Crowded Houses: Fund Managers Gorge on Homebuilders

According to a report from Bank of America Securities, the top seven builders had 3.4% of the market share in 1989, with a debt-to-capital ratio of 73.8%, a level on par with the airline industry.

Today, they account for 14.3% of the market, with a debt-to-cap ratio of just 47.8%. And earnings are growing fast.

Just like in 1999, when technology stocks were immune to the vagaries of the business cycle, the bulls believe the homeowners now defy their once-cyclical nature.

"Investors should ignore the conventional wisdom that homebuilders are cyclicals that should only be bought early in a recovery when P/E ratios are high and sold when earnings catch up with stock prices," said Carl Reichardt, an analyst with Bank of America Securities, in a research report last Wednesday.

But not everyone is convinced.

"The problem with that kind of reasoning is there's always a grain of truth to it and empirical evidence to back it up," said Anirvan Banerji, director of research at the Economic Cycle Research Institute. "And this apparently clear-cut evidence seems to add up to the thesis that cyclicality has been eliminated, when really, it was just dumb luck that put them in this position."

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Banerji contends that faulty projections, not sound management, largely explain why builders have uncharacteristically outperformed during the recession.

"Homebuilders are crediting themselves with not overbuilding, saying they learned from the mistakes of 1980s, but this was a fluke from misreading the census," said Banerji. "In the late 1990s, builders and industry forecasters said we'd see a trailing off in housing demand in the early 2000s. But when the 2000 census came out, there was a major surprise in the number of immigrant families buying homes, and the demand for homes caught them by surprise."

And some bears say the companies, now facing rising prices for land, are seeing their lucky streak drawing to a close.

"They've pulled forward a couple years of demand and they have sold all of their cheap land," Voigt says. "Margins in the future are going to be under pressure."

If Voigt and other shorts are wrong, they are likely to feel a lot more pain in the coming year. If they are right, and lot of fund managers -- and fund investors -- will be on the hook.

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