Barclays is moving to the sidelines on homebuilder stocks heading into next year, growing cautious due to the potential of interested remaining higher than investors expect. The firm downgraded D.R. Horton, Lennar Corporation, PulteGroup and KB Home to equal weight from overweight. "As homebuilding's utopia looks increasingly out of reach, we no longer expect builders to defy gravity," analyst Matthew Bouley wrote in a Wednesday note. "For builders, following two years of relative stock outperformance and an unprecedented market recovery that has occurred in spite of high rates and challenged affordability, we believe the new construction market has now hit a ceiling."
Each of those stocks has been under pressure this quarter as investors adjust their expectations for lower Federal Reserve interest rates. D.R. Horton is down more than 18% in the fourth quarter, while Lennar, PulteGroup and KB Home have shed 15%, 14% and 12%, respectively. The central bank is expected to lower rates by a quarter percentage point next week; however, recent U.S. inflation data makes the outlook for future rate reductions less certain. On Wednesday, the Bureau of Labor Statistics said the core consumer price index—which excludes volatile food and energy prices—rose 0.3% in November. That was in line with estimates but marked the fourth straight month of such an increase.
On top of that, the incoming Trump administration could impose tariffs on a bevy of imported materials used by homebuilders, which could also make it harder for the central bank to lower rates. "Indeed, the journey to the 'utopia' of lower interest rates with a still-healthy macro is fraught with obstacles in 2025, and we think a reset to earnings estimates and valuations is necessary to become more positive on the builder group again," Bouley noted. Unless interest rates take a sustainable path lower, Bouley said the rise in new and existing home inventory will put downward pressure on home prices. Rising labor and land costs don't help their case, he noted, expecting further downside to gross margins for homebuilder companies. "Builders will need to balance a trade-off between margins and dialing back starts growth," he said in the note.
Still, the firm's price targets suggest mild upside ahead for the stocks. Bouley kept his $170 price target on D.R. Horton and $181 target on Lennar, which imply roughly 9% and 13% potential upside for shares, respectively. His $85 target on KB Home suggests 11%, while his $140 target implies the stock can gain 12% over the next year.
D.R. Horton's latest financial results offered a peak into recent homebuilder struggles, as the company missed expectations and offered disappointing guidance. CEO David Auld said interest rate volatility staving off some homebuyer purchases. "We lower our multiple reflecting our incrementally more cautious view on the residential new construction housing environment," Bouley said about D.R. Horton.