6 Undervalued Housing Gems: Morningstar

• Rising mortgage rates have hit investors’ confidence in housing stocks this year.
• But homebuilder stocks will rally because demand is still outpacing supply, according to Morningstar.
• The research firm identified six undervalued gems that have become cheap during the sell-off.

House prices are still soaring, but homebuilding and housing-related stocks are struggling this year. SPDR’s S&P Homebuilders ETF (XHB), which tracks these stocks, is down 25.7% since January 1, compared with a 5% decline in the broader S&P 500 index.

Mortgage rate rises have made investors wary of the sector, according to Morningstar. The

Federal Reserve

hiked interest rates by 0.25 percentage points last month, which typically causes a long-term decline in house prices.

That’s made investors wary of homebuilders like D.R. Horton, Lennar, and Toll Brothers, which have all lost over 25% in 2022.

“There are a few factors feeding into it, but really the concern is affordability, and that’s a function of the fact that real home prices adjusted for inflation are at all-time record highs,” Morningstar’s equity research director for industrials Brian Bernard said. “It’s not surprising that we’re seeing a selloff in stocks.”

But that sell-off has been overblown, according to Bernard. He highlighted six homebuilding stocks that now look undervalued.

Stocks to buy

Bernard is confident about the homebuilding sector in the long-term because housing demand is still outpacing supply. He estimated that the US is currently facing a supply shortfall of 3.5 million units and builds 1.6 million houses each year.

Robust demand helped housing companies post record profit margins last year, and Bernard expects that to help his stock picks to break out of their current slump.

“It will take time for housing supply to catch up with demand, so gross profit margins could remain elevated relative to historical averages for a couple of years,” he said.

Bernard selected three pure-play residential construction stocks and three companies that concentrate on furnishing and remodeling. He said that this latter group will prove “much more stable” than homebuilders even if house prices do start to fall.

“Even if you are pessimistic about the future path of housing, it’s kind of unfair to have some of these players getting hit just as hard,” Bernard said. Their future prospects are likely much better even if demand does soften.”

Here are Bernard’s six housing-related stock picks: