Housing's Bright Spot: Stocks
Despite the Sector's Spiraling Crisis, Builders' Shares Are Gaining Fast

By Nancy Trejos
Washington Post Staff Writer
Sunday, April 6, 2008; F01

When the stock market becomes erratic, as it has in the past year, investors tend to play it safe, fleeing to recession-proof sectors such as consumer staples and utilities. After all, who's willing to give up shampoo and electricity?

But since the beginning of the year, analysts have noticed an upswing in one unlikely area: housing.

Shares of U.S. home builders rose 18.5 percent in the first quarter, according to Capital IQ, a division of Standard & Poor's. Residential REITs, essentially real estate mutual funds, were up 12 percent. Land subdividers and developers jumped 17 percent. By comparison, the S&P 500-stock index was down 9.9 percent.

So what's with the rebound in industries tied to home building, the root of the economic crisis that has spread across the globe?

"It's one of those things where you can probably come up with a million theories and none would be right," said Greg Fernandez, a financial planner with Nations Capital Wealth Management in McLean.

Chris Hussey, managing director of Goldman Sachs's small- and mid-cap research group, offered one theory: "These stocks are down a lot," he said. "[Investors] say to themselves, 'What didn't work out last year? Maybe they'll do well this year.' "

Recent government intervention has buoyed hopes of a recovery for the industry. Congress passed an economic stimulus plan. The Federal Reserve slashed a key interest rate. And last week, Senate Democratic and Republican leaders agreed on a package that would provide billions of dollars in tax rebates to home builders.

Such moves, said Hussey, signal that "the government was very singularly focused on the housing market." That, he said, is comforting to shareholders. "Investors say that's a good sign. Maybe that's a sign that the worst is behind us."

Another reason for the rebound could simply be that stock markets tend to predict what's to come. They've accurately predicted the last few recessions. "Stock markets are renowned for anticipating things," Hussey said.

Is the market anticipating correctly this time? Have these stocks hit bottom? Is now a good time to buy them?

Ask the National Association of Home Builders, and the future looks bright. The association projects that housing starts will reach 986,000 units this year and increase to 1.1 million units in 2009, said Stephen Melman, director of economic services for the NAHB. That assessment is based on several factors: government intervention, lower mortgage rates, pent-up demand, lower prices. "All these things will move people off the fence," Melman said.

Already, there have been some promising -- albeit still bleak -- data. Residential construction spending fell in February for the 24th straight month, but by a modest 0.9 percent, less than what economists had expected. Meanwhile, sales of existing homes increased unexpectedly in February after declining for six consecutive months.

Research firm Bespoke Investment Group turned positive on home builders at the end of last year. "It still has a long way to go to make new highs, but it's formed a nice uptrend there," said Justin Walters, co-founder of Bespoke.

He said that historically, bubbles follow similar patterns, and the decline of home builders' stocks has gotten as bad as that of the Nasdaq composite index when the tech bubble burst. From March 2000 to October 2002, the Nasdaq fell 78 percent over 943 calendar days, according to Bespoke's research. From July 2005 to January 2008, home builders' stock dropped 77 percent over 902 calendar days. "We don't think it has a ways to go down," he said.

Other industry experts and economists disagree, pointing to the recent drop in new-home sales and median prices. Foreclosures will continue to rise, they said, as homeowners with adjustable-rate mortgages see their interest rates balloon. That will dump more properties onto the market, which means that an already bloated inventory will remain so. And with the tightening of credit, fewer people will be eligible for a mortgage. For home builders, that means slashing more prices or offering more incentives -- and little or no profit.

"A lot of people say we've hit bottom. I don't buy it," said Seth Jayson, a senior analyst at the Motley Fool, a financial Web site. "It's going to be a while before any of these folks see a turnaround."

Investing in home builders, in particular, is fraught with risk. Many of them have too much debt, too much land and too many unsold homes. Some builders, including Centex and Lennar, have sold excess land to money managers at a discount to raise cash and move the land off their balance sheets. Analysts expect builders to continue taking write-downs and impairment charges.

Yes, stock prices have dropped, but they are down so significantly-- some as much as 80 percent from their peaks -- that enthusiasm for them should be tempered.

"I think individual investors would get killed if they try to get into home builders," Jayson said.

Here's why: You want to buy a stock when it is trading below the company's book value, or the value of its assets under accounting rules. But Parrish Glover, an equity analyst for Morningstar, said it's too difficult to assess home builders' true book value because their land is not worth what it used to be.

"It's not a risk-free investment," Glover said. "For the home builders, the stated value on the books has been overblown."

Furthermore, some of the companies have large bills coming due. "Lines of credit could disappear," Glover said. "You end up in a situation where Monday afternoon, everything is fine and Tuesday, you're having to write a check for $300 million."

Still, Morningstar has singled out some home builders as fairly valued, including NVR, Meritage Homes and M/I Homes, mainly because they don't have as much land as other companies. Reston-based NVR, in particular, should do well, said Glover, because it did not get involved in land speculation. In fact, he said, the company owns no land outright and keeps little inventory.

Luxury home builder Toll Brothers is another one that should be able to survive the crisis, said Morningstar analyst Eric Landry in a recent report. Although the company has a large inventory, it has a modest amount of debt, Landry wrote.

Even though home builders have curtailed their construction, a recent tour of one Toll Brothers community, Marlboro Ridge in Upper Marlboro, showed that the company is still betting on home buyers returning to the market. Construction cranes dotted the landscape, as did signs promising an equestrian facility, swimming pool and hiking trails.

Sales began about a year and a half ago, and at least 100 of the nearly 1,000 planned units have been sold, said William Gilligan, regional president for Pennsylvania-based Toll Brothers. "Obviously we're not going right now at the pace we were going when we opened," he said. "We're optimistic that over time that pace will return."

Regionwide, sales were slow in January but picked up in the past month, he said. The problem, he said, is that many prospective buyers have been stuck trying to sell their current homes. "That's our biggest obstacle," he said. "It's not that there aren't willing buyers. It's that they have to sell their homes."

With many builders themselves warning of tough times still to come, financial advisers and analysts say investors should remain cautious. Keep a diversified portfolio, and don't make any drastic moves, said Fernandez, the financial planner in McLean. "It's very hard to time when an asset class or when a particular group of stocks is going to do well," he said.

And despite a promising first three months, no one knows what the next three will bring, said Jeremy Payne, senior vice president for S&P's Capital IQ. "Stocks go up and stocks go down, and it's very hard to say why," he said.