Ken: What do you see that makes you think it’s a good time to invest in the national home builders?
Tim: It is at times of great pessimism that prices are driven down to such a low point that it doesn't take a lot of optimism to make them start to go up again. I see signs of optimism in some markets.
Ken: Wall Street analysts say real estate prices have to stabilize before there can be a real turn around in the housing industry. Do you agree?
Tim: Yes, but its hard to tell when real estate prices turn around. Most analysts look at the Case Shiller home price index, but it is an enormously trailing statistic. The number they released in April is really the February number which is itself a 3 month average. Furthermore, they are measuring closings, which typically follow transactions by 30 days or more. So the figures you get in April often reflects deals that were struck as much as 6 months earlier. If you want to know what's happening right now, you have to look at specific markets. It appears to me that there are some markets where housing prices have not just stabilized but are growing again such as San Francisco, Seattle, Fort Worth, and Arizona. The recovery is uneven, and so there is reason to be optimistic about the builders that operate in the markets that are doing well.
Ken: Analysts say the settlement over the robo signing scandal has given the banks a green light to start a wave of foreclosures that will make an already oversupplied housing market worse. How do you see it?
Tim: I don't see it that way. Analysts write about the coming wave of foreclosures as if the people in those houses were going to be taken completely out of the housing market when they are evicted. But many of those people are gainfully employed and they have been planning for this.
Someone who lost their job some years ago but is now gainfully employed again may be able to resume making payments, but why would they when their credit is already trashed, and the house is worth less than their mortgage? Many in this situation will take the free ride for as long as it lasts and save what would have been their mortgage payment or rent for the day when they are evicted. They are not going to be homeless after they are evicted. They are going to buy another house or rent. They may have another house all lined up. To some degree we are playing musical chairs with houses.
Ken: So you’re saying the foreclosure process is going to put many gainfully employed people back into the housing market who are currently getting a free ride?
Tim: That’s right, and the house enters the housing market at the same time as the people do. It’s a net zero. Foreclosures affect the supply demand equation when the person being evicted is unemployed and can’t buy or rent another house. If the person who is being evicted can afford housing someplace else you are not changing the supply and demand for housing. That’s why the coming wave of foreclosures is not going to have as big an effect on the housing market as some analysts believe.
Foreclosures will also have some positive economic impact. Carpet installers, painters, carpenters, everyone you need to get a house ready for sale will be working.
The foreclosure issue is not a tidal wave that is going to crush the homebuilders. The negative impact of the foreclosures may not be as bad as analysts expect, and there are some positives to offset the negatives.
Ken: Why Pulte?
Tim: Because it’s big in markets that I think are recovering well such as Texas and Arizona. They are big in some good markets. I am also buying other homebulders too such as D.R. Horton (NYSE:DHI) , MDC Holdings (NYSE:MDC) and Ryland (NYSE:RYL). I’m very positive on all of them, but Pulte seems to be in the markets that matter.
Ken: How much upside do you think there is in Pulte?
Tim: It’s trading at $9.75. In 2005 it hit $46. I certainly see $30 as being perfectly reasonable.
Ken: That's a triple from here.
Tim: It would be a triple. I don't see anything wrong with that. We have a housing market that is somewhat tight already in some markets and it is getting tighter every month. The national builders don't need every market to be healthy, they just need some healthy markets and they will do OK because they can concentrate on the areas that are growing and just not start building houses in the areas that look like its going to take a while.
Ken: What are the other analysts missing?
Tim: If you were to look at the assets of Pulte homes, the assets on their balance sheet don’t include their real asset which is that Pulte is one of the few firms that can borrow money at low rates and construct buildings on a large scale. That's a very valuable asset when people want buildings. But when people think there is a huge oversupply of buildings then the capability to construct new buildings on a large scale is not very valuable. Two years ago this asset wasn't worth a hill of beans. Five years ago, banks were lending money to everyone so even the little guys could build houses. Today, the regional and local builders are out of business because they can’t get financing.
Ken: Let me see if I’ve understood you. Pulte’s true asset is the capability to build houses in large scale. When the country looks like its awash in unsold houses that capability is not worth that much. Now that some parts of the country are doing well that asset is becoming more valuable. As more of the country starts doing well more and more analysts will see it.
Tim: That's right, and when everyone can see it, the investment opportunity will be gone.
Thanks Tim.
To review Tim's track record, click here.
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Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions chang
