Homebuilders Near a Bottom: Five Stocks to Benefit

Recent stock price performance of homebuilders and those that are affected by the housing slow-down that began in late 2005 echoes the sentiment shared by many of its pundits, including top executives of many homebuilders. At a recent Real Estate Summit in New York, Larry Sorsby, executive vice president and chief financial officer of Hovnanian Enterprises (HOV) said, "08 is probably not going to be a year of strong recovery. Our hope is that it stays no worse than we are today. We're not predicting any significant recovery".

According to Mortgage Banker's Association, nearly 50 mortgage lenders have folded due to the subprime crisis as part of a natural thinning of the industry. Robert Toll, Chief Executive of Toll Brothers (TOL) said at the summit, "I think there ought to be regulation of subprime. I think there ought to be regulation of prime. I don't think that the economy is best left to its own devices almost ever. The excesses that are permitted in the mortgage industry can and perhaps have led us into a dark hole."

The recent earnings reports from other homebuilders have reinforced this negative view. Even so, rumors of Warren Buffet buying shares of HOV led housing stocks higher on Friday on higher-than-average volume. The Dow Jones U.S. home builder index [.DJUSHB] is down about 25 percent so far this year and has lost half its value since July 2005. Currently, it sits at a key support level around 550, yet some real estate and financial pundits predict that housing stocks will remain week until interest rates start dropping.

Indeed, there is little evidence that residential real estate prices have bottomed. In Florida even with discounts of $100,000 on some homes, builders said they had realized that some developments simply would not sell and were opting to just hold onto the land for a few years in hopes of a market pickup. I recently had a conversation with a successful real estate agent in Southern California, and he summarized the market as being "terrible". He indicated that people are not "motivated" to buy and there are way too many homes that are being listed everyday. Too many sellers, no buyers. Most real-estate agents are not as honest. They are either too ashamed or too proud to admit that business is slow.

And it seems like the government does not want the price declines either. Appraisals, even those conducted by the city, are coming in higher than what buyers are willing to pay. One reason for this could be that counties that have enjoyed the excess cash from property taxes of high priced real-estate want their coffers to stay flushed. For this reason, sellers have thrown in all sorts of incentives like a free new car, free mortgage for a year, cash back for closing costs and lots more. But these $20,000 to $30,000 incentives pale in comparison to the prices still being demanded by sellers. The dichotomy between rental rates and mortgage rates for the same property is too huge and the gap needs to narrow before we can see home prices stabilize.

On the other hand, stock prices of home builders usually run six months ahead of any long-term trend changes. For instance, the home builder index mentioned above peaked in July even as home prices were going up in states like Florida and California. If you are looking to invest in the homebuilders, I believe its time to start picking away at some of the better ones. I recommended MDC Holdings (MDC) back in September of last year. Since then the stock has been up as much as 30% before pulling back to a gain of 10% as of last week. Some other ones that are worth buying on dips are Hovnanian (HOV), Standard Pacific (SPF), MDC Holdings (MDC), KB Home (KBH) and DR Horton (DHI). Just keep in mind that investing in home builders will require patience and a stomach to sustain a little loss for a few months.

Full Disclosure: I do not own any of the stocks mentioned here but this can change anytime without notice.

Comments

[tblakeslee:]

I am amazed that you would repeat the ludicrous rumor about Buffet which was clearly a planted lie by someone trying to get out of the stock. The home price freefall hasn't even begun as ARM resets which will increase payments by 40% are just beginning. They will peak next year and trigger even more forclosures and auction sales. These resets are in the pipeline and completely predictable. Here is a graph of coming resets:
www.autodogmatic.com/f...;highlight=resets

2007 Jul 16 11:11 AM

[Faisal Laljee:]

I don't disagree with you about foreclosures. If you follow my past posts, I have been talking about the Mortgage meltdown for a while. See stocksandblogs.com/200...

However, stocks and the companies they represent do not trade lock and step. I recommended CFC back in April and the stock is up since my recommendation. In fact, it was up as much as 25% after I wrote a bullish piece on it and currently sits 10% above the recommnded level. See stocksandblogs.com/200...

I also recommended MDC Holdings as indicated above and the stock is still up from the levels I recommended it even though housing is down.

-- Faisal Laljee

2007 Jul 17 06:15 AM

[joyofyoga:]

I'm with you Tom! My Mr. Lalijee is also trying to get out of these stocks. Why would a rationale person purchase a real estate stock?! There have to be some fundamental reason that those stocks will increase because surely there isn't a technical indication. No sane person would purchase a home today when they know the could pick it up for less in a year from now and even lower in two years. This is going to be a long, protracted real estate bear cycle. $1.5 trillion in arms are resetting this year, just THIS year, not next year. Next year there will be more. And people can't refinance at lower rate or lower payments so they are walking away from their homes. Not just individuals but block and communities of people. I see it every day in my business. Unfortunatley the media is focused on the big money, on Wall Street money, and then you can rationaize that it's only a small portion of their business. But the bottom line upshot is there is a glut of inventory on the market for sale and more becoming available every day. So that's the supply side, the inventory. Where is demand coming from? It's not like retail sales, say food. You have a big meal, you digest it, you need to eat again. How many homes can people live in at one time. The folks that already purchased are out of the market. The second home craze is a memory. There is no one to absorb the glut of inventory that is rolling down the tracks. Anyone who purchases real estate in the hope that it will go up in the near future is hallucinating.

2007 Jul 17 12:31 AM

[Faisal Laljee:]

As mentioned in my disclosure above, I do NOT own any of the homebuilders. Therefore, my viewpoint is completely unbiased. USG is also considered a real-estate stock. Do you consider Warren Buffet a fool for buying a 17% stake in this company?

2007 Jul 17 06:18 AM

[joyofyoga:]

Hey Tom - Just read that link! AMAZING! This is a great synopsis:

Posted: Wed Mar 21, 2007 12:37 am Post subject: Neg AM Recasts vs. Subprime Adjustments
The problem with Neg Am resets from loans originated in 2005 is that payment adjustments after recast can make the payment triple whereas subprime adjustments are typically around 30-35%.

Lets take a standard $350,000 loan at 75% LTV and compare a subprime 2 or 3 year fixed (interest only for first 5 years) at 6.5% to an "A" paper, prime option ARM with a 1.10% start rate, 40 year term, 5 year payment plan, 110% max increase to the principal balance.

Subprime: 350,000 at 6.5% = $ 1895., 1st adjustment: 3% to 9.5%. New payment: $2770.83. 32% increase. Interest only, no increase to balance, but decrease to value.

A paper Option ARM: $350,000 at 1.10%, 40 year: $901.64. Depending on margin, balance increases to 110% between months 28-38 (not 5 years payment schedule that is reflected on Reg Z). New balance at 110% $385,000 recast for remaining loan term per terms of note (NOW FULLY AMORTIZING) at fully indexed rate: 8.0% is fair average: new payment: $2702.00. Loan balance has increased and values have decreased. Add a piggy back second or E-line, and well... you get the picture.

The 30 year A Paper Option ARM fares a bit better. The recast occurs around the 36th month, and the payment only increases about 64%.

So, which is really worse, a stated subprime with a 32% payment increase or a stated income A paper Option ARM with trippling payment?

The Neg AM A paper loans aren't even on the radar screen. I nearly choked when Leatherface said that only 7% of their loans were subprime- when they led the pack in Neg AM financing (only they went to 90% CLTV). The only saving grace for Countrywide is that they went to 115% before recast which buys them a little more time than Downey.

This whole bubble thing is just getting started in California. Since incomes aren't rising to meet prices, prices will have to drop to meet incomes. Any economist that doesn't consider area incomes in their predictions are simply not doing the math. In the end, math always wins.

There is quite a bit of opportunity in the market. Some loans can be fixed, others can't. Some people who can hold out long enough will likely receive loan modifications with affordable payments. Some won't be so lucky.

One thing is for certain, however, is that affordability is going to be restored, and in the end, that is good math for economy and the industry.

Of course, I am curious how much this will really cost the taxpayers....
_________________
"Two things are infinite: the universe and human stupidity; and I'm not sure about the the universe." Albert Einstein

2007 Jul 17 12:43 AM

[Fred W:]

Are you drunk?
Try another career.

2007 Aug 05 06:56 PM