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.