Filed Under:
Tickers in this Article: HOV, KBH, TOL, LEN
It's generally a good idea, especially for contrarian value investors, to seek out value in the most unloved industry. No industry - save maybe the auto industry today - is experiencing more pain than the housing industry. And with home prices in a state of decline for over two years now, it may be tempting to make a bet that housing has bottomed. But despite the mess that the housing industry is in, I'd consider the following data before jumping in.

7 Tools Of The Trade

Appearances Can Be Deceiving

From the looks of it, it appears that the housing industry is heading in the right direction. New housing starts have fallen dramatically over the past year in response to a terrible real estate market. Basic economics tells us that when supply is cut off, over time a stabilizing demand picture should help things. This is even true for housing. Over time, folks get married and form households with the hope that someday they will be homeowners.

If the falling housing starts were the only problem facing housing, housing would probably be on a normal path to recovery within the next year or two.

Housing's Other Problem

The real issue concerning housing today is the foreclosure rate in the country. As people continue to struggle in the economy, foreclosure becomes a problem. If you agree that the majority of houses bought over the past couple of years are now being valued up to 50% in some places like Las Vegas, California, and Florida, it's easy to see how foreclosures continue to be a problem.

For example, someone who bought a house in California in 2006 for $800,000 may now be noticing that similar houses in the neighborhood are selling for $500,000. If you assume that a $720,000 mortgage exists, implying a 10% down payment, it's understandable why someone would lose interest in continuing to make those payments. (For related reading, check out 5 Mistakes Real Estate Investors Should Avoid.)

Add in the extra ingredients such as the fact that most were buying housing with 0% down, and that the job market is one of the worst ever, and foreclosures are a serious problem.

A Recipe for Long-Term Disaster

More foreclosures add to the supply problem and prolong any hope of a housing recovery. Such news will affect all home builders. To be fair, it will affect some worse than others.

Hovnanian (NYSE:HOV) currently has a market cap of some $300 million against debt of $1.9 billion. Such leverage is bad in normal times, terrible in weak economy and a disaster for a homebuilder amidst a housing crisis.

Despite slightly stronger balance sheets, DR Horton (NYSE: DHI), Lennar (NYSE:LEN) and KB Home (NYSE:KBH) all have debt levels at least twice their cash levels on the balance sheet. Toll Brothers (NYSE:TOL) appears to have the strongest balance sheet with some $1.7 billion in cash against $2.2 billion in debt.

The big picture is that the housing industry is not dead, but will remain in ICU for quite some time. Sure, with battered equity prices, pieces of good news could jolt share prices higher. But that's a game for speculators to play, not value investors.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

comments powered by Disqus

Trading Center