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Housing market might slow but there's still ‘a multi-year shortage of houses,' expert explains

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CFRA Research's Ken Leon joins Yahoo Finance Live to discuss housing market trends, the outlook for 2022, and how homebuilders will benefit.

Video transcript

ALEXIS CHRISTOFOROUS: The housing market we know has been red hot throughout this pandemic. And the combination of strong demand and low inventory has pushed home prices up about 20% in just the past year and out of reach for many first-time homebuyers. But there are signs that the housing market is starting to cool off and lose some steam.

Here with an outlook on housing as Ken Leon. He is Director of Research at CFRA. Ken, good to have you here with us. I'm curious if you think housing demand is going to remain strong into 2022, especially now that we believe the Federal Reserve is going to start raising interest rates sooner rather than later.

KEN LEON: Well, it's great to be here. And so housing might ease, but it's mostly coming off year-over-year 20% increases in housing pricing. So demand is still likely to be strong, although getting 20 different homebuyers at the front door trying to outbid one another might taper off. What's likely is we'll see more moderate growth in the single-digits next year for pricing.

But we have a multiyear shortage of houses, which is going to be a boon for home-builders. And it's likely to be a situation, because also with the pandemic, that we'll continue to see families look to new geographies, move from urban to suburban, or even second-tier markets. But I can tell you-- you look at markets like Boise, Idaho or some markets in the Midwest, they are expensive today than where they were maybe 12 or 18 months ago.

Housing is going to be good. Housing is going to be part of the inflation play as well. So I think, whether your risk-on or risk-off from the pandemic, the housing market and homebuilders should be a core part of your portfolio, given that's where the consumer is spending money.

- So housing market is going to be good, but the Fed has yet to announce when they will start increasing rates-- hiking them-- and what impact will that then have on the housing market, because markets are pricing in at least one rate hike next year.

KEN LEON: That's a great question. And what you really have to look at is when the Fed pivots to a rate regime rise of rates, it's also the magnitude and the number of rate increases they have. Prior to a year ago when we look back, when you go from green light to amber or even red light, it's when you get mortgage rates that are 3.5% to 4%.

Back just a month ago, the 30-year conventional fixed rate was 2.98%. So that's what's driving these very high housing prices is that households are able to afford to buy more house because rates are lower. Again, once you get above 3.5%, we probably go from green to amber in terms of raising concerns about rates.

ALEXIS CHRISTOFOROUS: I want to pivot for a minute and talk about where opportunities might be for investors in housing right now. I know that homebuilders, while demand has been very strong, a lot of them actually have been having a challenging time because of supply chain issues and labor shortages-- some of them having to even walk away from some jobs. Who do you like right now in the homebuilding space? And what's your outlook for them?

KEN LEON: Well, first, with that macro thought-- what the builders have been doing really for the last two quarters and well into '22 is managing the pace of home deliveries. That means possibly selling lower volume, but the gross margins on selling homes with higher prices are significantly higher.

That's going to be good for investors in terms of higher earnings. These stocks are trading at ridiculously low PE multiples of six times next year's earnings. And they're getting those lower multiples because of the higher earnings and the denominator.

What do we like? I think for large cap portfolios, we think the winners are Lennar, DR Horton, and also Pulte Home. For small mid-cap portfolios, Toll Brothers, Meritage Homes, and also Taylor Morrison. We think those that have a focus on the entry level new homebuyers obviously have to sell more homes. It's a little bit more of a challenge.

But they've streamlined what is offered to the homebuyer, both in choice of different floor plans and the number of options-- because a lot of options you just can't get, to your point, with the supply chain. Biggest costs for builders-- land. That's not a supply chain issue. Lumber really isn't either, although we saw lumber prices go in the last 12 months from $400 to $1,500, now trading like $550 to $600. Builders can live with that.

But what's really hurting on supply chain is appliances and also windows. But given what I said about pace of homes and higher margins of profitability, these stocks are going to go higher. The key test for any industry in the market is your 2022 earnings for the industry, or in this case homebuilding stocks, higher than '21? The answer is, yes. That is not true for other industries.

ALEXIS CHRISTOFOROUS: All right, Ken Leon, Director of Research there at CFRA, thanks so much for being with us.

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