The housing market has seen some volatility with mortgage rates as high as 8%, homebuyers pulling out of the market, and inventory remaining low. Despite this, homebuilder stocks have seen an upside in the market. John Lovallo, UBS Homebuilders & Building Products Analyst, joins Yahoo Finance to discuss his take on the housing market and his homebuilding stocks outlook for 2024.

In terms of interest rates, Lovallo said, "We believe that the higher interest rate environment, and who knows where rates go, but let's just say they're higher for longer, is going to cause continued sort of incentivisation which will weigh on margins next year. Now to be perfectly clear, we expect margins to remain above historical levels, but maybe trend down off of today's sort of mid teens. If that is the case, you will see some normalization in returns, but, let's be clear, even on our estimates that are 15% below our sale side competitors, stocks looks compelling from a valuation standpoint."

Click here to watch the full interview on the Yahoo Finance YouTube page or you can watch this full episode of Yahoo Finance Live here.

Video Transcript

JULIE HYMAN: Well, it has been a brutal housing market for homebuyers between a lack of inventory, high prices, and high mortgage rates. But that doesn't seem to be affecting some of the homebuilder stocks. Joining us now is John Lovallo, UBS Homebuilders and Building Products Analyst, to talk about the outlook for this space.

So John, I wanted to start big picture here, right, because the homebuilders have been in an interesting position because of the tightness of the market. There seems to be a lot of demand for new inventory. So have we seen sort of a rising tide for all of the homebuilders as of late?

JOHN LOVALLO: Yeah. Julie, thanks for having me, first of all. I think that's exactly right. The environment out there today is such that there is very little existing home supply. Think about it, mortgage rates went from 3 and 1/4 up to almost 8% a month ago. They've trailed back about 90 basis points since then but are still at very high levels. And when you put that in the context of something like 80% of mortgages in the US being struck at 5% or below and almost 60%-- 4% or below, that's created this lock-in effect where people don't want to move. They can't make that math work.

And surprisingly, demand, overall, demand has remained resilient. So the extent that someone wants to buy a home today more than at any point in history, they've been forced to look at new homes. And I think when you couple that with the fact that the new homebuilders on the public side have the ability to offer a lot of attractive financing options, that has created a lot of market share wins for the public homebuilders and, to your point, has created this sort of rising tide, lifts all boats for the public.

JOSH LIPTON: And, John, I'm interested, too, when you look at your coverage universe, these homebuilders, John, have their business models kind of shifted at all in the last few years? For example, have they become more efficient?

JOHN LOVALLO: 100%, Josh. Look, I think this is something that is not fully understood or appreciated yet in the valuations of these stocks is if you went back a decade ago, in many cases, and not to be disparaging, but in many cases, these companies were looked at as land speculators that at the end of the day will put a home on to monetize that land. That has changed dramatically. They are truly focused on the home and on the community development. They have de-levered. They carry less land. They carry better land.

And in fact, they're doing much more of, I would say, diversified things with their capital where. They're not putting every dollar of cash flow back into land. They're paying dividends. They're buying back stock. So they're much different companies, in our view, require probably a higher multiple.

And to your point on the way they're building, they have absolutely become more efficient as a function of COVID. They were forced to. They were offering less skews. They're building homes a lot more efficiently than they have in the past. And that's evident in the returns.

JULIE HYMAN: Can they sustain this level of returns going into 2024?

JOHN LOVALLO: It's a great question. And it's one that is highly debated at this point. I'll be honest with you, we are a little bit more cautious than I would say some of our sell side competitors. And we believe that the higher interest rate environment, and who knows where rates go, but let's just say they're higher for longer, is going to cause continued sort of incentivization, which will weigh on margins next year.

I'd be perfectly clear, we expect margins to remain above historical levels but maybe trend down off of today's-- off of today's mid-teens. If that is the case, you will see some normalization in returns. But let's be clear that even on our estimates that are call it 15% below, our sell-side competitors that stocks still look very compelling from a valuation standpoint.