Brief Note on Homebuilder Valuations
I have not been tempted to nibble at homebuilders yet. Take one look at the chart of TOUSA, and you can see why:
TOUSA always looked cheap, but the level of leverage was way too high. Falling housing prices would have a larger negative effect on them. Now they are staring at bankruptcy.
As it is, housing prices probably have another 10-15% to fall on average before this cycle ends. There will be more bankruptcies among homebuilders before all of this is done. When the cycle is done, there will be a few signs amidst the wreckage:
- Surviving builders trade at 50-75% of written-down book value.
- Earnings are negative, but no longer getting worse.
- Early value investors will have given up on the sector.
- Bond managers will reinstate the “no homebuilder bonds” rule.
- Leverage will be similar to today, but on smaller companies.
- Financial magazines will run articles on how smart MDC Holdings was during the “bad old days” of 2004-2006.
- Old standards will return for loan underwriting. Financial magazines will talk about prudence in borrowing against residential real estate, and how it is not a “one way ticket” to riches.
- Inventory levels decline 20% from their peak levels.
Anyway, that’s what I expect. At that time, or slightly before, I would probably buy two of the best capitalized homebuilders. That’s what I try to do in investing… arrive slightly before the point of maximum pessimism.
