It Might Be Time to Sell the Homebuilders

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Investors are getting mixed signals out of the homebuilders this earnings season. Shares of D.R. Horton (DHI) rose 6 percent on Monday after it posted better-than-expected quarterly results. Unfortunately for the industry, D.R. Horton appears to be more the exception than the rule.

  • Two weeks earlier we saw KB Home (KBH) surrender 24 percent of its value after falling woefully short of Wall Street profit forecasts.
  • Lennar (LEN) also took a hit around the same time when it revealed that it has had to boost the incentives that it shells out for potential home buyers to close sales.
  • Last month it was luxury homebuilder Toll Brothers (TOL) painting an uninspiring portrait for 2015. It sees a flat year with limited power to increase prices the way it had during the past few years of the housing market’s revival.

It was bound to happen. Home prices weren’t going to go up forever, and now three of the four major homebuilders that have made announcements in recent weeks have issued warnings that didn’t sit very well on Wall Street.

Then again, it’s not as if D.R. Horton investors are feeling giddy these days. Even with Monday’s pop, the stock is still trading slightly lower in January.

Things are getting iffy, and it could get even worse. Both KB Home and Lennar warned two weeks ago of gross profit margins contracting, and that finds Wall Street pros shaving their profit projections. The same analysts that, on average, were holding out for a KB Home profit of $1.70 a share this year are now settling for $1.27 a share.

Crashing the Open House

By some accounts, this should be a great time for the housing industry. Employment rates are improving, qualifying more potential buyers for mortgages. Copper prices have been plummeting, and that’s an important cost component for homebuilders.

Real estate developers have made the most of the welcome environment by building out new properties. New residential construction in this country rose to its highest level since 2007, with homebuilder confidence in January at its highest point in nearly a decade.

Lost in the euphoria is the nugget that it’s not really the middle class that’s snapping up homes. Mortgage originations came out to roughly $1.12 trillion last year, according to the Mortgage Bankers Association. That’s 39 percent below 2013’s production, and the lowest tally since 1997. This means that cash buyers — primarily the wealthy and international investors — are the ones who have been driving the demand lately.

This doesn’t mean that it isn’t also getting easier for others to get in on the fun. Mortgage financing bellwethers Freddie Mac and Fannie Mae recently lowered the down payment required for the purchase of a property from 5 percent to 3 percent. Lenders are making sure that we don’t repeat the subprime lending crisis by getting stingier on who gets approved for a home loan, but this could very well be a house of cards if prices begin to decline to send more homes underwater.

When you factor in other emerging trends — including the popularity of renting versus buying, a glut of available homes, and median sale prices stabilizing — it’s a pretty risky time to snap up the homebuilders. The past few years were great, but clearly the market’s correcting now.

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