Homebuilder stocks have seen significant gains since investors began factoring a potential September rate cut from the Federal Reserve into their expectations. Oppenheimer executive director Tyler Batory says that to approach homebuilders, one must always consider the impact of interest and mortgage rates on market performance.

When examining the existing home sales market, weakness in the resale sector is notable, but Batory stresses that this presents an opportunity for public builders to gain market share. Moreover, he points out that the strong margins and profitability seen among builders in recent periods represent "strong tailwinds" driving the stocks higher.

However, Batory does not believe a rate cut will be sufficient to thaw the somewhat frozen housing market. He also argues that mortgage rate buydowns may hit builders’ profit margins more heavily than anticipated.

Batory recommends Toll Brothers (TOL) and PulteGroup (PHM) among his preferred stocks within this space, citing reasons in the video above for these selections.

Navigating Big Picture with Yahoo Finance Playbook

Homebuilders are experiencing a surge. Encouraging economic data have led investors to believe the Federal Reserve could ease interest rates soon, boosting homebuilder stocks’ growth and putting the sector on track for its best performance this year. We welcome Tyler Batory, Oppenheimer Executive Director, to discuss these developments.

What’s Behind This Bullish Trend?

Tyler: When considering homebuilders or the housing market, one crucial aspect is always the influence of interest rates and mortgage rates on both consumer affordability and builder profitability.

You see, a rate cut – most likely in September, given current projections – while beneficial for borrowers and sellers alike, may not be as transformative as anticipated by some. A mere 50-basis-point decrease won’t radically alter the housing landscape or immediately inject supply into the market from existing homeowners who prefer to remain locked into their properties.

Impact of Mortgage Rate Buydowns on Builders’ Bottom Lines

Tyler: Homebuilders do have a powerful ally in mortgage rates, though. By buying down these rates, they can offer a more affordable mid-$500,000 price point compared to the current market average around $700,000, improving affordability and driving potential buyers toward new homes.

Will This Strategy Hit Builders’ Profits?

Tyler: Yes, there is a slight hit on profitability when homebuilders reduce mortgage rates for consumers. However, this strategy can have offsetting positive effects; specifically, if the ongoing trend of mortgage rate decreases continues, it won’t be as necessary or costly to lower those rates further.

Selecting the Right Stocks

Tyler: For investors looking to play this trend within publicly traded homebuilders, I recommend Toll Brothers. It’s situated at the higher end of the value scale among builders and focuses on a distinctly affluent clientele, with nearly a quarter of its buyers paying in cash for its properties.

For those seeking to avoid market bets on segments or consumer preferences, PulteGroup offers a balanced portfolio that mirrors the market more closely, incorporating a range from entry-level homes through higher-priced options. This diversity should appeal especially to those concerned about either betting too heavily on one end of the market spectrum or missing out on broader housing trends.

Tyler: And that’s how you would approach investing in homebuilders today with these two top picks in hand, offering diversification and a strategic move into the housing market while it remains strong.