Growing demand and an improving economy are undoubtedly building homebuilders’ hopes. Yet land and labor shortages, burdensome mortgage underwriting standards, cutthroat competition and cost inflation amid moderating home price increases could hold back the recovery in 2016.

It would be prudent to take a closer look at these dampeners before investing in this space. Below, we discuss the impact that these can have on the sector in the coming months and years.

Labor/Land Shortages

Several years of production deficits during the housing downturn resulted in a limited supply of both rental and new homes in the country. At present, a shortage of buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing ones.

The labor market has tightened with limited availability of labor arresting the rapid growth in housing production. Also, limited capital for land and land development has left entitled lands in short supply. Moreover, the regulatory environment for mortgages remains challenging.

New home inventory for sale was 226,000 units at the end of October, a 5.5-month supply at the current sales pace, down from a 6.0 month supply in September. Total housing inventory of existing homes was 4.5% lower at the end of October than a year ago, per data released by the National Association of Realtors in October.

Rising Labor, Land and Material Costs

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are resulting in higher wages while land prices are inflating due to limited availability. There could be more inflation going forward. This is eating into homebuilders’ margins considering that home price increases are moderating.

Rising construction, labor and material costs have hurt gross margins of the likes of Lennar Corporation (LEN – Analyst Report), KB Home (KBH – Analyst Report) and D.R. Horton, Inc. (DHI – Analyst Report) in the past few quarters.

Slowing Sales Trends in Texas