Homebuilders offering mortgage rate-lowering incentives are now taking charge of the market

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Published Date 6/12/2023

There’s the lowdown and the smackdown, but Wall Street is now bullish on the “buydown.”

Suffice it to know that in the second half of 2022, homebuilders across the country were scrambling as spiked mortgage rates caused buyer cancellation rates to soar. “In response, many builders quickly ramped up their incentives, including offering ‘mortgage rate buydowns,’” says Fortune's Lance Lambert. “While builders in fast-correcting markets like Reno and Austin had to go much further, and slashed new community home prices by 10%, 15%, or in some cases even 20%.”

A mortgage rate buydown is something many buyers might seek when negotiating to buy a home, but in this case, builders are offering it as an incentive to have buyers sign on the dotted line in order to move through their inventory and build more homes. It’s a way for a borrower to obtain a lower interest rate by paying discount points at closing. Discount points, also referred to as mortgage points or prepaid interest points, are a one-time fee paid upfront. In the case of discount points, the interest rate is lower for the loan term.

According to his report, those incentives and price markdowns are working now: New home sales are on the rise again, and builder cancellation rates normalized this spring. “Rate buy-downs turned reluctant borrowers to enthusiastic buyers… The post-pandemic homebuilding environment is not the post-apocalyptic wasteland that many were predicting last fall,” wrote Deutsche Bank researchers in a report published last week.

Wall Street loves that incentives, like mortgage rate buydowns, will give homebuilders a housing market edge in not just 2023, but also as long as mortgage rates stay elevated. “Not to mention, builders are facing limited competition as existing home supply remains tight amid the so-called ‘lock-in effect,’” says Lambert.

Simply put, those in the know think the housing market’s next move is one where new construction is busy, while the existing/resale market remains constrained until rates begin cooperating or sellers offer to buy down their buyers’ rates as well, which isn’t common in resale.

Lambert reports that builder enthusiasm has translated into a rush among investors to buy homebuilder stocks, including a 55.9% year-to-date jump in the share price of PulteGroup. It’s followed by Toll Brothers (up 46.9% this year), D.R. Horton (+25.7%), and Lennar (+24.2%).

He also recounts how, during the Pandemic Housing Boom—a period of seemingly unlimited housing demand—builders including KB Home, PulteGroup, and NVR achieved huge profit margins as they swiftly jacked up prices. “Those fat profit margins gave builders the breathing room to reduce margins (i.e., cutting prices and/or aggressive rate buydowns) in pursuit of ‘finding the market.’"

"We [have] quickly turned from being cautiously optimistic to decisively bullish on new residential construction," wrote Deutsche Bank researchers in their latest builder report. "We expect solid demand for new housing to accompany a continuing normalization of margins and returns, and as book values grow, the stocks should generally move higher, but we see opportunity for stock selection."

Fortune, TBWS

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