Shorting Homebuilders - A Sure Thing

It doesn't happen often that the market conditions present a "sure" money maker, but homebuilders are now as sure a short as they can ever be.

Here are 7 reasons why:

1. Unsold inventory of homes is rising with no signs of improvement, exacerbated by stricter lending criteria by mortgage lenders and rising foreclosures that compete with new construction for a few available qualified buyers.
2. Weak economy, rising unemployment, spent out consumers squeezed hard by high gas prices, higher down payment requirements and still too high property prices place many potential buyers out of the real estate market.
3. Home sales continue to deteriorate. As reported yesterday by the National Association of Realtors, home resales fell 2% in February and inventory of unsold homes have risen 1% representing a 9.9 month supply at the pace of sales in March.
4. Many of the builders have loans that will mature and be due for refinancing over the next two years and some of them may not be able to "roll" them.
5. On top of all that, homebuilders are finding themselves between the rock and hard place of inflation. Rising cost of labor and building materials against collapsing revenues spells trouble for profit margins. What profit margins?
6. Despite all of the above, homebuilder stocks have risen year to date as much as 60% from the bottom in January, making their valuations based on the current and next year estimates astronomically expensive...
7. The insiders are actively selling their stocks at fraction of the value of 2006 and 2007 - taking advantage of the bounce from the low? Who knows the state of the business better than insiders? Do insiders know that the glut of unsold homes and tighter credit standards are not helping buyers and hurting sellers?

When a high stock price is combined with weak and further deteriorating fundamentals - the stock price will follow the fundamentals.

The easiest way to take advantage of this rare situation, is to short US Home Construction iShares (ITB) ($20.70) or short individual builders such as Ryland Group (RYL) ($34.00), Pulte Homes (PHM ($14.06) and others.

In my long and hard earned experience, real estate cycles NEVER turn quickly. They are always long, they last for decades and this is one of the worst kind.

I am shorting builders. You place your bets.

Disclosure: Author holds short positions in the above-mentioned securities.

Comments

[Mule:]

There are a few more "non-homebuilder" items not mentioned which makes shorting homebuilders compelling. Owning a home is becoming less affordable to the masses every day. Property taxes increase every year, heating & cooling costs are going through the roof. Some areas of the country you can't even get homeowner's insurance.

2008 Apr 23 07:12 AM

[ringy:]

I don't know about real estate taking decades to turn around. Having lived through the 80s in Dallas when oil prices went from $17/b to a nose-bleed $33/b ;) Real-estate tanked massively. Condos that once went for mid-80s sold for 20K. Yup you read it right - 20K. It took about 8 years for the mess to clean up. But it did. So depends on your level of patience. But $ cost averaging into XHB may not be a bad thing.

2008 Apr 23 10:02 AM

[sorgmot:]

Stop by our site to see our experimental short portfolio of 30 stocks across many industries.

Our advice is to know a date or a price at which you will cover.
Fit your shorts to the business cycle. Make any short position a very small part of your portfolio. Short positions are risky even if successful, do not make as much money as long one.

2008 Apr 23 11:32 AM

[Govitman:]

Alan...I am in total agreement with your post. I am short homebuilders myself. With that said, whenever I hear someone mention "a sure thing" I start to get a little worried.

Sorgmot...I am confused by your comment on short positions being risk and not making as much money as long one. Unless all your long are averaging 100%+ returns, shorts can be just as profitable as longs with the same risk. Can you please explain your reasoning

2008 Apr 23 12:39 PM

[fbrothers:]

The problem will also be rising interest rates. And interest rates are going higher. In order to stop the bleeding U.S. dollar. So far, the only companies to meet or exceed earnings are the ones that have benefited from the weak dollar.

2008 Apr 23 02:25 PM

[Ames Tiedeman:]

This looks promising. I do not know how any of these builders will make any money this year or in 2009.

2008 Apr 23 10:39 PM

[JDan:]

Another "sure thing" article is one of the strongest indicators that I can think of to go long the XHB at this point.

2008 Apr 24 03:04 AM

[Adanenberg:]

I would agree if it were May 2006. Since then, the ITB reached a low of $13.40 on January 9, 2008 with a loss of -73% from its high in May 2006. It's certainly not a "sure thing" at this point. As a matter of fact, I believe ITB is a buy for long-term investors.

2008 Apr 27 04:24 PM