Homebuilders Likely Have Further to Fall

From time to time, we manage to bite the bullet and take another look into the homebuilding industry, in hopes that we will start seeing some relief on the horizon. Zacks senior analyst Mario Ricchio was once again on hand to sit us down and give us the sobering news.

Your forecasts on the housing market - from 12 months, 18 months and even farther back than that - seem to have been right on. At what point do you think we are right now in the housing down-cycle?

We believe the housing market is at the mid-point of the down-cycle. We had previously discussed the big risk to the housing market from the sheer number of ARM resets in 2008. We estimate that the amount of ARMs on track to reset in the first half of 2008 alone is approximately $521 billion.

The U.S government came around to the issue and launched the “Hope Now Initiative,” which was publicized as freezing teaser rates as low as 1-2%. In reality, the plan set a minimum loan rate at 7.5% that ended up limiting the pool of qualified homeowners. Also, it targeted borrowers with LTVs [loan-to-value ratios] greater than 97%, and that have much less equity at risk than the average American homeowner.

With so many high LTV loans issued during the bubble years, a national home price decline of 10-15% this year could put millions of homeowners into a situation called negative equity. This is already happening to borrowers that purchased homes near the peak of the housing cycle, in the markets that had the greatest price appreciation, such as California, Florida, Nevada and Arizona.

Many homeowners (i.e. primary residency) will try to ride out the difficult market. Unfortunately, speculators with a short-term horizon, that played such a major role in the coastal markets, are likely to put their homes up for sale amid declining prices.

What can be done to arrest the surge in foreclosures?

While there are several proposals out there to stem foreclosures, we hope President Bush uses a veto on them. Let the free market sort it out. Yes, it may take a few years for the cycle to bottom, but it would avoid introducing a new moral hazard into the marketplace.

A government bailout — fostered through an expansion in FHA [Federal Housing Authority]-secured loans — would be taxpayer-funded in the event the loan went into default. And in a proposal where the bank writes down the principle of a $400,000 loan to $300,000, home foreclosures may actually increase.

What happens to your neighbor that does not have a re-negotiated loan? Some incentives are lost for that borrower to make regularly scheduled payments. Rather than a taxpayer bailout, we believe banks should raise capital and its shareholders should take the loss.

The housing market is suffering from a bubble induced by lax lending standards, rampant speculation, over-building and rapid price appreciation. Trying to limit foreclosures would temporarily stabilize prices, but it would do so at the expense of inventory reduction.

What the housing market needs is lower prices, which sends a signal to the homebuilders to slash new starts. At the same time, improved home affordability would draw in new buyers to soak up the glut of existing homes on the market. If we try to prop-up home prices, it will take longer to work off the inventory glut of new and existing homes.

Regardless of what housing solution the U.S government puts into place, homeowners, lenders, and bank shareholders will continue to take losses. The policy response will determine how the losses get distributed among the parties involved.

Are there deals for bargain-hunting investors in housing right now, or is there a ways downward to go yet, do you think?

We suggest investors avoid bottom-fishing or trying to catch the proverbial “falling knife.” Based on current book values, investors may be tempted to buy up homebuilding shares. However, the builders, such as a D.R. Horton (DHI) or a Ryland Homes (RYL) may have to take an additional write-down on land assets and write-offs to reduce land option positions. This means book values have further to fall before they adequately reflect the current condition of the housing market.

How would you advise investors play the housing market going forward? What should we be looking for?

We continue to recommend underweighting housing and housing-related stocks. The builders have another six to eight quarters of poor earnings ahead of them. Given the prospect of a further decline in housing starts, lower median home prices, and aggressive incentive use, industry profit margins are likely to remain under pressure. We do not see an earnings recovery until fiscal 2010. Investors should seek growth elsewhere.

Mario Ricchio is a senior analyst covering the homebuilding industry for Zacks Equity Research.

Comments

[darcydancer]

It's refreshing to see realism here.

[icandoitdon]

damn! cnbc told me the crisis was over!

[drmalaka]

I don't know, all those guys on TV talking their books tell me that housing has bottomed and should start improving this year. Those guys are real smart, maybe even super geniuses like Wiley Coyote.

Why does this Ricchio dude think he has the answers? Just because he has been right all along why would we listen to him? Imagine if you were dumb enough to listen to Ackerman about MBIA four months ago when he said they were down but going lower. Just because he had been right for two years on the stock were we supposed to listen to him? I mean those guys on TV were so convincing, honest and well respected by each other. Oh wait, MBIA hit $5 today, oooooops.

Remember in Feb. when those ABk rumors kept creeping up each week and the stock would trade up to $11 or $12 how does $3 sound like today.

Why do we need to keep going through this dance every month. The people who understand the market and have been right keep telling us what will happen and these morons in the press just keep on fighting them and the market listens to the morons, not the guys who have been proven right.

We need to think out the herd. Let the banks and builders who need to just go out of business and lets start the solution instead of just treading water.

[notsosmart]

sadly-everybody has an agenda.you cant believe anybody.

[User 201843]

The truth at last. Folks this is someone that is telling it like it should be said. The banks and their shareholders should take a hit here! Not the Tax Payer.
Stay away from Real Estate for about a year and a half... it is not going to be healthy for people to do otherwise.