It looks like time to short some home builders again. Check out NVR aka Ryan homes, which sells, for example, in the northern VA area. At just over $600 per share, it is now back to where it was in Q4 2004. But back then it had just earned $66 per share and was expected to grow earnings to $87 per share. Now it is expected to earn $23 per share this year with no visibility beyond what is in current backlog that anyone can rely on. This with the bulk of foreclosures yet to come, and very few foreclosures that have become REOs having been sold.
We spoke to the heads of 2 different REO disposition outfits that work for some of the largest servicers in the past month. Both (men who have been in the business since the early 90s) said this was the scariest pipeline they had seen, with the traditionally bad markets (Ohio, Michigan) rapidly being supplemented with the new bad markets (CA,FL,NV,VA,AZ). They generally expect their pipelines of REO properties to grow for at least the next 12-18 months. Their inventories of existing properties are set to increase by between 3 and 4 times this year.
On the other hand, the people that take REOs off the market are: investors, move-up buyers and first-time buyers. Investors are not yet stepping forward because they would prefer to hold out for lower prices, so they can start out cash flow positive (ie with a renter occupying the property, which means mortgage payments need to fall below rental income). Move up buyers are generally stuck because it is exceedingly hard to get a loan with less than 10% down now, and very few people nowadays seem to be able to come up with this without selling their original property. So you have some very high FICO saver types in this category, but it is something like 1 in 4 move-up buyers.
Then, in the first-time buyer camp, you have only people who didn't get moved into this camp in the last 2-3 years when financing was super-easy to obtain. ie people who were simply too young to be first-time buyers, or those who were too cautious. Again, this is a small part of the 25-32 year-old traditional first-time buyer age group precisely because the housing bubble sucked in so many of these people prematurely already. Why would someone who is 25-32 be buying their first home now, when financing is so much harder to get, and you need more down, than 2-3 years ago unless you were 23 back then? Only if you were the rare value investor....
Our experience is that the proportion of value investors goes up significantly with age, and momentum investing is much more common with that age group. Bottom line, REO properties are going to hang around in most housing markets for the next 2 years. This means, even with a 10-20% premium for a new house, homebuilders are going to need to continue knocking their prices down. And volumes are going to have to hit some sort of bottom - look back to 1996-2000 for some guidance, then take 25% off that volume for the bottom.
We consider fair value for NVR to be in the $400-450 range and would be sellers over $550.
We will check back on this trade idea in 2 weeks.
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