By Shaina Mishkin

It isn't a great time to buy a home. It could be a good time to buy builder stocks.

The clouds gathering around builder shares have darkened as investors fret the spring home buying season will be imperiled by the combination of high home prices and high mortgage rates -- despite some recent easing in rates. Some of Wall Street's fears may ease in the coming months, creating a buying opportunity for the group.

The iShares U.S. Home Construction ETF had its worst start to the year since 2022, according to Dow Jones Market Data. The ETF is down 4.3% year to date, with the ETF's home builders down about 8% on average.

The group has room to rise, price targets imply. Analyst ratings compiled by FactSet for the 16 home builders in the ETF suggest the shares could rise an average 31% from recent levels.

Builder stocks sold off at the end of 2024 as mortgage rates rose. The scant home-sales data available for this year so far has done little to put investors' concerns to rest. Contract signings for both new and existing homes sagged in January, with the latter dropping to the lowest level on record.

"It is unclear if the coldest January in 25 years contributed to fewer buyers in the market," Lawrence Yun, the National Association of Realtors' chief economist, said in a statement. "However, it's evident that elevated home prices and higher mortgage rates strained affordability."

Builders have a lot stacked against them as the busy season for home sales approaches. Many buyers remain sidelined by higher costs. The companies' preferred tactic for drumming up demand, offering incentives such as mortgage rate buydowns at the expense of their margins, isn't working as well as it did. Immigration crackdowns or tariffs from the Trump administration would raise costs for builders. All the while, the inventory of homes, both new and existing, is expanding compared with earlier in the pandemic. Investors are now worried about a surplus of homes for sale.

These factors could lead to a slow 2025 and cut into builders' profit margins, investors fear. The companies' gross margins on home sales in 2025 are expected to narrow to an average 22.3%, from 23.7% in 2024, according to analyst estimates for 10 public builders on FactSet. That would make margins the slimmest since 2020, FactSet data show.

But perhaps the biggest issue for home builders right now is all the unknowns. "You have this dynamic of uncertainty really impacting the way people think about what the future could be," BTIG analyst Carl Reichardt says.

That goes for builders as well as investors. Industry confidence measured by the National Association of Home Builders dropped in February as uncertainty around Trump administration's policies stoked fears of weaker traffic in the coming months.

The thing is if any one of the near-term headwinds battering the stocks isn't quite as bad as feared, the stocks could shake off their doldrums. "A lot of these concerns -- higher interest rates, affordability challenges, tariffs -- a good portion is now reflected in the stocks," Jeffrey Kolitch, who manages the $2.6 billion Baron Real Estate fund, told Barron's in late February.

Plus, some recent good news may have gone unappreciated, says Wedbush analyst Jay McCanless. Mortgage rates, while still high, have fallen significantly on signs of economic weakness. Mortgage News Daily on Wednesday registered the 30-year fixed mortgage rate at 6.72%, a drop of more than half a percentage point since this year's high in January and near its lowest level since December. "The move in rates has kind of flown under the radar," McCanless says.

In the long run, economists say millions of new homes are still needed to meet demand from Millennials and Gen Z, a process that will take years. "At the current rate of building it's probably three or more years before we completely fill the gap," says Len Kiefer, the company's deputy chief economist.

The long runway ahead for home construction could make the recent pullback a good entry point. "The entire space could be looked at this point because it has underperformed the market so significantly," KBW analyst Jade Rahmani told Barron's recently . The analyst's most recent price target on Overweight-rated Lennar implies roughly 25% upside from recent levels.

Kolitch, the fund manager, sold shares of builders in the fourth quarter after the past few years' significant run-up. But, given the recent pullback, "we are razor focused on the valuations and aware that there is a unique opportunity to perhaps begin to chip away at some very high-quality companies," he says.

As a group, the builders in the industry ETF are trading at an average of about 1.4 times book value, compared with a five-year average of about two times, according to FactSet.

Kolitch likes some of the industry's biggest names, such as luxury home builder Toll Brothers, and the first and second largest builders by market capitalization, D.R. Horton and Lennar. The companies, which Kolitch's fund still owns, are down on the year. Toll Brothers is about 12% lower, while Lennar and D.R. Horton are both down about 7%.

"If you have an opportunity to buy a best-in-class home builder such as Toll Brothers, Lennar, or D.R. Horton and take a three-to four-year view, you are going to do very well," Kolitch says. Based on their reduced multiples, Kolitch says the stocks could rise more than 50% over the next several years.

The opportunity could extend beyond the industry's biggest names. "I have several small-caps that are trading well below book value, which I don't think is warranted," says Wedbush's McCanless. Among the analyst's Outperform-rated stocks trading at or below future book value are the $675 million Beazer Homes, the $3.2 billion M/I Homes, and the $6.1 billion Taylor Morrison. McCanless's recent price targets on the companies imply the stocks could rise 101%, 55%, and 38%, respectively, from recent levels.

McCanless prefers builders who construct move-up homes for less interest-rate sensitive buyers. But better conditions could be ahead for first-time buyers too.

"Mortgage rates are moving the right way for home affordability," he says. "If we can get some more help, there's still plenty of time for the builders to make the spring season."

Write to Shaina Mishkin at shaina.mishkin@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

March 06, 2025 00:30 ET (05:30 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.