The slowdown in the Washington, D.C., housing market has hit Comstock Homebuilding ( CHCI) especially hard, but patient investors could see their recent burns soothed if real estate rebounds.

Last summer, things looked rosy for Comstock as it rode the wave of the red-hot housing market in the nation's capital, where the small-cap builder receives the bulk of its revenue.

Management's bullishness was evident during the company's second-quarter earnings conference call in August. With Comstock's stock flying as high as $29, CEO Christopher Clemente dismissed reports about signs of a housing slowdown in the region, and the company boosted its 2005 forecast.

In coming months, however, management would slash its guidance several times, as the D.C. market clearly began slowing down. The stock has since fallen 68% off its 52-week high hit in August. Around $9.50, Comstock now trades about 7% below its book value of roughly $10.29 a share. The company went public in December 2004 at $16 a share.

"It's a management credibility issue. That's the bottom line," says Christopher Lucas, a R.W. Baird analyst. Nonetheless, Lucas rates the company outperform and thinks shares are "somewhat undervalued." (R.W. Baird was a co-manager of Comstock's IPO.) However, Lucas doesn't expect many catalysts for a short-term pop in the stock.

"They have a lot to learn as it relates to dealing with the investing community," says one fund manager who invests in the stock and asked not to be named. "They need to improve their communications, and the stock could easily go back to $16 without anything changing."

To send the shares higher, investors also need to believe that the housing market eventually will recover in Washington. The area is seen as a great long-term housing market; last year, the region produced 80,000 new jobs.

"When you look at the fundamentals of the Washington, D.C., market, it is a healthy economy," Comstock Chief Financial Officer Bruce Labovitz said in a recent interview. Labovitz estimates that for every 80,000 new jobs created, 50,000 new households need to be created in the city and the suburbs of Northern Virginia and Maryland.

But lately, the high prices for housing in the region have put a choke on sales as investors and speculators looking to make a quick buck have left the region. In the fourth quarter, Comstock's net new-home orders fell 6.8%, with the dollar value of those contracts dropping 39%.

Comstock "was hung out to dry because it was centered on D.C.," the fund manager says. "D.C. in '05 was what Las Vegas was in '04 ... a speculative market." (After speculators left Las Vegas and prices evened out, the market returned to a more normal sales pace.)

Comstock earlier this month lowered its 2006 EPS guidance to a range between $2.25 and $2.75 from a prior projection of $3.95 to $4.05, largely due to the slump in Washington. The company recently reported 2005 earnings of $2.12 a share, up from $1.95 a year earlier. (Last summer, Comstock said its 2005 EPS would hit as high as $2.73.)

One bright spot for Comstock has been its 465-unit high-rise Eclipse condo project in Alexandria, Va., across the river from D.C. city limits.

Comstock says about a third of its revenue this year will come from home closings at Eclipse. The project's units range in price from $300,000 to $1 million. At the end of 2005, the company had $157.6 million of Eclipse sales in its backlog. Comstock estimates the total sales value of units at Eclipse to be $200 million to $210 million, with about 300 units to be delivered in the second half of this year for $120 million to $140 million of revenue. The remainder of the revenue for Eclipse will be booked in 2007.

While Eclipse is clearly a boon, other pieces of Comstock's business may not provide much help in offsetting the troubles in Washington. The company's operations in Raleigh, N.C., have fared well, but it makes up less than 10% of Comstock's annual revenue. Comstock recently expanded into Atlanta with the acquisition of local homebuilder Parker Chandler Homes, which is expected to account for about 20% of revenue in 2006. But those sales will have lower margins, because Atlanta isn't seeing rapid price appreciation.

Besides some small land sales, the rest of the Comtock's revenue comes from condo conversion projects and new construction in and around Washington. "The residual ongoing business is where investors are looking, and it does not seem to be today the sense that they're going to generate substantial earnings growth for that business right now," Lucas says.

Recently, Comstock began offering aggressive price discounts to move some of its product in D.C.

"There is good traffic (in Washington). It isn't that buyers aren't interested in buying product today," CEO Clemente told investors on the fourth-quarter earnings call earlier this month. "The issue is that I think there is less of a sense of urgency and more of a sense of value-hunting among buyers today."

With the stock now trading at just over four times the low end of Comstock's 2006 EPS guidance, is there a possible value story?

Lucas thinks so, but admits it might take some time for the market to become comfortable with management again. He values the company's current $20 million in cash, along with the income on Eclipse, at $4 to $4.10 per share. He calculates the run rate EPS excluding Eclipse to be $1.41 in 2007. Add in the cash and income on Eclipse, apply a 5.5 times multiple, and he gets a $12 price target.

"Ultimately a couple of quarters of positive performance and improved management credibility will be the likely catalysts for the shares," Lucas says.

The aforementioned fund manager, who cashed in some chips last summer but still maintains a position, also thinks the stock is very cheap now. The investor believes the company might hit a growth snag in 2007 but can achieve long-term revenue growth of 10% to 20% annually. If Comstock can get back to a P/E of at least six and hit the high end of its 2006 guidance, then stock could go back $16, the fund manager says.

"Is the stock undervalued? Of course it is," he says. "It's a steal at these levels ... Are they good operators? Ask me a year from now."