs recently downgraded the stock from “Buy” to “Neutral,” setting a price target of $174—slightly below its previous peak. Thus, there is no unanimous view that Lennar will reach new highs soon.
Nonetheless, Lennar’s fundamentals are strong. The company exceeded expectations with its Q2 earnings and holds a $5 billion cash reserve, supporting a current valuation of $49 billion. With the stock trading at around 12 times earnings and offering a modest 1.1% dividend yield, it remains an attractive option in a market where such metrics are increasingly rare.
Should consumer confidence rebound and buying activity accelerate, Lennar could emerge as a standout performer in the next housing market cycle.
D.R. Horton’s Growth Prospects
D.R. Horton is another key player in the homebuilding sector that has seen strong performance over the past year. Much like Lennar, DHI is trading near its all-time high, as investors anticipate improved demand and reward the company for strong past results.
D.R. Horton now forecasts the delivery of between 90,000 and 90,500 homes for fiscal 2024—slightly above previous estimates. This suggests that management expects robust demand to continue. While affordability concerns and a modest increase in the supply of new homes present potential headwinds, the limited supply of existing homes could make new homes particularly attractive, especially if lower interest rates bolster the economy.
Much depends on the Federal Reserve’s next moves. However, D.R. Horton expects its cash flow to improve significantly next year as its rental investments stabilize, potentially enhancing shareholder returns. With momentum clearly on its side, D.R. Horton may have considerable room to grow. Of course, risks remain, including the possibility of an economic downturn. Yet, if the consensus view of a “soft landing” prevails, D.R. Horton could see substantial upside.
Key Takeaways for Investors
The trajectory of homebuilder stocks like Lennar and D.R. Horton will hinge heavily on the Federal Reserve’s actions in the coming months. A series of rate cuts could provide a catalyst for renewed growth in the housing market, driving demand and boosting the valuations of these homebuilders. However, investors should remain vigilant for potential risks, including the possibility that rate cuts may not materialize as expected or that economic conditions could deteriorate.
For those with a high-risk tolerance and a belief in a stable or improving economy, the current environment presents compelling opportunities in the homebuilding sector. As always, a careful analysis of each company’s fundamentals and market conditions will be crucial to making well-informed investment decisions.