What happened
Shares of residential mortgage lender PennyMac Financial Services (PFSI -0.77%) and homebuilders/financers D.R. Horton (DHI -1.29%) and Meritage Homes (MTH -2.21%) all fell by more than 10% in October, according to data provided by S&P Global Market Intelligence. That was much worse than the S&P 500, which sank only 2.8% during the month.
D.R. Horton -- the largest homebuilder in the U.S. by number of homes sold -- had the smallest decline, with shares "only" down 11.7%. PennyMac's stock fared slightly worse, down 12.6%. Meritage Homes got hammered, though, tumbling 21.1%.
It was a rare month of underperformance during 2020, which has been a stellar year for real estate-related stocks. Even with October's sell-offs, all three stocks are up big. So far this year, D.R. Horton's shares are up 38.3%, Meritage's are up 58.4%, and PennyMac's have soared an amazing 67.3%, compared with an 8.7% year-to-date gain for the overall S&P 500.
Image source: Getty Images.
So what
Lots of conflicting trends are impacting the residential real estate and residential mortgage markets right now. So far in 2020, those trends have generally been a net positive for both homebuilders and mortgage lenders. It's worth noting that while Horton and Meritage are both builders of new residential housing developments, they also have financing departments, essentially serving as their own mortgage lenders. PennyMac, on the other hand, is a pure-play residential mortgage lender.
There were some troubling signs for the mortgage industry in October. During the week of Oct. 12, the average interest rate on a 30-year mortgage again fell to a new record low of 2.81%. It was the 10th time rates had hit historic lows in the last eight months alone. Lower rates, of course, mean that lenders make less money on each mortgage they offer. Worse for lenders, the active housing market we've seen has meant that plenty of sellers are moving into a new home, swapping an existing higher-interest mortgage on their old home for a cheaper one on their new home.
This trend is clearly a problem for lenders, but there was another concerning data point that emerged in mid-October. According to a report from the Research Institute for Housing America (RIHA) -- a subsidiary of the influential Mortgage Bankers Association (MBA) -- more than 6 million U.S. households failed to pay their rent or mortgage in September. That amounted to about 8.5% of renters and 7.1% of homeowners. While it's an improvement from the numbers in late spring and early summer, it's an indication that the recession and pandemic are still having an impact on the industry. Analysts are concerned about what will happen when eviction moratoriums expire in January.
The three companies' share prices had been faring relatively well for the first half of the month, but the releases of these numbers coincided with the beginning of their respective share price declines. Investors were probably inclined to take profits in October prior to the companies' Q3 2020 earnings releases. Fall 2019 marked the beginning of the U.S. housing boom, so homebuilders' Q3 earnings are likely to seem less rosy with tougher year-over-year comps with which to contend.
Now what
One trend that should benefit homebuilders like D.R. Horton and Meritage is the ongoing lack of housing inventory. Those cheap mortgage rates coupled with a lack of available inventory have caused a severe shortage of existing homes on the market, and competition is fierce, driving up home prices. That ought to benefit homebuilders: After all, why spend months trying to win bidding wars for homes when you could just get a new one built to your specifications?
Better still for developers, the coronavirus pandemic has put a premium on large homes with plenty of room between them and their neighbors -- features that are much more likely to be found in new housing developments than in existing housing stock. It's no surprise that Horton and other homebuilders foresee a strong market for their products over the next five years.
While low mortgage rates may weigh on PennyMac and homebuilders' financing arms, housing still looks like a solid bet for the future.
