Higher Rates Can't Hinder Housing's Recovery

If the recent rise in home sales is yet another indication of the real estate market returning to normal, now may be the time to consider investing in homebuilders.

In July, home sales rose to their highest level since November 2009, when a federal tax credit spurred a surge of homebuying. This July's seasonally adjusted sales rate was up 17% from July 2012, and the 5.39 million homes sold beat economists' estimates of 5.15 million. In a sign that demand for homes is picking up, median home prices have risen to $213,500, up 14% from July 2012. That's the biggest year-over-year gain since 2005.

Will rising rates scare buyers away?
Market experts are predicting that sales could slow due to rising rates on mortgages, but prices should remain high if the inventory of homes remains tight . USA TODAY reports that interest rates have risen a full percentage point since May, meaning that a median-price homebuyer with a 20% down payment can expect to pay about $100 more a month.

The participants in the housing market are also changing. According to ABC News, investors now make up 16% of home purchasers, down from February's 22%. The data also noted that first-time homebuyers haven't joined in, making up only 29% of July sales. A healthy real estate market usually has about a 40% participation rate from first-time buyers .

While stock prices for homebuilders have fallen in recent months due to rising mortgage rates, the sector may provide buying opportunities for patient investors who believe that housing demand should return to normal levels in the next few quarters. After all, even those higher rates remain historically low. Let's examine how some of the top names in U.S. homebuilding are benefiting from stronger housing demand despite rising mortgage rates.

Lennar reports demand in its markets outpacing supply
Lennar's (NYSE: LEN  ) second-quarter net earnings for the period ended May 31 were $137.4 million, or $0.61 per diluted share. Earnings were hurt by the partial reversal of a deferred tax asset worth $41.3 million, or $0.18 per diluted share. Note that a deferred tax asset is used to decrease the company's tax expense in future periods. Earnings for the second quarter dropped about 70% from $452.7 million, or $2.06 per diluted shares in the previous year . 

CEO Stuart Miller remains confident in a solid housing recovery. Demand in all of Lennar's markets is outpacing supply as it is being squeezed by a limited availability of land and fewer competitors. Despite the rate increases, Miller believes homes are still affordable and has noted little impact on unit sales or pricing .

Toll Brothers has rising sales volume and unit prices
For the third quarter ended on July 31, Toll Brothers' (NYSE: TOL  ) net income was $46.6 million, or $0.26 per share. The latest income figures were down 24% from last year's third-quarter results of $61.6 million, or $0.36 per share. The company's total quarterly revenues were $689.2 million, up 24% over last year, and homebuilding deliveries were 1,059 units, up 10% compared to the same period last year .

According to CEO Douglas C. Yearley, both sales volume and prices increased during the quarter; this pattern is consistent with recent quarters. He confirmed that he believes the housing recovery is in its early stages. The company is committed to growth and increased its land position during the quarter. Toll Brothers' community count was 225 at the end of the third quarter, and is projected to grow 10% to 15% by the end of fiscal 2014 .

PulteGroup has high growth expectations
PulteGroup (NYSE: PHM  ) reported $36 million, or $0.09 per share, of net income for its second quarter ended June 30. Net income included charges for several events that took place in the quarter. In the prior year's quarter, the company reported net income of $42 million, or $0.11 per share. CEO Richard J. Dugas Jr. believes the housing market is on track to a long-term recovery. He finds that consumers see good value in the market, despite a limited supply of housing inventory, rising prices, and higher interest rates.

Adjusted home sales gross margin for the third quarter was 23.9%, an increase of 360 basis points. Net new orders for the second quarter were 4,885 homes, down 12% from prior year. On a dollar basis, the value was $1.5 billion, a decrease of 5% from 2012 .

My foolish conclusion
The average PEG ratios for Toll Brothers -- 0.73 -- and PulteGroup -- 0.51-- are much less than the industry average of 1.92. Sales of Toll Brothers' homes may also be less susceptible to rising mortgage rates since the company caters to a more affluent consumer. Both Toll Brothers and PulteGroup have high five-year growth rate projections of about 54% and 30%, as compared to an industry average growth rate of approximately 20%. 

Based on these numbers, and increasing evidence of a strengthening market, Toll Brothers and PulteGroup may offer a good value for investors looking to invest in the early stages of the housing recovery. 

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