Rising rates are leading to lower mortgage demand forecasts. But Millennials are increasingly turning to new home builders. Investors are worried about demand if rates keep rising, making many new home builder stocks very cheap now.

Higher Mortgage Rates

The Mortgage Banker’s Association (MBA) reported on April 14 that mortgage applications for new home purchases fell. They declined by 5% from a year ago in March and by 10% from February 2022, a month earlier.

This is a direct result of higher interest rates. The average rate for 30-year mortgages increased to 5.13%, according to CNBC. This is up from 4.90% for conforming mortgage loans with 20% down. The increase over the 5% rate level is the highest since Nov. 2018.

Lower Mortgage Forecasts

As a result, MBA has now forecasted lower new home sales for the fourth month in a row. In addition, MBA expects that there will be a 35.5% decrease this year in total mortgage originations in 2022.

In other words, people are not willing to buy as many homes at higher interest rates. This could eventually put a damper on home prices as the effects of supply and demand work out imbalances.

For example, The Wall Street Journal (WSJ) reported last week that there is a “growing sense of urgency to list properties before the market cools.” The WSJ referred to a study by the Dallas Federal Reserve that the prices of homes were approaching a “bubble” level.

The decline in applications is proof that prices may soon be cooling off, according to Redfin chief economist Daryl Fairweather, says the WSJ.

Lower Mortgage Forecasts

As a result, MBA has now forecasted lower new home sales for the fourth month in a row. In addition, MBA expects that there will be a 35.5% decrease this year in total mortgage originations in 2022.

In other words, people are not willing to buy as many homes at higher interest rates. This could eventually put a damper on home prices as the effects of supply and demand work out imbalances.

For example, The Wall Street Journal (WSJ) reported last week that there is a “growing sense of urgency to list properties before the market cools.” The WSJ referred to a study by the Dallas Federal Reserve that the prices of homes were approaching a “bubble” level.

The decline in applications is proof that prices may soon be cooling off, according to Redfin chief economist Daryl Fairweather, says the WSJ.

Don’t Write Off Real Estate Growth Just Yet

However, the MBA reports that homebuyers are increasingly looking at new homes, given the lack of existing homes for sale.

In fact, the CEO of Tri Pointe Homes (TPH), Doug Bauer, told CNBC’s Squawk on the Street on April 13 that housing is still in good shape long term. Despite interest rates rising over 200 basis points in all 10 states they operate in, they still see good demand for new homes. He said this is because there is a limited supply of new homes, especially for the core Millennial home purchase group.

New Home Stocks Are Cheap

TPH stock trades on a forward price-to-earnings (P/E) of just 3.6 times. According to Morningstar, its average forward P/E over the past 5 years has been 8.6x. This shows that there is no extreme pessimism in the valuation of new home stocks like Tri Pointe Homes. This could make them a good purchase for value investors.

Similarly, PulteGroup (PHM) trades on a forward P/E of just 3.92 times. But according to Morningstar its average in the past 5 years has been 8.66x. 

In fact, a screen of residential home stocks shows that 16 home stocks presently trade for price-to-earnings less than 6 times. The largest is DR Horton (DHI) with a market cap of over $25.6 billion. Its 5-year average forward P/E is over 10.1x but the present forward P/E is less than half that at 4.59x.

This is historically a good time to buy such stocks. Investors clearly expect a good deal of bad news in the next year. Contrarian investors traditionally like to buy stocks when pessimism reigns like this.