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.