Spring Home Selling Season Presents Challenges for Homebuilders

Economic Uncertainty and High Mortgage Rates Impact Housing Market / AP Photo/Ross D. Franklin

The upcoming spring home-selling season is anticipated to be particularly challenging for major homebuilders, primarily due to the potential for a trade war and persistently high mortgage rates. In recent years, builders have accelerated their construction of new homes to address the shortage in the resale market, driven by high borrowing costs that have discouraged existing homeowners from selling. However, with mortgage rates remaining elevated and economic uncertainty looming, builders are facing significant hurdles.

Analysts, such as Rafe Jadrosich from Bank of America Securities, forecast that the difficult environment for homebuilders will likely persist through the first half of 2025. Signs of strain are already becoming evident in the market. For instance, DR Horton, the largest homebuilder in the United States, reported a 1% decline in net orders for the first fiscal quarter, which ended on December 31, compared to the same period last year. The company secured contracts for 17,837 homes during the quarter, falling short of analysts' expectations of 18,478.

To stimulate sales, builders like DR Horton are actively offering incentives, such as mortgage rate buy-downs and smaller homes. Unfortunately, these strategies have begun to negatively affect profit margins. DR Horton's margins fell by 90 basis points in December from the previous quarter, largely due to increased incentive costs, and the company anticipates these costs will continue to rise. Consequently, they project lower gross margins of 21.5% to 22% for the second quarter, compared to 22.7% in the first quarter.

Despite these challenges, executives at DR Horton remain optimistic that the spring selling season could be a turning point. CEO Paul Romanowski expressed the need for the spring season to bring sales momentum. Jay McCanless, a senior vice president of equity research at Wedbush Securities, shares this optimism but notes that a robust selling period hinges on a more stable mortgage rate environment. He cautions that volatility in mortgage rates could negatively impact buyer confidence, a sentiment echoed by builders themselves.

Toll Brothers has also adjusted its expectations, lowering its guidance for home deliveries. The builder anticipates closing between 2,500 and 2,700 sales in its fiscal second quarter, below analysts' estimates of 2,781. CEO Douglas Yearley noted that while demand remained solid in the first quarter, mixed results have emerged so far in the spring selling season. He acknowledged that while demand is healthy in several markets, particularly at the higher end, affordability issues and rising inventories in certain areas are pressuring sales, especially in the lower end of the market.

The overall housing market reflects signs of weakness, as sales of existing homes slowed in January due to high home prices and elevated mortgage rates dampening housing activity. Analysts from Wall Street suggest that challenges extend beyond mere demand. Jadrosich highlights rising land prices and increased competition stemming from higher inventory levels. Data from the National Association of Home Builders indicates a significant 46% increase in the number of completed ready-to-occupy new homes, which have risen to 118,000 compared to the previous year. New homes now constitute 30% of homes available for sale, maintaining the same pace observed in December of the previous year.

Another significant concern for builders arises from President Trump's executive order imposing a 25% tariff on all imported steel and aluminum products, set to take effect in March. The National Association of Home Builders warns that these tariffs could escalate residential construction costs, potentially passed on to consumers, driving up home prices and further impacting home sales negatively.

Research from Wolfe Research indicates that if builders can transfer increased construction costs to buyers, raising the price of a new home by $10,000 would result in an increased monthly housing payment from $2,470 to $2,518, assuming a 6% mortgage rate buy-down. Smaller builders are exercising caution as they navigate the complexities posed by tariffs, elevated mortgage rates, and high housing costs. This uncertainty is reflected in a notable five-point decline in homebuilder confidence, marking the lowest level in five months.

As housing affordability continues to be a pressing concern, Trevor Allinson, director and senior research analyst at Wolfe Research, asserts that the most significant obstacle is land inflation. He elaborates that land prices could rise anywhere from mid-single digits to high single digits in 2025, potentially impacting builders' average selling prices and creating additional headwinds for gross margins.