When Will Homebuilders Hit Bottom?

12/06/2007 12:00 am EST


Vaughan Scully of Standard & Poor’s says homebuilders are taking big charges, but that may be a sign that the industry is beginning to pick up the pieces of the housing bust.

From the Federal Reserve to the average investor, the unraveling of the US housing market has the country transfixed. Shares in the largest US homebuilders have been pummeled this year, as demand for new homes slumps and access to credit dries up in the wake of the subprime mortgage situation.

The downturn has forced homebuilders to report huge operating losses in the second and third quarters. Is the situation getting worse? Or, is it time to start moving back into these stocks now that they’ve lost half their value since the end of 2006?

One way to tell is to look at the industry’s impairment charges. What they reveal are declines in the value of land or unsold homes a builder owns from previous estimates of worth. Asset write-downs have skyrocketed in 2007, dashing hopes of a quick recovery.

Twelve of the top 14 publicly-traded homebuilders reported collective charges of about $5.1 billion during the third quarter of 2007 alone, according to Standard & Poor’s. That’s up 41% from the second quarter and more than all of what was reported in 2006.

“This one stroke tells you that the magnitude of the downturn is pretty significant,” says Ken Leon, an S&P equity analyst. Impairment charges “may be hitting their peak right now.”

Impairments have highlighted the risks and rewards of each homebuilder’s operating strategy, Leon says. “NVR (NYSE: NVR) doesn’t buy land until it is ready to build. It will pay more for land that’s ready for development,” rather than buy land cheaply, hoping to develop it later. “NVR still has operating losses, but the impairments have been less significant,” Leon says.

Toll Brothers’ (NYSE: TOL) leading position in more expensive and luxury homes and its strong balance sheet has helped its financial results, though higher priced homes have begun to be affected, too. Profits for homebuilders won’t return until orders (gross and net), backlog value, and average selling prices begin to improve.

“My gut tells me that’s probably going to begin by June, more likely September, because the comparisons get easier,” Leon says. Depending on how well homebuilders do in the fourth quarter—results will be released in late January and early February—investors will start looking ahead to a possible recovery. A real recovery in housing probably won’t occur until the second half of 2008, Leon says, but homebuilding stocks “have historically begun to move in anticipation of a housing recovery.”

Homebuilding stocks will still be under pressure until there is some evidence that things will get better in the future. “We have a negative outlook on homebuilding stocks,” says Leon. That outlook won’t change until companies report quarterly results that exceed expectations.

S&P thinks homebuilding stocks won’t begin to recover until mid-2008. A rally could be delayed further if high oil prices or an economic slowdown reduce consumer confidence.

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