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6 Reasons to Short Housing Stocks

by: Mark Hines January 31, 2008 | about stocks: CTX / DHI / HOV / LEN / PHM / RYL / TOA / TOL    
Mark Hines

Mark Hines

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The steady stream of negative news has continued to flow from the homebuilder industry over the last several weeks, yet enigmatically stock prices have risen (perhaps due to short squeeze buying or overly anxious bottom callers). Regardless, the fact remains that the homebuilders are in big trouble.

Let's review some of the facts...

First of all, homebuilders' earnings are falling like knives. For example Ryland Group (RYL) reported negative earnings on 1/23, and missed analyst estimates by a huge amount. On 1/30, Centex (CTX) also reported negative earnings and also missed analyst expectations by a huge amount. Over the next week, we will hear from D.R. Horton (DHI), Pulte Homes (PHM), and others, and I won't be surprised to hear more very negative news.

Secondly, homebuilder economic data continues to deteriorate. For example, new home sales for December 2007 was 604,000 (well below the consensus estimate of 645,000), and it represented the worst full year decline since the government started tracking this data. Also, the median price of a new home is off 10.4% since last year. Further, don't be fooled by dropping inventories. Some analysts will point to reducing inventories as a sign that things are getting better. Inventories have fallen from 535,000 a year ago, to 495,000. However, sales are dropping faster than inventories, and the more relevant metric is months supply at current selling rates which has increased from 6.2 a year ago, to 9.6 last month.

Thirdly, homebuilder executives are selling their own stock . For example, the chairman, chief executive and president of homebuilder Ryland Group just excercised opitons for 80,000 shares of common stock and then turned right around and sold the shares the same day.

Fourth, rating agencies have been cutting homebuilder credit ratings to junk status. For example, Moody's recently cut D.R. Horton and Ryland to junk status.

Fifth, unlike financial institutions plagued by subprime asset woes, I don't see anyone "bailing out" the homebuilders. There really is no reason NOT to let them go bankrupt. Unlike subprime securities which are a significant portion of the worldwide economy, homebuilder stocks are barely a blip on the radar screen, and there really is no strong incentive for the government to bail them out. Further, I don't see any incentive for private sector investors to bail out homebuilders anytime soon considering that revenues continue to deteriorate.

Sixth, based on the trading range over the last twelve months, it appears to be time for homebuilders to bounce off the upper resistance level and continue their downward trend.

Overall, I don't see much upside potential for these stocks anytime soon. I can't imagine a sudden flood of buyers drying up the excess inventory, and bringing down the months supply. Also, I don't see home prices suddenly shooting up. Perhaps a big Fed rate cut could drive the stock prices up, but this would only be temporary and it wouldn't resolve the underlying homebuilder problems. In fact, I imagine it won't be until well after a few of the homebuilders go out of business that the survivors will gain market share and begin some kind of a recovery (perhaps 2009 at the earliest). In the meantime, the whole industry will continue to flounder.

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This article has 12 comments:

  •  
    Jan 31 11:15 PM
    In the Denver, CO area, I've spoken with building supervisors in developments who have told me that, at least during the current winter months, it's costing them approx. $350.00/day for each house that sits idle. Lennar, for example, has quite a few communities in the area that I can think of, and within those, they might have 20-25 homes sitting empty...and many communities in surrounding areas.. Just those 20-25homes, by these calculations, are costing them well over 200,000.00/month; I can only TRY to imagine how many homes they have throughout, not only the state, but the U.S. How do any of these builders plan to survive?
    Reply
  •  
    Feb 01 02:32 AM
    strutzma, can you break down the $350/day/house? Is the majority of that financing?
    Reply
  •  
    Feb 01 01:08 PM
    This is the internet at its worst.
    In the last month, I've tried to short 4 different home builder stocks.
    For all 4 I got the REJECTED, NO SHARES AVAILABLE message.
    Are there any builder stocks that can be shorted?
    If not, what's the point of this article?
    Reply
  •  
    Feb 01 01:14 PM
    bcr - the $350 per month might work in Colorado but in other markets the cost to carry a near complete home is more in the $650-750/month per home. In the northern virginia marketplace you have to pay the property tax on the completed home. For a $500K home that could be $450/month. Additon on top of that the carry and the damage that is done to the home while sitting. It is much better to sell the home and get rid of it at a discounted basis then to carry it.
    Reply
  •  
    Feb 01 04:01 PM
    another caveat about drops in inventory is that they should specify "finished homes". Sometimes approved projects that have not yet broken ground, and are then cancelled, are includud in the "drop in inventory" numbers.
    Reply
  •  
    Feb 01 09:49 PM
    JJJTTT, hey if I were you don't short the common stock buy puts on the stock. That way you can limit your downside and never have to deal with borrowing issues. If your a retail investor you'll never get a borrow on something that should be shorted. The game is slighted away from your favor if your not a fund.(IMHO) Buy a far out PUT(time wise) and near were the stock is trading, you'll be happy you did if the stock goes against you in a big way.
    Reply
  •  
    Feb 01 10:06 PM
    Good call lobsterboy. I am the author of this article, and I've got some homebuilder puts. Check it out at vestopia.com/mark
    Reply
  •  
    Feb 01 10:08 PM
    Good call lobsterboy. I am the author of this article, and I've got some homebuilder puts. Check it out at vestopia.com/markh
    Reply
  •  
    Feb 01 10:13 PM
    Enter your comment hereLiked the article, charting techniques very good. Question: after you fill out an article and they ask in the disclaimer if you own a position either long/short or just general?
    "Among other issues the ETF Digest maintains long or short positions in: SH, SDS, TWM, RWM, PSQ, IEF, GLD, DBC and DBA."
    You seem bearish; I think to add more creditably you should be specific what you’re long and short in. Or let me guess what you are:
    Long SDS, IEF, GLD, DBC and shortTWM?
    Reply
  •  
    Feb 01 10:14 PM
    sorry wrong hole...haha this was meant for a different article...
    Reply
  •  
    Feb 03 04:49 PM
    Isn't this article a bit late? There's no discussion of what's priced in to the stocks already. Sentiment is already really bad.
    Reply
  •  
    Feb 04 02:02 AM
    Another good way to play this is:
    UltraShort Real Estate ProShares (SRS)

    Reply
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