The Housing Chronicles Blog: Home builders still waiting for the bottom

Sunday, February 24, 2008

Home builders still waiting for the bottom

There's a very interesting post at about which public building stocks might be a good buy, but more than that discusses what's going on in the overall market. For example, although larger builders -- which now account for 80% of the market -- have been cutting both prices and staff and even turning to auctions (both on their own and through third-party sources), smaller builders have yet to face up to the same reality:

The big builders, to be sure, have taken their medicine, and this is a good sign. Between them D.R. Horton (nyse: DHI - news - people ) and Pulte Homes (nyse: PHM - news - people ) have laid off 5,000 workers and written down their inventories of land and houses by $3.8 billion. Publicly traded companies build 80% of this country's single-family houses. The rest of the industry is in the hands of smaller outfits, ranging down in size to a carpenter putting up one speculative house. In this crowd reality has not yet settled in. When it does, you will see another round of price-cutting and another round of writeoffs.

Take a look at the auction market. A spec home can go to auction only if the auctioneer, the builder and the bank come to terms beforehand. The auctioneer wants to see a reserve price low enough that he knows the property will move. The bank is going to release its lien only if it knows that any shortfall between that price and the construction loan will be covered by the builder. The builder may be unwilling or unable to put more money into the investment...

Home prices have definitely not hit bottom. The S&P/Case-Shiller national index of home prices was down 7.7% year-over-year to November 2007. But the inventory of existing homes for sale in the U.S. is up 13.2% from a year ago, to 3.9 million homes. Not all of the motivated sellers have been heard from.

Can the Federal Reserve save the day? Not easily. There is a limit to what it can do about long-term interest rates. The last cut in overnight rates, Jan. 30, barely budged the rate on long-term Treasurys. People lending money for 30 years correctly perceive that an overnight stimulus from the Fed doesn't help them. It just means that they are going to be repaid with inflated dollars...

Meanwhile, home builders such as kb Home, D.R. Horton, Pulte Homes and Standard Pacific (nyse: SPF - news - people ) are in danger of breaching the covenants on their bonds because of their financial problems. That may well trigger ruinous requirements to repay investors the face value of the bonds, right away.

What passes for good news in the sector really isn't. Beazer reported in late January that its inventory of unsold homes was down 37% year over year, owing not so much to sales as to a halt in building. Pulte Homes is still holding the line on prices despite mothballing 50 developments; it just recorded its first annual loss in its 58-year history. Debt- and land-laden Lennar (nyse: LEN - news - people ) is rumored to be an acquisition candidate. With some 190, often opaque, joint ventures on its balance sheet, though, that's unlikely...

Is any home builder worth buying? Washington, D.C.-focused NVR (580, NVR ) has very little land--a good thing--and a long record of uninterrupted profitability, even in fraught 2007. If you want to buy now, get that one. Luxury home builder Toll Brothers (nyse: TOL - news - people ) (21, TOL ) has pulled itself into a strong cash position. Toll management has been forthright in confronting its challenges, as when it faced up to a 33% slide in contracts signed for 2007's final quarter. It has pruned excess landholdings, and its operations in the New York City area (one of the few not yet suffering) remain relatively healthy. Toll expects further revenue drops--22% in the current quarter--and I suspect the stock will drop another 10%. Buy it then.

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