Builder Stocks Drop as 10-Year Treasury Yield Rises

Builder stocks experienced a decline on Tuesday, potentially due to the increase in the 10-year Treasury yield, a factor that often influences mortgage rates. Notably, two exchange-traded funds tracking builders and related companies, namely the SPDR S&P Homebuilders ETF (XHB) and the iShares U.S. Home Construction ETF (ITB), dropped by 3.2% and 3.8% respectively.

Tuesday's pullback can be attributed to the rise in the 10-year Treasury yield, which reached a preliminary 4.247% in the morning — marking the sixth highest yield of 2023 according to Dow Jones Market Data.

On the same day, D.R. Horton (DHI) experienced a decline of 4.6%, whereas PulteGroup (PHM) saw a decline of 6% and Lennar (LEN) dropped by 4.9%. It is worth mentioning that these three builder stocks have shown significant growth this year, with their values increasing between 27% and 70%.

The increase in yield signifies potential rises in mortgage rates, which have remained relatively high throughout this year compared to their historic lows seen earlier during the pandemic. In fact, the average 30-year mortgage rate, as tracked by Freddie Mac, reached as high as 7.23% in August — its highest point in decades — before slightly decreasing last week.

The combination of rising rates and strengthening home prices has put considerable pressure on prospective buyers. In particular, a buyer of a $400,000 home would owe nearly $400 more each month if they were to buy at last week's average rate compared to the average rate from a year ago.

While higher mortgage rates have negatively impacted existing-home sales, new home sales have seen growth as prospective buyers actively seek options. Builders generally possess greater flexibility than homeowners when it comes to offering incentives, such as mortgage rate buy-downs, in order to stimulate business.

However, this increased volume may come at the expense of builders' margins, as noted by analysts from Moody's Investors Service. In a recent note led by Griselda Bisono, the analysts predicted that "incentives and other factors will lead prices and builder margins to fall through 2024" for new homes. They also highlighted the fact that the limited inventory of existing homes for sale, as homeowners are hesitant to sell due to locked-in low mortgage rates, will only partially alleviate the strain on builders' revenue and margins.