The 30-year mortgage rate tops 5%. Here’s what investors should know

Published Sun, Apr 10 20228:17 AM EDTUpdated Sun, Apr 10 20228:19 AM EDT

Homebuyers aren't the only ones affected by rising mortgage rates. Investors in industries such as mortgage finance, home building and home improvement will likely see a ripple effect. The average rate on the popular 30-year fixed mortgage crossed 5% last week for the first time since 2018 . The rate stood at the 3.3% level a year ago. "There is an overwhelming sense of foreboding hanging over the housing stocks these days. Despite continued reports of strong sales and pricing, in the eyes of many investors, the industry is on borrowed time," Evercore's Stephen Kim said in a note last Friday. "With deeply entrenched fears of housing unaffordability, investors look at the latest mortgage rates and swallow hard," he said. The rapid ascent of mortgage rates comes as the Federal Reserve hikes interest rates in an attempt to rein in sky-high inflation. Mortgage rates typically track with the yield on the benchmark U.S. 10-year Treasury, which has also climbed in 2022. Buying a home or other real estate becomes more expensive as mortgage rates rise, which impacts demand. Every 0.1-percentage-point rise in mortgage rates worsens affordability to the same degree as a 1% increase in the home price, according to Credit Suisse's Daniel Oppenheim. "Mortgage rates are starting to cool off the markets," Philadelphia Federal Reserve President Patrick Harker told the Delaware State Chamber of Commerce last Wednesday . "As we raise rates, it's natural that those rates will go up. And it is natural that you're going to see some cooling of the housing market." Here's what analysts and fund managers are saying about the impact of rising rates on mortgage finance, home building, and home improvement stocks. Mortgage finance Elevated mortgage rates are already affecting prospective homebuyers and current homeowners looking to refinance their properties. Total mortgage application volume for the week ending April 1 declined 6% from the previous week, according to the Mortgage Bankers Association. That's down 41% from the same week a year ago . Refinancing applications also dropped 10% week to week, or 62% lower than same period a year prior. "As purchase affordability pressures intensify, and the financial attractiveness of refi wanes, we expect the mortgage originators to begin to face the meaningful fundamental headwinds that have been increasingly priced by the market over recent quarters," Morgan Stanley's James Faucette said in a note last Thursday. Analysts at Piper Sandler, Jefferies and Goldman Sachs expect mortgage banking earnings to be under pressure as waning demand cramps companies' fee revenue stream. Shares of mortgage lenders are struggling this year. Rocket Companies , America's largest mortgage lender, is down roughly 30% in 2022. The S & P Composite 1500 Thrifts & Mortgage Finance Index is down about 13% for the year . Wells Fargo in late March lowered profit estimates for Rocket, primarily citing lower mortgage origination volume. The firm has an equal weight rating on the stock. "We remain cautious on RKT shares near term and our macro assumption is that the 10-year US treasury yield continues to rise this year," Wells Fargo analyst Donald Fandetti said in a note. Homebuilding Mortgage rates' relation to housing demand also affects homebuilders. "Homebuilding stocks have generally not done well in a rising rate environment because investors anticipate that once rates go up, demand will eventually suffer and that will impact homebuilder profitability," said Alan Ratner, managing director at housing sector research firm Zelman & Associates, told CNBC. According to a KeyBanc analysis, homebuilding stocks fell in 16 of 18 past Fed tightening cycles. "We expect to see an air pocket in housing," Jefferies' Philip Ng said in a note last Tuesday. Some analysts and fund managers aren't ready to get negative on homebuilders just yet. Housing supply has tightened significantly through the pandemic, with homebuilders struggling to meet existing demand. "Supply chain issues and labor kept them away from exploding to the upside, which is just going to elongate the next five- to ten-year cycle for home builders," Bill Smead, Smead Capital Management chief investment officer and portfolio manager, said Thursday on CNBC's "The Exchange." Plus, as renting has become more expensive, homeownership may still be relatively affordable for consumers, analysts at Credit Suisse said. Even so, homebuilder stocks have been hit hard. Toll Brothers is down 36.7% for the year. D.R. Horton is 34.6% lower, and PulteGroup is off 28.8% this year. "If the stock prices are the scorecard, it doesn't matter to investors because the stocks are down in spite of the tight supply," Ratner said. Don't expect to see many breakout names from the homebuilding sector either, according to Ratner. "This is a very homogenous group. I don't think it's likely that one stock will be up and others will be down," he said. Home improvement Home improvement companies' profits surged during the pandemic as consumers spending extra time in their houses shelled out on home renovations and projects. But with decreasing housing demand and soaring inflation, home improvement stocks have been under pressure. In 2022, Home Depot and Lowe's are down 25% and 20%, respectively. During the four previous mortgage rate spike periods over the past 30 years, home improvement retail sales slowed each time, according to a Piper Sandler analysis. On average over the four periods, home improvement sales started to slow five months after mortgage rates moved one percentage point and slowed by an average of 4% to 5%. Piper Sandler on Thursday lowered its 2022 estimates and price targets on Home Depot, Lowe's and Floor & Decor Holdings . "Home Depot and Lowe's say over and over again they're not as well correlated with interest rates, but their multiples sure are," Loop Capital's Laura Champine said Thursday on CNBC's "The Exchange." "You'll see people discounting them at a higher rate than they otherwise would." Not only does housing demand impact home improvement retail sales, but also companies are facing tough year-over-year comparisons due to the elevated consumer demand earlier in the pandemic. "As we come again out of the pandemic, consumers are looking to spend money on services. They're really not looking to buy, you know, the next refrigerator or the next grill," Sarat Sethi, Douglas C. Lane and Associates managing partner and portfolio manager, said Wednesday during a CNBC Pro Talk. "It's a comp story here." —CNBC's Michael Bloom contributed reporting.

Diego Perez works on a Toll Brothers home on August 21, 2018 in Boca Raton, Florida.

Joe Raedle | Getty Images

Homebuyers aren't the only ones affected by rising mortgage rates. Investors in industries such as mortgage finance, home building and home improvement will likely see a ripple effect.

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