House Builders

[Jason Strasser (strassa2)]

Seems like the last 2-3 months, the housing builders have just been getting punished. A combination of lending issues and an overall downturn in the RE market seems to be the catalyst. Isnt stuff like this cyclical? Is this a decent time to buy into this market? Also I'm sure there is a simple answer for this, but why are the housing builders getting crushed and the REITs are not getting hit nearly as bad?

[ahnuld]

I may be wrong but I think REITs are alot more commercial real estate whereas homebuilders are residential of course. And I was thinking toll brothers and other home makers might be cheap now. But im just guessing, I havent looked into anything.

[DesertCat]

Homebuilders have appeared cheap since last year. Their earnings were at a cyclical peak, and still the homebuilders were all trading at less than 10x earnings. Now those earnings have dropped substantially and stock prices have followed. It may be overdone, I don't have an opinion because I haven't done any research.

Here is an article about some of the issues from the Wall Street Journal.

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Risks Pile Up for Builders
Shares Remain Vulnerable
As Impact of Surety Bonds
Could Bring Down Values
March 28, 2007; Page C16

Earnings at Lennar, the largest U.S. home builder by revenue, fell by 73% in the last quarter. Home-building stocks, inflated by the housing bubble, have given up all the gains they've made since 2004. They are selling now for little more than the value of the assets on their balance sheets. So they might appear to be bargains. But investors should beware. The home builders' book values rest on shaky foundations.

Development land weighs heavily on the builders' balance sheets. In the fourth quarter of last year, the five biggest builders by market capitalization -- D.R. Horton, Lennar, Pulte, Centex and Toll Brothers -- wrote down their land assets by a combined $1.5 billion. Lennar alone lost $26.5 million on recent land sales. There's the danger that land prices will continue falling, leading to further writedowns. That potential is visible on the builders' balance sheets. But another risk is less apparent.


The top five have almost $13 billion in commitments to local authorities, having promised to build the necessary infrastructure for new housing developments. They back these commitments with surety bonds, which are pledges to pay a municipality a big slug of money if a builder doesn't finish a project. These surety bonds total between a quarter and a third of the book value of the leading home builders. Centex's $6 billion of surety bonds actually exceeds its book value, though it estimates it has just $2.5 billion of work left to complete. In a recent regulatory filing, Lennar revealed it had $1.8 billion of these commitments. However, they won't affect its balance sheet unless they are triggered.

The surety bonds make it tough for home builders to walk away from projects. With land prices falling, disposing of development land and dealing with surety bond commitments is costly. This leaves home builders with one option -- to keep building. But that's not appealing either, as home sales are falling and inventories keep rising. In more than one way, the builders have dug themselves a hole.

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[NajdorfDefense]

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Seems like the last 2-3 months, the housing builders have just been getting punished. A combination of lending issues and an overall downturn in the RE market seems to be the catalyst. Isnt stuff like this cyclical? Is this a decent time to buy into this market?

[/ QUOTE ]

Yes, they have been, yes it's cyclical, no, no one can tell when it will turn, usually around Book Value historically, the sector trades btw 0.7-1.2x Book right now depending on level of distress and fin'l security.

12-yr high for short interest ratio...sector has returned about 20% CAGR since that date including this downturn. I find that somewhat interesting.

The sector will move up 6mos b4 biz improves, same as always. You want to buy these at high PEs [20+ now] and sell at low PEs as others have noted [2005].

Rinse, wash, repeat. No positions yet.

[DespotInExile]

Jason, I was just thinking about home builders the other day, and came to the conclusion that while I'm sure there will be a day to start sorting out good investments from the rubble, the problem is that to invest in this sector you need to have a fundamental view of the real estate cycle.

Of course, this is pretty hard to do--guys as smart as Greenspan were incorrectly calling the bottom months ago, and have been repudiated by the recent S&P/Case-Shiller index results, as well as concerns about subprime problems spilling over into the main real estate market.

Net net, if you decide to get into home builders right now, you're liable to be trying to catch a falling knife if the underlying real estate market hasn't corrected. Additionally, my own view is that some of these guys probably have balance sheet corrections that need to be taken, namely the marking down of carried real estate options at fair market value.

Even the home builders are cryptic about what they see--as recently as yesterday, Lennar was revoking the 2007 guidance that it issued at year end, and home builders are likely to tend toward the bullish.

So if I were going to start picking through the rubble today, I probably wouldn't focus much on their current valuations relative to the rest of the market or to recent price history. Instead, I'd start by looking back through a few real estate cycles including the early 90s downturn, and run some basic historical metrics like price/book and price/earnings, to get a sense for when the market has fully devalued these equities.

Once you get back down to early 1990s multiples, I think you can start digging further into specific companies, or if you prefer, just put together a basket of performing home builders with decent balance sheets, and figure you'll hold these equities for 5 years, because in 5 years, people are going to still be buying new homes.

BTW, are you planning to come back to NYC? R u getting a job on Wall Street? (I saw your comments on the job interview thread.) What's up? We played a few times at the NYPC.

[disjunction]

(1) My understanding is that it has been a bad time to be selling a home, but not such a bad time to be a landlord. People are renting instead of buying. My rent just went up by 5%.

(2) Nobody knows if this is a good or bad time to buy into the market. Is the bad market going to cause a recession which will make the market worse? Is land simply overvalued with people owning homes they can't afford? Or will the motto that they aren't making new land hold and the market will rebound?

(3) One potential play is to assume price/rent ratio will return to historical norms.

[pig4bill]

So you guys have forgotten already that the CEO of the nation's largest homebuilder said business would "suck" throughout all of 2007 and wouldn't be that great in 2008?

The homebuilding business is cyclical, but that cycle is years, not months.

[CrushinFelt]

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Net net, if you decide to get into home builders right now, you're liable to be trying to catch a falling knife if the underlying real estate market hasn't corrected.

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This can also be stated as: You'd be taking a complete gamble and would just be speculating on absolutely no forward-looking information. Not typically a good idea ;p

[Jason Strasser (strassa2)]

thanks for the post, yea im working for morgan stanley next year likely on the single stock equity deriv desk

[Groty]

When the builder stocks started selling off after the boom, they bottomed last July at roughly 1.0x book. They then re-traced roughly 50% of the selloff. Starting about February 1, the second leg down began.

Since then, it's just been massive distribution. They are once again trading around book value but the deep value guys who became buyers in July '06 aren't yet stepping in.

Many of the builders have mortgage finance subsidiaries. I think investors are going to be reluctant to buy the stocks until they see if the authorities are going to extend the investigations started at Beazer to the whole group. The Beazer investigations are serious stuff, not trivial.

If you didn't hear about the Beazer investigations, here's a link to the story:

http://www.businessweek.com/print/bw...327_838032.htm