Every now and again, you come across a development that looks remote and innocuous…but is so much more!
I just found one.
Reader, discover ‘the buydown’. It’s a US sales incentive when it comes to the housing market. I don’t think we have the equivalent down here.
What is it and why does it matter?
The Economist reports on US homebuilders:
‘Developers have drawn up a menu of incentives…the novel element, this time, has been aggressive use of mortgage buydowns through in-house lenders, in effect prepaying some interest on behalf of customers to reduce mortgage rates.’
Apparently, a common way of doing this is called a 2-1 buydown.
Money, lent to the borrower (homebuyer), is placed into an escrow account, and used to help service the monthly repayment.
A 2-1 is where the buyer receives the equivalent of a 2% reduction in interest in year one of the buydown and then a 1% reduction in year two.
Then the loan reverts to the original rate at year three. By then, the escrow account is spent, and the buyer should be earning more to afford the higher rate.
You get the idea, I’m sure.
It’s to get buyers into the market with a cheaper repayment for the first year or two than they might otherwise feel comfortable going for.
Ingenious, really. And who knows? Maybe in two years, indeed likely, the Fed will be cutting rates again, and the buyer might be able to refinance at a lower mortgage rate for good.
Hey, this is the US! Why do we care?
The US housing market is a US$45 trillion asset class. The Aussie share market, by comparison, is about $2 trillion.
What happens to US housing is vital for the world’s largest economy…and, therefore, whether the global economy has a tailwind or headwind.
Incidentally, the US housing market has the same problem as Australia. There’s hardly any stock on the market.
This should, at least in theory, put a floor under prices from simple supply and demand.
Another way to view this is through the lens of the stock market. James Hardie [ASX:JHX], for example, gets a significant component of its earnings from North American residential housing.
Here’s what I found interesting on this front: Fed Chair Jerome Powell came out with his testimony to the US Congress.
A report on this came though as this:
‘At this point, a 50-basis-point hike or 25-basis-point hike is on the table at the central bank’s next policy meeting in two weeks…After Powell’s testimony today, odds skewed to the latter. “Consensus thinking was that the higher of the two options was a slim possibility just a month ago.’
Let’s deconstruct all this a bit more. What this is saying is that Powell indicated that the Fed would go harder on interest rates than most were presuming before this testimony.
Gold stocks got hit out here after this. Higher rates hurt gold.
James Hardie, interlinked with housing, is also sensitive to higher interest rates and their effect on demand. And yet it held relatively steady.
How come? We’re taking an educated guess at this point.
One conclusion is that the market is no longer primarily concerned with this current hiking cycle or the next set of numbers from JHX. Investors are looking beyond to the 2024 and 2025 accounts.
It may be too that developments like the ‘buydown’ are helping the outlook for JHX. Anyway, the market can circumvent the Fed’s hikes to increase affordability is a win for the company.
James Hardie isn’t the only ASX-listed stock that can benefit from a renewed and invigorated American housing market.
Beacon Lighting [ASX:BLX], for example, is trying to muscle in here. And so is plumbing group Reece [ASX:REH]. Another one or two spring to mind.
Please note, I’m not saying you should buy the above three stocks…
Only that interest rates aren’t always the full story, and they could benefit from developments more than the market is currently pricing in.
And hey! Maybe we see the buydown ‘innovation’ migrate down to Australia too.
I’ll keep you posted!
Editor, The Daily Reckoning Australia