Is It Time to Move Into Homebuilder Stocks?

Housing prices look to remain soft in most markets in 2012. That's confirmed with a drive through new subdivisions scattered across the country, where a home might be surrounded by unoccupied structures or weedy lots.

Still, depressed home prices, down some 33 percent from 2007, equate to low homebuilder stock prices. These stocks suffered double-digit drops in 2011 but experienced a late-year bounce. The 2011 discount may prove to be an attractive entry point to risk-tolerant investors, especially if housing continues its slow and bumpy recovery indicated in recent statistics.

Among those brighter industry figures, a National Association of Realtors report said pending home sales hit a 19-month high in November, up 7.3 percent from a month earlier. That report included a 14.9 percent jump in the West, where some of the biggest bubble bursts in parts of California, Arizona, and Nevada fronted national declines. The news lifted homebuilder stocks including PulteGroup (symbol: PHM), D.R. Horton (DHI), KB Home (KBH), Beazer Homes (BZH), and Toll Brothers (TOL).

Goldman Sachs economists said in a recent outlook that housing prices are likely to continue to ease into the second half of the year, as excess inventory is worked off. But the economists are willing to say that "the housing price bottom is probably in sight."

A deeper look into the market is still sobering. Much of the housing improvement boost is credited to the multi-family sector. Existing home sales, which rose in November, are still at a low annual rate of about 4 million. Single-family housing starts rose in November but are still down some 1.5 percent from year-ago levels. The median sales price for a new home fell 3.8 percent to $214,100 last month. Compared with November, the median price was down 2.5 percent.

There's Still Risk

Risks to the optimistic forecast persist. There's a difference between a housing market that is improving from weak levels, which is more like saying it is stabilizing, and a market that is truly strengthening.

And, there have been false bottoms. It's a recovery aggravated by the number of foreclosures and the arduous process for some applicants to obtain financing. There have been some 3 million mortgage defaults recorded since 2007, according to RealtyTrac. In fact, the reluctance of some analysts to call a bottom hinges on the fact that foreclosures are still working their way through a back-logged system.

U.S. economic data on jobs, consumer confidence, and manufacturing are pointing up, but outlying factors like the European debt crisis could still scuttle the domestic recovery. The Federal Reserve has urged Congress to act to ease the burden on the mortgage market from so many underwater loans and has pledged to keep interest rates low into at least 2013. "Restoring the health of the housing market is a necessary part of a broader strategy for economic recovery," Federal Reserve Chairman Ben Bernanke said in a letter to the top lawmakers on the Senate Banking and House Financial Services committees. The Fed's attention on the housing recovery could prove to be a bonus for homebuilder stocks in the coming year.

Don't forget about location, location, location. Industry veterans have long argued that real estate headlines often miss the mark because they don't capture regional differences in housing markets. But during the financial and housing implosion, real estate was a national story. Now, a spotty recovery that's stronger in some areas than others is likely and calls for investors to analyze relative strength within micro markets.

"In 2008 and 2009, it was a national housing market. Everything was collapsing together," says David Blitzer, chairman of the Index Committee at S&P Indices, including the S&P/Case-Shiller Home Price Indices.

"One thing that's happened in the past couple of years is that it's going back to being more of a local market phenomenon," says Blitzer. "The old adage 'location, location, location' is coming back to have a lot of meaning. Three years ago, it didn't matter where you were looking at housing in the United States -- prices were collapsing. Now when you look around the country, you find some differences."

The latest S&P/Case-Shiller Home Price Indices showed decreases of 1.1 percent and 1.2 percent for the 10- and 20-City Composites in October compared with September. Nineteen of the 20 cities covered by the indices also saw home prices decrease over the month. The 10- and 20-City Composites posted annual returns of -3.0 percent and -3.4 percent versus October 2010, respectively.

Miami saw no change in annual returns in October; meanwhile, Atlanta, Detroit, Las Vegas, Los Angeles, and Minneapolis saw their annual rates worsen. At negative 11.7 percent, Atlanta posted the lowest annual return. Detroit and Washington, D.C., were the only two cities to post positive annual returns of 2.5 percent and 1.3 percent, respectively.

Builders Are Optimistic

For its part, the construction industry is feeling more optimistic. Builder confidence in the market for newly built, single-family homes edged up two points from a downwardly revised number to 21 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) for December. This marks a third consecutive month in which builder confidence has improved, and brings the index to its highest point since May 2010.

"While builder confidence remains low, the consistent gains registered over the past several months are an indication that pockets of recovery are slowly starting to emerge in scattered housing markets," says Bob Nielsen, chairman of the National Association of Home Builders (NAHB) and a home builder from Reno, Nev. "However, the difficulties that both builders and buyers continue to experience in accessing credit for new homes are holding back potential sales even in areas where economic conditions are improving."

Builder confidence primarily gained strength in the South in December, where a four-point gain to 25 brought that region's HMI score to its highest level since March 2008. A one-point gain to 16 was registered in the West, while the Midwest held unchanged at 24 and the Northeast slipped one point to 15.

Five of the more actively traded homebuilder stocks posted strong third-quarter to fourth-quarter gains, a sign of potential momentum change. Pulte was up some 52 percent from quarter to quarter; Toll Brothers rose 38 percent, Beazer Homes gained 56 percent, D.R. Horton saw a 35 percent jump, and KB Home rose more than 10 percent.

Builders are reflecting the changing times. Pulte, for instance, announced in early January a suburban-Chicago area purchase of 45 bank-owned lots at a stalled development, Crain's Chicago Business reports.

Homes will range from 2,600 to about 3,400 square feet and are targeted toward empty-nesters with features including first-floor master bedroom suites. Pulte plans to price the homes from about $575,000 to $700,000, a significant drop from the original prices that local builder Callaghan, the first lead on the project, had planned; they ranged from about $900,000 up to $1.5 million, the Crain's report said.

Investors should also consider overall company and balance sheet strength. NVR (NVR), for instance, ended 2011 little changed and has received bullish accolades based on low debt and less land speculation than some of its peers.

Other names in the industry include Centex (CTX); Lennar (LEN); Brookfield Homes (BHS); The Ryland Group (RYL); Avator (AVTR); and Tarragon (TARR).

Investors might also consider a homebuilder-focused, yet more diversified, exchange-traded fund. The SPDR S&P Homebuilders (XHB) includes multi-family exposure and stands to benefit from ongoing demand for apartments over standalone dwellings in parts of the country where real estate values remain depressed. Retailers Home Depot (HD) and Lowe's (LOW) are also folded into this ETF. Lackluster sale prospects are keeping some homeowners in their current residence longer than they expected, so they're remodeling to stay put.

This story comes from U.S. News & World Report.

Keep reading: How I Did It: Buying a Foreclosure as an Investment Property

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