6/14/2010
By David Urani, Research Analyst

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The Homebuilder Free Agency

This Wednesday brings the Census Bureau's May report for Housing starts, and the current consensus estimate is for starts to fall to 650,000 annually adjusted from 672,000 in April. The big hurdle the industry faces of course is the April 30 expiration of the homebuyers' tax credit. After a late surge by buyers to take advantage of a government handout, homebuilders are looking ahead with understandable caution as we've heard voiced homebuilding CEOs.

First of all, we should note that homebuilders do in fact have an incentive to keep building homes, and that's largely because many homebuilders aren't generating enough revenue to turn a profit these days. Having cut overhead costs seemingly to the bone, homebuilders are still running at a loss simply because of the severe lack of demand. As a result, even debt-laden builders such as Beazer (BZH) and Hovnanian (HOV) continue to spend cash on new lots despite having significant obligations for interest payments and looming maturity deadlines.

That being said, builders also don't want to get caught having large amounts of inventory on their hands like they did at the housing bubble's peak. Holding expansive portfolios of real estate as prices tumbled set off a multi-year long string of losses for the industry in general. With record high rates of bank repossessions of homes persisting and home supply at its highest level in more than a year, it's clear that housing is still in a very precarious position. In fact, despite rising demand from the tax credit through the early months of this year, home prices fell in each of the six months through March, according to the Case-Shiller index. The end of the tax credit is likely to be yet more impetus for prices to fall more, meaning any homes homebuilders decide to construct, and land held for that matter, are now are likely to immediately fall in value.

To best point out the ominous post-tax credit situation, we will point you to mortgage purchase applications (applications for home loans), which have fallen precipitously (42%) since peaking as the credit expired on April 30. I expect homebuilders to have taken a wait-and-see approach, so I am expecting housing starts to fall to a range of 600,000 to 625,000 annually adjusted.

David Urani
Wall Street Strategies