Jay McCanless, senior vice president of equity research at Wedbush Securities, joins Yahoo Finance Live to discuss declining homebuilder sentiment, new home construction and the overall state of the US housing market.
DAVID BRIGGS: New data shows new home construction rose more than 12% in August after a sharp drop in July. This follows a report that homebuilder sentiment fell for the ninth straight month. Jay McCanless with us, Wedbush Securities senior vice president of equity research.
Nice to see you, sir. So we’re talking about that number, a 12% increase. On the other hand, building permits have fallen by 10%. It’s a bit confusing. Is there any reason for optimism?
JAY MCCANLESS: you know thanks for having me I think part of the problem with the beginning being a bit delayed is the supply chain, both in terms of developing the land to get it ready for the house to be built and actually moving into the house. self constructed. Once the parts and parts are available, the builders get to work and get started.
I think the slower growth in permits is a function of what you talked about with higher mortgage rates, maybe builders are a little more cautious until we find out where mortgage rates are going to end up. I also think that the builders already have a lot of houses that were under construction. And again, now that they’re starting to get the parts to build and build them, maybe slow down the forward production a bit until they can catch up in the field.
SEANA SMITH: Jay, speaking of these higher mortgage rates, what do you think the potential demand destruction is? And how long do you see this challenging landscape here for housing?
JAY MCCANLESS: Yes, I wish I knew when mortgage rates would stop going up. It’s been quite a challenging environment, certainly the highest rates we’ve seen in years. What we saw in August when rates stabilized for about – or late July and early August rates stabilized for about six weeks. That helped invite some buyers back.
Who knows where mortgage rates will go this time. But if we could find a level and stay there, even if it’s a higher level, that helps people figure out what their monthly payment is going to be, and in turn, I think helps the builders generate more — more web traffic and foot traffic to get people on this home buying journey.
RACHELLE AKUFFO: And, Jay, I want to ask you about the neutral rating of Toll Brothers and the $50 12-month goal you have for them. Discuss some of the issues at play and what you think could potentially turn the tide.
JAY MCCANLESS: Yeah, we’re wary of– we like Toll Brothers, the company, but we’re wary of the stock right now just because these high-end consumers, which Toll, that’s their focus, luxury, high-end Consumers are the Consumers appeared to have declined more in terms of confidence and willingness to buy a home than what we saw from some of the entry-level home builders during the June and July earnings season.
So until we see that this high-end client might be a little more willing to step out and get a house, which is something we’ve seen from a few other builders as well, but that’s I think — if we’re ahead — I’m June earnings cycle was the expectation, on my part at least, that we might see entry-level consumers pull back a bit, but this uptick in luxury consumers would be able to weather this rate change.
And it was actually the opposite. This need-driven newcomer growing their family needs more space, this buyer, when they find a payment that works for them and a home that works for them, they go ahead and make the move. While this high-end consumer is currently a bit more hesitant. So that’s the reason for Toll’s neutral rating at this point.
DAVID BRIGGS: Most of the big home builders are close to 30% year-over-year. Compare that to what you see in KB Homes and why they perform better.
JAY MCCANLESS: So KB makes about 55% to 60% of its quarterly volume in entry-level. However, their entry level is more of a, call it a tweener, not really a smaller home for a home that one person can customize. We like your model. We like the fact that they’re focused on the entry level of 55% to 60%, because that’s where the demand seems to be, too.
When we go to print, we have the edge in terms of results. But we think orders may be a bit weaker this time around because unlike some of the so-called speculative home builders, which are homes being built without a sales contract, it can take six to nine months for your KB Home to get it, you may be a little more hesitant to buy it now. While the other three names we like, Meritage, Century, and Horton, have homes that are available for purchase in 60 days or less.
And buyers seem to like that right now because they can set the interest rate on their mortgage, have an idea of what their payment is going to be like — the monthly payment is going to be like, and I think that might give those three names a little edge at the moment versus KB. But we also like the entry-level exposure here. And as that buyer who might have a little more — a little more money saved, or maybe a little higher income demographic — once that buyer returns to the market, we think KB will benefit.
SEANA SMITH: Well, Jay, it’s certainly a very difficult environment, a deteriorating environment for the housing sector right now. What do you think will be the impact on this space? Do you think we could possibly see a consolidation as a result?
JAY MCCANLESS: You know, I haven’t seen any real consolidation in a couple of years. And I think given the options that some of the builders have in the single family rental space, it wouldn’t surprise me if we saw some of the production that was supposed to be for sale move into rental. I cannot rule out a consolidation. But there are so many investors and dollars that are destined and targeted for this rental market that I think there is a lot that needs to be built out there. It may not be exactly what builders were expecting for this year.
And I also think if you look at the competition for housing for sale, apartment building rents are still going up 15% a month. Rents for single-family homes are increasing by 15% to 20% every month. So we believe that overall demand for accommodation is still very high. It’s just that some of the builders may need to reset prices and/or help on the tariff side to get people into these homes.
But if we look at the demand and the demographics because millennials are such a large demographic that is totally in household building mode right now and you compare that to 2009 when we had too much inventory and not enough Gen X buyers I think from a demand and accommodation demand point of view we are in a much better position this time than we were during the GFC.
RACHELLE AKUFFO: And, Jay, you mentioned multi-family projects. That was actually one of the bright spots in the client data. And that, of course, is being driven by strong demand for rental properties. Are there certain companies that can benefit from this better than others?
JAY MCCANLESS: Yes, the two we’ve covered that play in the multifamily market – or build in the multifamily market are DR Horton – or sorry – three, DR Horton, Toll Brothers and Lennar, all three building multifamily projects to one extent or another . DR Horton also started their own single-family rental division, where they build entire communities, lease them, and then sell them to mutual funds.
And most of my other builders that I serve have started to get into the single family rental space, either through joint ventures or some direct to investor sales. So, yes, multi-family and single-family homes for rent are other revenue opportunities for builders. But specifically for multi-family homes, especially with some of the really strong rent increases we’ve seen in this market, Toll, Horton and Lennar will be our most immediate beneficiaries.
DAVID BRIGGS: It seems where the trends are going. Jay McCanless, I appreciate you being here. Many Thanks.