J.P. Morgan analyst Michael Rehaut on Friday elevated his outlook on the homebuilding industry, stating that the housing sector has made it through the worst of the correction. Rehaut changed his rating to a positive from a negative on the homebuilder sector.
According to a research report the analyst stated, “While fundamentals will likely not demonstrate an uninterrupted solid rate of improvement over the next six to 12 months, we believe that not only is housing solidly past its trough, but over the next 24 months, will continue to recover and drive further upside to the current rally in homebuilder stocks.”
On an encouraging sign, the U.S. Census Department reported on Thursday that new residential construction rose 1.5 percent in August from July to an annual rate of 598,000 units, the highest pace since November 2008. Earlier in the week, the National Association of Homebuilders reported that its confidence index rose in September for the third consecutive month.
J.P. Morgan upgraded Toll Brothers Inc (TOL) and KB Home (KBH) to overweight from neutral. M.D.C. Holdings Inc (MDC) was downgraded to underweight from overweight.
Homebuilder stocks swelled this past summer on the belief that the housing sector hit bottom earlier this year after experiencing the worst housing contraction since the Great Depression. However, most economists remain cautious going forward, noting that there are a number of obstacles facing the homebuilding industry. The $8,000 federal tax credit for first-time buyers is set to expire at the end of November. The tax credit has been effective enticing first-time buyers to purchase homes this year. Further, economists are expecting a meaningful rise in foreclosure filings over the next several years due to planned rate resets on option ARM and interest only mortgage loans. A rise in foreclosures promises to increase the supply of existing homes which, in turn, inhibits new home building.
This view conflicts with Rehaut who states, “Importantly, we believe a key distinction between today and the last three and a half year, during which time we have largely maintained our negative stance, is that during the downturn not only did supply rise, but demand also consistently fell as different buyers existed the market. Today, despite being elevated, supply appears more manageable, while demand has begun to stabilize and even slowly re-emerge.”
Homebuilder stocks have more than doubled in value from March lows. However, the top six builders had fallen 86 percent from their peak in 2005 so they have more upside.
Some economists and analysts are also worried that the expected pull back in government housing subsidies (e.g., tax credit) represents a major risk for the housing recovery in the coming months.