Homebuilder pessimism deepened this month as mortgage rates reached 23-year highs. But the downcast outlook may not be shared equally among developers.
More builders again classified housing conditions as poor rather than good in October, according to a monthly sentiment index from the National Association of Home Builders (NAHB) and Wells Fargo Housing. The index reading dropped to 40 from a downwardly revised 44 in September, marking the second straight month it fell below the crucial breakeven measure of 50 — and the lowest point since January.
While the results underscore the chilling effect rising mortgage rates are having on housing activity, the index may not reflect the experiences of the largest builders, which are better capitalized to take advantage of the odd dynamics in the market.
"The tone will be pessimistic, [but] I would say it is a better indicator for small to mid-sized builders," Jody Kahn, senior vice president of research and surveys at John Burns Research and Consulting, told Yahoo Finance before the index was released. "It’s about the haves and have-nots when it comes to capital."
Other index measures this month were also weak.
The gauges for current sales conditions, sales expectations in the next six months, and traffic of prospective buyers all dropped month over month. All readings sit below 50, indicating that more builders believe those particular conditions are bad than good. Buyer traffic was especially poor, coming in at a reading of 26.
Housing conditions in the four regions covered by the index all worsened in October with three of four — the Midwest, South, and West — posting readings below 50. The Northeast’s index measure teetered at 50.
The widespread decline in sentiment came as mortgage rates remained above 7% for nine straight weeks, with some experts warning that they could reach 8% this year.
Read more: Mortgage rates at 20-year high: Is 2023 a good time to buy a house?
"Builders have reported lower levels of buyer traffic, as some buyers, particularly younger ones, are priced out of the market because of higher interest rates," NAHB chairman Alicia Huey, a custom homebuilder and developer from Birmingham, Ala., said in a statement.
As a result, builders reached into their pockets to attract buyers.
Read more: How to buy a house in 2023
The index found that 32% of builders cut home prices in October, the same share as September and the highest rate since December 2022. Overall, 62% of homebuilders provided some kind of sales incentives this month, up from 59% and also the highest since December 2022.
And that’s where the divergence in moods among homebuilders may come in. The well-financed builders can negate rising interest rates with specific inducements, while also offering near-ready inventory for buyers frustrated by the dearth of properties on the resale side.
"Those two factors are really driving sales," Kahn said.
Homebuilders now are serving more entry-level buyers than normal because of the supply shortage among existing homes. (Homeowners are reluctant to sell and buy a home at such high mortgage rates when they have such a low one currently.)
For instance, 42% of new single-family homebuyers were first timers in 2023, up from 27% in 2018, which was a more normalized market, the NAHB found.
Read more: First-time homebuyer in 2023: What you need to know
These are also more budget-conscious buyers with smaller down payments and who are sensitive to rapid changes in mortgage rates, which can make a monthly payment unworkable.
Larger builders with mortgage lending arms or joint ventures with lenders can afford to pinch their margins some to buy the rate down on mortgages for the entirety of the term for these borrowers. So instead of a 7.75% rate for 30 years, these buyers get a home loan at 5.75%, Kahn said.
Smaller builders largely can swallow only a temporary buy-down, which lowers the rate for one or two years. But if a buyer can’t qualify for the higher monthly payment after the buy-down expires — a requirement put in place after the Great Recession — the deal is dead.
These buyers also want to close quicker because a shorter window is a way to protect themselves from future rate increases, Kahn said, and it mimics the transaction timing on the resale side.
Having inventory that’s 30 to 60 days from completion provides that assurance and timeframe, but that’s a scenario mostly well-capitalized builders can offer. Smaller developers don’t have the financing to hold incomplete and unsold properties on their books.
"These two things are significant in supporting the sales," Kahn said. "Smaller builders don’t have the capacity to do those things."
That goes a long way toward explaining why the sentiment reading from the NAHB — whose membership skews toward those that develop fewer than 100 homes a year — could be echoing the experiences of those homebuilders over the biggest private and public ones. (The panel of builders surveyed for the NAHB index is proportionate in size and geography to NAHB's membership composition, a spokesperson said.)
In fact, John Burns conducts its own regular surveys of builders throughout the year and the most recent one — results Kahn has yet to publish — showed a considerable gap between how smaller builders and larger ones answered survey questions, she said.
That’s a key consideration for investors looking toward a number of third quarter results from seven of the top 10 publicly traded homebuilders in the next few weeks, including D.R. Horton Inc. (DHI) and PulteGroup Inc. (PHM).
"The biggest builders are making those earnings reports," Kahn said, "and they definitely have all the advantages."
Janna Herron is the personal finance and real estate editor for Yahoo Finance. Follow her on Twitter @JannaHerron.
