Housing: Bigger Bust or Bottom?

Housing headlines, fact or fiction?

We’ve seen this sequence of headlines about the housing market in the last year:

Is it a housing bubble?
Will the housing bubble pop?
Is the housing bubble slowly losing air?
New home sales drop
Record fall in new home sales
Is the housing market bottoming?

Today, December 11, 2006, according to luxury-home builder, Toll Bros., their business slump may be bottoming out.

Experience tells us that housing cycles falls are easier to predict than cycle bottoms are. If the soothsayers are saying the bottom will occur next spring or this winter, it may be a good strategy to plan for a bottom in 2008, since previous housing market slumps show it generally takes longer than one year to recover.

According to the latest earning report on MSN, Toll Bros. net income fell 44% (from $310 million to $174 million). That’s a 44% drop and the company expects profits to fall up to 62% in 2007. However, Toll is not a very good indicator of the housing markets direction in general. Toll Bros. is a big company, but their high end homes are a small portion of the market.

Centex Corporation is probably a better indicator of what’s going on in the housing market. Centex has a 6.5% net profit margin. (By the way, Toll Bros. has a 11.2% net profit margin.) So how much must the average price of a home drop before it cuts into the builder’s profit margin?

Centex earnings per share declined 56% over the quarter compared to last year.

Still think it is the bottom? We can only hope it is. But the very thing that inflates a housing bubble is only going to add momentum to the down stroke. Look at the loan default rates rising. When the defaults increase, credit tightens and it becomes more difficult for people to get loans. This reduces demand.

What about the builder’s inventory of homes rising so drastically across many markets? This has a bigger effect on the housing sales market. As builders try to dump inventory, the prices must fall and home values in general fall.

You would think falling prices would stimulate buying, and they do. But the thing you think will help the market actually hurts it more: people that bought using variable rate loans are only beginning to feel the pressure. Some will bail out and some will sell out, and with falling prices many of them will sell at a loss to get out of those big payments. We are already seeing large increases in late payment and loan defaults.

We are optimistic about the housing market - but not in the next 12 months. This is just the first dip. Watch the late payment and foreclosure statistics. A continuation or increase in numbers will be your indicator.

On the other hand, if the economy and the average Joe’s ability to buy a new home is better than the popular news media want you to think…it may be a good time to buy shares in home building company stocks, a bad time to buy new houses, and a bad time to be a homebuilder with inventory.

Hoping we’re wrong, but it looks like the caution light is still blinking.