An economy that has been good for the wealthy makes stocks of luxury homebuilders a better choice than stocks aimed at first-time buyers, a Wall Street analyst said.
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Jade Rahmani of Keefe Bruyette & Woods this week acquired luxury builder Toll Brothers Inc. upgraded to outperform and downgraded the broader Lennar Corp., saying the former will be better able to defend margins given the economic backdrop.
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“The K-shaped recovery theme has become clearer,” Rahmani said in a telephone interview, citing rising gasoline prices, accelerating inflation and mortgage rates that have risen against expectations, and a somewhat uncertain labor market, all of which are putting pressure on affordability. “When you buy a house, it’s really a challenge,” he said.
At the same time, an “exuberant” stock market makes rich people feel more comfortable, Rahmani said.
The latest home sales data shows that the average price of a new single-family home rose 2.2% in April from a year ago to $422,500. Fewer homes priced under $300,000 have been sold, while more contracts have been signed for homes in the $400,000 to $500,000 range. In May, the average sales price of an existing home rose 1.3% from a year ago to $429,300.
Toll’s median home price is above $1 million, and the company is seeing order growth and solid gross margins, giving them an edge in an incentive-heavy environment. Toll offers potential buyers an average incentive of about 8% to boost sales, usually through upgrades such as granite countertops or adding a home office, Rahmani said. The company gave an optimistic outlook and reported strong margins in its recent earnings results.
Meanwhile, Lennar’s incentives are around 14%, all thanks
Rahmani’s new rating on Lennar was his first sell call on the stock since he started monitoring builders in 2010. The shift reflects issues such as a decline in margins by Millrose Properties, the company’s spun-off land banking operation, in addition to broader considerations.
“I soured on Lennar because of management mistakes,” Rahmani said. Nearly half of the 20 analysts Bloomberg tracks have sell ratings on Lennar stock, while Toll Brothers has one in 20. Toll shares are up 8.9% so far this year, versus a 7.6% decline for Lennar and a 2.4% gain for the S&P homebuilder index.
The rating downgrade was “risky” ahead of the company’s earnings results, he said. Still, Thursday’s results after the market close showed that third-quarter expectations for new orders and deliveries fell below analysts’ expectations. Lennar Chief Executive Officer Stuart Miller said headwinds including higher mortgage rates, limited affordability, inflation and cautious consumer confidence weighed on results and prompted the company to lower its full-year delivery forecast.