Mortgage rates are moving higher. According to Freddie Mac, 30-year mortgage rates surpassed 6% for the first time since 2008 and are moving directly due to the Federal Reserve's fight against inflation.
Since March, the federal funds rate, or the interest rate that banks charge each other to borrow or lend excess reserves overnight, has gone from near-zero in early March to 3.25% currently. The Federal Reserve is on a mission to bring inflation down closer to its 2% target rate, a goal reiterated by Fed chair Jerome Powell during a speech last month in Jackson Hole, Wyoming. The rate hikes have had a ripple effect across different assets and various market sectors, including nearly doubling 30-year mortgage rates that started the year at around 3%.
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Sales of previously owned homes fell 0.4% in August (compared to July), the slowest rate since May 2020, and it was down 20% from the same month the year before. Home sales have fallen for seven months in a row, and with the Fed intent on raising interest rates, it doesn't look like that trend will change anytime soon.
Given all these factors, three stocks I'll be avoiding as long as interest rates keep rising are Rocket Companies (RKT -0.89%), Redfin (RDFN -1.44%), and UWM Holdings (UWMC -1.03%).
1. Rocket Companies: a top mortgage refinance company
Rocket Companies makes getting mortgages simple by using its app or website to get a quick quote on a mortgage catered to their customers.
Rocket is one of the top mortgage lenders in the U.S. and depends heavily on refinancing loans to drive revenue. The company crushed it when interest rates plummeted to record lows. Last year, it made $13 billion in revenue, and 81% of its revenue came from its mortgage origination business, which makes money from originating and selling its loans in the open market. But the company is feeling the squeeze with rising rates.
What makes Rocket especially vulnerable is its reliance on refinancing to generate income. Rising mortgage rates can discourage people from buying new homes, but they hit refinancing especially hard because people aren't going to refinance when rates are higher. In the first half of this year, Rocket's gain on home sales was down 61%, while its net income (which includes its refinancing segment) fell 69% compared to last year.
The company is shoring up its business, managing costs, and investing in partnerships and products to expand the business and make it through these challenging times. One new product is RateShield, which helps clients lock in interest rates for 90 days until they find a home. Rocket has also entered into an agreement with Banco Santander to originate loans on behalf of the bank. While these moves will help its business, it is still a highly cyclical industry amid the slow part of the cycle. It's best to give the cycle some time to move to the next part before considering this stock.
2. Redfin: the technological real estate broker
Redfin leverages its online platform to pair real estate agents with customers, making the process more efficient and cheaper than other brokers. The company makes money from commissions and fees charged on transactions closed by its business and buying and selling homes from homeowners. Last year it brought in 47% of its revenue from brokerage commissions and another 45% from selling properties.
With significant rate hikes dampening customer demand for homes, Redfin struggled this year. Through the first half of the year, the lender's gross profit increased by 13%. However, rising expenses in technology, marketing, and other administrative costs caused its net loss to balloon from $63 million last year to $169 million this year.
This year forced the company to simplify its business. One way it plans to compete is by attracting renters in addition to home buyers. CEO Glenn Kelman told investors recently that more people are turning to rental houses and that Redfin began catering to these customers in March. While this is a good move, it's not enough to make up for the home sales slowdown.
If mortgage rates and the housing market stabilize, Redfin stock would be a solid buy. However, the current environment has me uneasy about investing in the real estate broker.
3. UWM: a top wholesale mortgage lender
UWM Holdings originates mortgage loans and is the largest wholesale mortgage lender in the U.S. As a wholesale lender, UWM originates, underwrites, and closes loans that an independent mortgage broker writes.
Last year, loan-production income, or income from originating and selling loans, made up 87% of the company's total revenue. The company focuses on home-purchase loans instead of refinancing loans, which can help it perform a little better amid rising interest rates. However, purchase originations are dependent on the real estate market, which has slowed sales. This year, its loan production income dropped 56% to $680 million.
Its loan-servicing income, or fees received for collecting payments from borrowers, was up 41% and helped negate some of those declines in loan production. Loan servicing does well when interest rates rise because fewer ongoing loans are closed as part of refinancing deals. Despite this, revenue is still down 17% overall and net income is down 46% compared to the first half of last year. The company is another that will feel pressure as long as the housing-market demand stays cool amid higher interest rates.
A final note
All of the companies above are well run and do a solid job at their core business, but they are all highly cyclical, and their growth depends on interest rates falling or staying low and stable.
With volatility in interest rates, and with home sales taking such a big hit, I'll be avoiding these companies for the time being. However, if the Federal Reserve were to slow down or reverse its aggressive rate hikes (to combat a recession, for instance), these would be solid stocks to buy once again.
