Wall Street is eyeing homebuilder stocks as investors prepare for the next move in the housing market

In the second half of 2022, homebuilders across the country ran into trouble as increased mortgage rates caused buyer eviction rates to soar. In response, many developers quickly upped their incentives, including offering “mortgage buybacks.” While developers in rapidly correcting markets like Reno and Austin have had to go much further, slashing new community home prices by 10%, 15%, or even 20% in some cases.

Those incentives and rebates are now taking effect: New home sales are picking up again, and developer cancellation rates have normalized this spring.

“Rate cuts turned reluctant borrowers into enthusiastic buyers… The post-pandemic housing environment is not the post-apocalyptic wasteland that many predicted last fall,” researchers at Deutsche Bank wrote in a report released last week.

There is growing optimism on Wall Street that stimulus such as mortgage rate buybacks will give homebuilders a head start in the housing market not only in 2023 but as long as mortgage rates remain high. Not to mention that builders face limited competition as the supply of existing homes remains tight due to the so-called “lock-in effect”. Because if homeowners were to sell something and buy something new, they would trade their 2% or 3% mortgage rate for a 6% or 7% rate.

Simply put, companies like Deutsche Bank anticipate that the next step in the real estate market is to see plenty of new construction while the existing/resale market remains constrained.

That enthusiasm from homebuilders led to a rush by investors for homebuilder stocks, including a 55.9% year-to-date rise in PulteGroup's share price. They are followed by Toll Brothers (up 46.9% this year), DR Horton (+25.7%) and Lennar (+24.2%).

Check out this interactive chart on Fortune.com

During the pandemic housing boom – a time of seemingly unlimited demand for housing – developers like KB Home, PulteGroup and NVR made huge profit margins by rapidly raising prices. These high profit margins gave builders the opportunity to reduce their margins (e.g. by cutting prices and/or aggressively pricing) to “find the market”. According to Deutsche Bank, many developers are offering mortgage rates between 5.0% and 5.5% because they pay lenders for so-called “mortgage buybacks.”

In Deutsche Bank's eyes, there's even more room for home equity stocks as the U.S. housing market remains “underdeveloped.”

“We [have] “We expect demand for new housing to be matched by continued normalization in margins and yields, and as book values ​​increase, the…” Stocks should generally rise, but we see an opportunity for stock selection.

In the report, researchers at Deutsche Bank outlined their “target price” prospects for some home builders. See below.

DR Horton – DHI: Deutsche Bank $150 target price (trading at $114.01 at Friday close)

Merit – MTH: Deutsche Bank's $200 price target (trading at $129.67 at Friday's close)

Consoles – PHM: $95 Deutsche Bank price target (trading at $71.99 at Friday close)

Tri Pointe – TPH: $42 target price by Deutsche Bank (trading at $32.38 at Friday close)

Toll Brothers – TOL: $94 Deutsche Bank price target (trading at $74.29 at Friday close)

Taylor Morrison-TMHC: Deutsche Bank's $50 price target (trading at $46.70 at Friday's close)

KB Home – KB: $49 Deutsche Bank price target (trading at $48.74 at Friday close)

NVR, Inc. – NVR: Deutsche Bank price target: $4,400 (trading at $5,818 at Friday close)

Lennar – LEN: Deutsche Bank price target: $105 (trading at $114 at Friday close)

This story was originally published on Fortune.com

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