Housing Still in a Rut but Homebuilders Near a Bottom
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, rumours 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 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.
– Faisal Laljee
Full Disclosure: I do not own any of the stocks mentioned here but this can change anytime without notice.
In your story you quote Sorsby from Hovnanian who “hopes” 2008 does not get any worse and then you claim homebuilder stocks are a good buy. Let me clarify, you said they are a good buy because they tend to look six months out. Isn’t that contradictory? Then you went a step further and said investors who buy now “may” have losses for a short period of time.
Unfortunately people who blindly follow your advice are in for a rude awakening. The temporary small losses that you warn of may turn out to be permanent large losses. In some cases they may be 100% because at least one of the major builders (my money is on HOV and BZH) will file for bankruptcy. Perhaps you should do a little research and stop drinking the kool-aid. Things are bad and getting worse with no end in sight. The statistics reported are bad but the real data is much worse. Check out the raw data on the home sales to get an idea.
Any sane individual knows Buffett has no interest in Hovnanian. Hovnanian is a heavily shorted stock, on the Regulation SHO list, and we have option expiration next week. Do you think perhaps this was rumor was floated out there by somebody who is in underwater? Perhaps a large writer of puts? The homebuilders with their large debt loads and poor cash flows are not the types of companies Buffett would target.
This real estate bubble is something we have never witnessed before. The homebuilders were greedy and continued to purchase land and build houses as fast as possible. Now with the downturn they cannot sell them. There is nothing like carrying depreciating assets on your books. The “peak” selling season has almost passed and sales continue to erode. What do you think is going to happen with all of the inventory over the next six months? Is it going to magically disappear? What happens when sellers of existing homes begin to drop their prices in order to compete with homebuilders and their large discounts and free incentives? What if rates creep up? What happens when the ARMs adjust and people that can barely make their payments now are looking at payments in some cases three times greater?
Your recommendation to buy homebuilders is wrong.
Over a short period, stocks almost never sync with the state of a business. The stocks have fallen up to 75% in some cases since reaching a peak back in July 2005. There is hardly anyone out there bullish on homebuilders. Yet, as soon as these stocks turn around, bears will become bulls, analysts will start upgrading and before you know it, you will have missed the move.
Yes there is inventory that needs to be cleared. There are developments that have been halted due to the inventory glut, but do you think thats a secret? These stocks have priced in all that and more. Any bad news you can think of has been priced into the declines and the smallest hint of good news will send these stocks up. The risk/reward is pretty good. The stocks I named can go 15% lower, but 50-70% higher over the next 2-3 years. I recommended MDC last Sept, and those who bought were sitting on 30% gains earlier this year. Today, they are still sitting on 10% gains. Money can be made in stocks no matter how bleak the future of the business. Do you think Warren Buffet is a fool to have bought USG? He has bought a lot of the stock at $45 because he knows that when things turn, the stock will hit $70-$80 in quick time.
– Faisal Laljee