Top 3 Homebuilder Stocks to Watch as Rates Drop

Key Points

• The Fed's September rate cut has pushed mortgage rates down and may make it easier for homebuilder companies to finance new developments.
• Nonetheless, these firms face a prolonged credit crunch, and the market may have already priced in the bulk of the benefit of a rate cut.
• Individual homebuilder stocks with a size or product advantage may still have room to grow.

The Federal Reserve launched the first of several expected interest rate cuts in its September meeting, making a larger-than-anticipated half-percentage-point reduction. The real estate market, plagued by issues including insufficient supply relative to surging demand and mortgage rates that have risen dramatically since their COVID-era lows, stands to benefit from the rate cut.

In the days following the Fed's announcement, rates on 30-year fixed-rate mortgages dropped to just over 6.1%, their lowest rate in two years. Rates had already been falling for several weeks prior to the September meeting, as markets predicted a reduction of the federal funds rate. This provides additional incentives to homeowners to sell their homes and move and to first-time buyers to put in offers.

Homebuilding companies may also capitalize on lower costs of financing construction and land development, allowing for an increase in the production of new homes. This could help offset the housing shortage and potentially bring down home prices—or at least help slow their climb.

Investors should consider whether homebuilder stocks have already priced in all of the likely benefits of a rate cut or if there's still room for growth. Given that the SPDR S&P Homebuilders ETF NYSEARCA: XHB has already increased more than 58% in the last year, it's easy to see why some investors may be cautious. However, a handful of homebuilder companies stand out nonetheless.

DHI: Market Dominance and History of Growth

D.R. Horton Inc. NYSE: DHI has been the largest U.S. residential construction company in terms of volume for over 20 years and the dominant homebuilder—producing the largest share of new homes—in about half of all markets in which it operates. With a focus on entry-level homes at a low price point, D.R. Horton posted diluted EPS of $4.10 in the latest quarter, up 5% year-over-year, on 2% consolidated revenue growth at a time when some other homebuilders struggled to maintain an upward trajectory.

Analysts project that the company will see earnings growth of nearly 10% on top of its recent gains in this area. This is all as the stock is already up more than 73% this year and trading just off of all-time highs. Though it's already a $62-billion major player in homebuilding, D.R. Horton may still have room to climb.

IBP: Key Midwestern Expansion

Installed Building Products Inc. NYSE: IBP is just a fraction of the size of D.R. Horton, but this company specializing in the installation of insulation, waterproofing, and similar materials in home construction offers an impressive financial performance given its 44.9% return on equity and last-quarter earnings beat.

Perhaps even more importantly, Installed Building Products is in the midst of a strategic expansion plan. The company recently acquired Euroview, a maker of shower and closet doors and similar components for home construction. The acquisition is expected to add $20 million in annual revenue to Installed Building Products' top line, and it should improve the company's position in the Illinois and Minnesota markets, both of which are sizable and growing.

BLDR: Single-Family Projects Lead

Builders FirstSource Inc. NYSE: BLDR is a supplier of materials and pre-fabricated components used in home construction. As such, the company has a role to play in the building of many different types of homes throughout the country. In its second-quarter report, revenue declined by 1.6% and net income by 15% year-over-year, largely due to a slowdown in multi-family homebuilding. The company has also recently gotten a share boost from a planned CEO transition and a new $1 billion share repurchase program.

A bright spot for Builders is single-family development, which is expected to grow in the single digits for this year. Even before the Fed's announcement, nationwide single-family home construction began to pick up significantly. A September report from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development showed single-family housing starts in August up almost 16% relative to July.

Credit Crunch Easing?

Prior to the Fed's rate cut, U.S. homebuilders faced a year-over-year reduction in lending from banks of about 10%, the greatest credit crunch for the industry in at least a decade. Lower rates could help to reduce this obstacle, though the situation will likely continue to improve into 2025 if additional rate cuts arrive as expected.