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  1. Home
  2. / Investing
  3. / Stocks

Homebuilders Are Doing Better? Cool. Still Not Buying.

Investors have been shifting away from the builders and toward the apartment developers and managers.
By ROGER ARNOLD Feb 23, 2016 | 03:00 PM EST
Stocks quotes in this article: TOL, BZH, PHM, KBH, CAA

It's been six months since I addressed the homebuilders in the column, "Like I Said, Stay Away From Homebuilders."

That was part of a series of periodic columns on the subject over the past two years that started with "Time to Move Out."

With the big jump in the stock prices of each yesterday, from 2% for Toll Brothers (TOL) to 7% for Beazer Homes USA (BZH), this is a good time to evaluate the situation again.

Starting in the column from two years ago, and repeated regularly since, my advice has been that the homebuilder stocks were priced at roughly two times too much and should be sold or avoided, and that I would address the situation again after those corrections had occurred.

On average, most of that initial process has played out.

Toll has declined by 33%, PulteGroup (PHM) by 17%, KB Home (KBH) by 44%, Hovnanian Enterprises (HOV) by 74% and Beazer by 69%.

Since I wrote about the sector last summer, Ryland Homes and Standard Pacific have merged and changed the name of the combined entity to CalAtlantic Group (CAA), which is down by 36% in the past two years. (CalAtlantic Group is part of TheStreet's Stocks Under $10 portfolio.)

The only one of the group that is near where it was two years ago is Lennar (LEN), which is only off by about 4%, although it is down by about 17% since the beginning of the year.

However, most of those corrections have come within the past six months. Market participants have begun to exhibit an understanding that the domestic economy is not as strong as the Federal Reserve has maintained, that demand for home purchases in total is not increasing because first-time homebuyers do not have the capacity to buy, and that the shift to renting is a structural economic phenomenon and not a transitory legacy of the last housing crash.

As a result, investors have been shifting away from the builders and toward the apartment developers and managers, as I discussed was probable last summer in the column, "Here's a Better Way to Invest in Housing."

The returns for this group over the past six months have been almost universally positive, and I expect that to continue.

Avalonbay Communities (AVB) is up by 3% since August, Camden Property Trust (CPT) is up by 2%, Essex Property Trust (ESS) is down by about 1%, and Mid-America Apartment Communities (MAA) is up by about 19%.

The only one of the group that has lost substantially was Forest City Realty Trust (FCE.A), down by 17%.

The relatively positive returns by Lennar over the past six months are also due to its aggressive business reorientation to multifamily development, and that should continue to be positive for it.

This shift toward renting and away from homeownership is doubly bad for the homebuilders, as it is beginning to show signs of overdevelopment in many areas, which will likely cause owners to start discounting rents after several years of rising rents.

Although this hasn't happened broadly yet as discussed in the recent National Apartment Report: February 2016, from Abodo.com, it has begun in Chicago and appears to be imminent in the Washington, D.C., metro area.

It is likely the same issues will begin to expand to the rest of the country soon.

Falling rents will put pressure not only on the builders but also on the mortgage lenders, as there is almost no way left for them to attract buyers.

Mortgage rates have maintained record-low levels for the past five years and were little impacted by the Federal Reserve's third round of quantitative easing that was intended to pull them even lower.

Bank of America's (BAC) latest venture into attracting first-time homebuyers with a 3% down payment and no mortgage insurance requirement will likely prove to be a boon for the bank but will not be able to counteract the structural issue of a lack of qualifying income by borrowers. (Bank of America is part of TheStreet's Action Alerts PLUS portfolio.)

As the spring housing season materializes, unless there is a surge in home purchases and signed contracts within the next 30 days, investors will most probably anticipate that another housing season will underwhelm, as has every one since the Lehman crisis era, and respond by selling the builders.

In such a case, an average decline of 50% from current levels is probable, in my opinion, taking them back to the 2011 lows.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Arnold had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Stocks

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