Zacks - Housing Prices and Homebuilder Stocks

Don't Build It, They Won't Come
Monday September 29
By Michael Vodicka

Cheap money and artificially inflated housing prices are the root causes of the problems that have been plaguing the real estate market and big financial institutions for the past year.

So while the Fed's $700 billion bailout provides a much needed lifeline to a financial sector that is close to collapsing after being ensnared in a sticky web of under-peforming assets, it does not address the litany of underlying fundamental issues that continue to weigh heavily on the housing market.

Median Household Income Growth

On a historical basis, housing prices have advanced in tandem with incomes, but these two variables began decoupling in the late 90's, with housing prices accelerating at a breakneck pace and incomes remaining mostly stagnant. Since 1990, annual household incomes are up a little more than 60%, to $50,233 per. But when adjusting for inflation, 'real' incomes are mostly unchanged.

Housing Prices Sky Rocket

This comes in sharp contrast to housing prices, which have been in a serious boom cycle for at least the last decade. In many cities across the country, it was not at all uncommon for housing prices to post annual gains of more than 15%. In Chicago's Cook County, hardly considered bubble-icious territory, the average home price was up over 200% from 1996 to 2006. The relationship between these variables needs to rebalance, and until it does, there is very little chance housing prices will stabilize.

Housing Inventories

The second problem confronting the real estate industry is the high level of inventories of homes for sale. The National Realty Association's August reading of housing inventories indicated that the current supply of homes for sale stands at 11.2 months, more than twice the historical average. This glut of homes on the market is chipping away at prices and driving average selling prices lower.

Lending Standards Tightened

And finally, in light of the battered credit market, banks have already made significant adjustments to their lending standards, requiring hefty down payments and high credit scores for potential borrowers to qualify for a mortgage. Neither of these benchmarks were in play during the halcyon days of over-leveraged lending and borrowing.

So while the bailout will remove toxic assets from the books of the big financials, it will do very little, if anything, to cure the wounds that have been inflicted on the housing industry. Here are three stocks that will be challenged to grow earnings within the next year because of their exposure to the housing market.

Three Stocks To Avoid

Fannie Mae is the poster company for the broken-down mortgage industry, requiring a federal bailout to prevent a bankruptcy filing. If Fannie unloads its 'toxic assets' to the government's newly formed purchasing agency, look for more big write downs. The current-year estimate is down to a loss of $7.01 per share from a loss of $2.90 per share 90 days ago.

Toll Brother Inc. share price has begun to rebound from its recent lows, but this company has plenty of challenges ahead. With housing inventories sky-high and far ahead of the market, there should be little demand for hew home construction over the next few years. The company has posted losses in each of its last four quarters.

Pulte Homes, Inc. is another home builder and mortgage lender that has struggled in the challenging housing environment. Analysts are projecting a current-year loss of $4.59 per share. Pulte has posted losses in each of its last three quarters, with the next-year estimate projecting much of the same, forecasting a loss of 37 cents per share.

Conclusion

Patience is without a doubt one of the most important components of successful investing. Right now, there are plenty of stocks from the building and lending sector that are trading well below their historical averages. But in spite of these lower prices, the industry faces considerable challenges. The time will come to move into this segment of the market, but for the time being, the fundamentals say, 'Not Yet.'