U.S. Housing Demand Seen Holding Up Despite Rising Rates

Fears that higher home mortgage rates this year will keep buyers away and hit home sales could be overblown.

While interest rates are expected to rise this year and wages will likely remain stagnant, buyers can look forward to a potential slackening in home prices during the crucial spring selling season.

Home prices are expected to rise at their slowest pace in six years as affordability - an industry measure based on income and home prices - is expected to hit its lowest since the recession.

This may hurt margins at homebuilders such as Lennar Corp and PulteGroup Inc, but a pick-up in volumes as buyers slowly return to the market is expected to offset losses.

PulteGroup said in January it expected 2017 gross margin to come in the low-end of its forecast of 24.0-24.5 percent, partly due to an expected drop in affordability.

Homebuilders are also keeping a tight lid on costs as they rein in home prices to attract buyers, analysts said.

"Even in the face of slowing price growth, I think they'll continue to see fairly good profitability," said Alvaro Lacayo, an analyst at New York-based research firm Gabelli & Co.

"Builders are more focused on controlling costs to better deal with slowing price growth."

U.S. home prices have risen steeply over the past four years amid ever-tightening supply and a shortage of skilled labor, crimping affordability for the average homebuyer.

In December, the supply of houses on the market dropped to levels last seen in 1999.

The 30-year fixed mortgage rate, which hovered around 3.77 percent just before the December 2016 Fed interest rate hike, has now risen to about 4.20 percent, according to Freddie Mac.

Annual wage growth, meanwhile, has remained firmly below 3 percent, making it difficult for home buyers to save up for downpayments.

All of this is expected to push down the Housing Affordability Index to 153 this year from 164.8 in 2016.

"As rates go up, it is going to increase the monthly costs of servicing a mortgage which in turn means that potential home buyers are going to have to bid a smaller price when they buy homes," said Robert Dietz, chief economist, National Association of Home Builders.

DISCOUNTS AND INCENTIVES

New home prices are expected to rise only 3 percent this year compared with a 6.4 percent increase in 2016, according to data from the National Association of Realtors.

To be sure, analysts don't expect buyers to start buying homes immediately as affordability still remains a problem and a rationalization in home prices is only expected to boost volumes later in the year.

For instance, if a buyer paid $60,000 in downpayment for a home worth $300,000 in March last year, they would have shelled out $63,540 for the same home in January this year.

While homebuilders have not commented on whether they are reining in prices, analysts said companies have rolled out incentives to offset higher payment costs.

Pulte said it offered higher discounts in the December quarter and some of it "may have been interest rate related."

D.R. Horton, the largest U.S. homebuilder, said in November it expects average selling price (ASP) to be flat to slightly up in 2017. The company's ASP rose 2.3 percent last year.

D.R. Horton and LGI Homes Inc did not respond to requests for comments. PulteGroup declined to comment. KB Home and Lennar Corp directed Reuters toward their publicly issued statements.

"Homebuilders (are) showing a willingness to use incentives to lessen the impact on consumers; consumer confidence has improved considerably, while there is also fear of even higher costs in the future," Barclays analyst Michael Dahl wrote in a note published in March. (Reporting by Sweta Singh and Arunima Banerjee in Bengaluru; Editing by Sayantani Ghosh and Saumyadeb Chakrabarty)