US housebuilders have emerged as surprise winners from the rapid rise in interest rates over the past two years, and these same companies could now benefit again as rates fall. 

The counterintuitive tailwind to new-home sales from Federal Reserve hikes is explained by the fact that most Americans take out decades-long mortgages on fixed rates. Moving house is one of the few triggers that requires a mortgage deal to be renegotiated.

With US 30-year mortgage rates now hovering around 7pc – compared with the below 3pc rate seen during much of 2021 – there is a disincentive for homeowners who locked in low rates to move. Reduced supply means existing home sales are currently running at 4.1m a year compared with a 10-year average of 5.3m, and over 6m before rates began to go up. Lower supply has supported both house prices and new home sales volumes, which are currently running at 619,000 a year.

Markets had not expected this, as illustrated by the rollercoaster ride of shares in PulteGroup, America’s third largest housebuilder. Its shares were savagely derated to 3.3 times forecast earnings two years ago, reflecting predictions of falling volumes and sale prices. They have since rerated to 9.7 times earnings.

Yet even after a 250pc gain from the 2022 nadir, the shares only trade in line with their 10-year average price-to-earnings (p/e) multiple. Meanwhile, the forecast price-to-earnings growth (Peg) ratio looks a bargain at 0.6 times. Peg compares p/e with growth and is normally considered attractive below one.

The value on offer helps explain why even after such big gains so many of the world’s best portfolio managers are betting on more upside to come.

A total of nine of these top investors, each among the top 3pc of over 10,000 global equity managers monitored by financial publisher Citywire, hold shares in PulteGroup. This results in the company earning Citywire’s top AAA Elite Companies rating, which is awarded based on the amount of smart money interest.

Falling interest rates could prove the catalyst to unlock further gains because while house builders have benefited overall from tight supply, demand has weakened.

Many had expected the Fed to start cutting early this year but cuts have not yet materialised. Meanwhile, a ramp up in home building last year and rising building costs have created an anxiety that housebuilders’ margins will suffer as they are forced to offer greater incentives to buyers.

While operating margins are expected to moderate somewhat at PulteGroup, the company has been good at navigating these tricky market conditions. It has cut back on some building to support prices. 

Meanwhile, an abnormally wide difference between mortgage rates and Fed rates has provided it with the opportunity to entice buyers by offering cut-price “buy-down” mortgages while doing less damage to profitability than would typically be expected.

Rate cuts could finally be on the horizon, though. Lower-than-expected inflation numbers and positive comments from Fed governors mean this is widely expected to start in September. That should improve demand at the same time as building costs fall and existing home sales remain muted.

PulteGroup is also well placed to benefit from the positive long-term outlook for the sector. A lengthy hangover from the subprime mortgage crisis has resulted in significant undersupply of US homes. PulteGroup’s management has put the US homes shortage at “several million”. The wide range of home types and geographies PulteGroup is exposed to should help it profit from the opportunity.

Shareholders also stand to benefit from the company’s aim to secure more land under option rather than buying it outright. It wants to ultimately control 70pc of its landbank this way, compared with its current 51pc. This will free up cash to support returns to shareholders. Historically, buybacks have accounted for most of PulteGroup’s cash returns and the share count has almost halved since 2013. A 0.7pc dividend yield is also forecast.

While PulteGroup’s New York-listed shares are available through most British brokers, the right paperwork needs filling out to minimise dividend withholding tax.

The US housing market has been through a particularly confusing and counterintuitive few years, which has wrongfooted many investors. However, the smart money has called it right so far and this column believes top managers’ strong support for PulteGroup ahead of expected rate falls is an example that remains worth following.

Questor says: Buy

Ticker: NYSE:PHM

Share price: $129.99 (£101.12)

Algy Hall is editor of Citywire Elite Companies https://citywire.com/elite-companies

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