Why Housing Should Stand Tall


By Michael Jaffe The housing sector has enjoyed a tremendous run over the past decade or so, and so have shares of the companies that build homes. But are the good times drawing to an end? Homebuilding stocks took a hit on Jan. 8, following news that Ryland Group (RYL

; recent price, $74; S&P doesn't follow Ryland), which caters largely to first-time buyers, reported an 8.9% decline in new orders for the fourth quarter.

However, we at Standard & Poor's Equity Research don't think the warning is reflective of the industry as a whole. Given our view that mortgage rates should stay buyer-friendly through 2005, we remain largely bullish on these companies.

As 2004 gets under way, we believe some of the predominant factors that influence the homebuilding industry remain quite positive. Sure, some could work against the sector. We believe that sales levels stayed healthy through late 2003 and will remain solid in 2004, as long as our macroeconomic forecasts are in the ballpark.

MORE AFFORDABLE. Accommodating mortgage rates have been the biggest factor in the industry's powerful performance in recent years. As of November, 2003, S&P projected that average rates for 30-year conventional mortgages would stay in check through 2006. From an average of 5.9% in the fourth quarter of 2003, we're forecasting modest increases to 6.4% in 2004, 7% in 2005, and 7.1% in 2006, on an improving economy.

Affordability should be another big contributor to the still-active pace of home buying in the U.S. With the nation's historically low mortgage rates reducing the cost of ownership, housing affordability reached its highest level in 30 years in the first quarter of 2003.

The most prominent hurdle that we see for home sales in the coming year is the maturity of the present housing cycle. New single-family home sales have generally been in an upcycle since 1992, leading us to believe that pent-up demand has probably already been satisfied. Nonetheless, growing demand from immigrants who are first-time home buyers and from baby boomers who are trading up could continue to drive the market. Another possible obstacle to home sales in the coming year: the sluggish job market.

SOFTER TREND. Despite those concerns, S&P still expects new home sales to remain strong through at least the end of 2004. We estimate that sales of new single-family homes rose in the low double digits in 2003, to a new all-time high of almost 1.1 million units. Sales in the first 10 months of 2003 were up 12%, to 931,000. We expect them to move slightly higher in 2004, to another new record.

As for the multifamily segment, we see the softer trends of 2003 continuing, given the higher affordability of homes, with historically low mortgage rates enabling more individuals to buy single-family homes instead of renting apartments. However, further down the road, multifamily demand should be assisted somewhat by factors such as a growing number of higher-income individuals gravitating toward urban condominiums and capital-gains provisions in the 1997 tax-reform legislation that should particularly benefit those looking to move into smaller residences.

Our top selections in the homebuilding group are D.R. Horton (DHI

; $26) and Lennar (LEN

; $89), each of which is ranked 5 STARS (buy). (Lennar is also a member of S&P's Top 10 Portfolio.) We have 4-STARS (accumulate) opinions on KB Home (KBH

; $67), Centex (CTX

; $100), Pulte (PHM

; $44), and Hovnanian (HOV

; $75). Analyst Jaffe follows homebuilding stocks for Standard & Poor's Equity Research


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