Homebuilding Stocks: Time to Buy?

The credit crisis has made mortgages more expensive, home foreclosure rates are at all time highs, and there is a ten month supply of new homes that indicates home prices will continue to drift lower. Furthermore, as home prices continue their descent, homeowners who are current on their mortgages may elect to turn their house back to the bank because they are paying a mortgage on a home that has declined in value; that could further throw additional homes onto the market exacerbating the downward home price spiral. With all of that bad news weighing on the market, is this a time to invest in homebuilding companies?

Baron Rothschild said “buy when there is blood in the streets.” With all of the bad news around home prices, there certainly is sufficient blood in the streets to consider investing in the homebuilders. Much of the blood in the streets is red ink spilling out of the homebuilders’ financial statements – they are losing a lot of money on their inventory of homes already built, and are selling vacant land that they purchased at higher prices for home construction. WCI Communities, a publicly-traded home and condominium builder declared bankruptcy recently, as did privately-owned Levitt & Sons. Homebuilders Tousa, Kara, and Neumann Homes also sought bankruptcy protection within the last year. However, despite the awful market conditions, not many publicly-traded homebuilders have gone bankrupt. Granted there are some that are weak, and the industry is clearly suffering the worst homebuilding environment in decades – maybe even generations, but the current bad news is already price into the stocks for these companies.

It is interesting to note though that with much less building housing starts on an annualized basis have declined to below 1,000,000, historically recessionary levels from which housing turnarounds have begun. Furthermore, single-family housing starts have declined to the point where there are fewer homes being started than are being purchased so that the inventory of new homes is starting to decline. Granted there is a large inventory of used homes (called existing homes) for sale, and with foreclosures rising there could be more.

This writer believes that Toll Brothers (symbol TOL), a luxury homebuilder, and an S&P homebuilding exchange-traded fund (symbol XHB) are reasonable purchases in today’s risky homebuilding environment. There is a lot of risk in the homebuilding companies today, but there are also conditions being established for a turnaround. There will be further volatility in the sector, but with so much bad news already priced into the stocks of these companies, the downside risk seems bearable; whereas any good news in the sector could signal the end of a trying couple of years in a battered industry and reward patient investors with returns above that of the general market. By the time the headlines tout the positive trends for homebuilding companies, much of the stock price gains from the turnaround will have occurred.