The Federal Reserve's rate cut may have sent homebuilder stocks jumping, but the rally already is proving fleeting. Lower short-term interest rates will do little to help the beleaguered housing market or the builders. Wise investors continue to stay away from these clunkers. Their reason: Why put money into companies that can't turn a profit, and can only shed homes at fire-sale prices to satisfy hefty debt burdens? Hovnanian's ( HOV) weekend "deal of the century"
price cuts exemplify the sad state of the industry. With the housing market continuing to deteriorate, Hovnanian and many other builders are finally paying the price for years of irresponsible land buying. Now price cuts are the only way to clear inventory, and they hold ugly ramifications that the lower interest rates cannot solve. After the Fed's rate cut Tuesday, the Philadelphia Housing Sector Index jumped 6%. It has already given back ground, falling 0.8% Wednesday, and recently sliding another 2.6% Thursday. "I don't really think this Fed cut is going to help the fundamentals for the builders," says Alex Barron, senior homebuilding analyst at Agency Trading Group. "I suspect a lot of people are probably going to use the post-Fed rally to come in and start shorting the builders again, knowing that all these weekend sales they are doing is going to cause them to report more impairment charges over coming quarters."
This quandary was raised by Ryland ( RYL) Chief Financial Officer Gordon Milne at a Credit Suisse investor conference Tuesday. Milne said his company is offering price discounts ranging from 5% to 20% nationally at its communities. These prices are based on what the competitor is doing across the street. "We have to match in order to keep business up," he said. Land impairment charges, meanwhile, may continue at a rapid rate so long as prices keep falling. As Milne said, the builder either doesn't sell the house or it writes down the value of the community. The former, he said, is not really an option.
In order to play the sector, Barron says investors should first focus on which builders will even survive the coming carnage in the sector. Those with the lowest debt burdens and shortest land pipelines are the best candidates, he says. They include Toll Brothers, NVR, MDC Holdings ( MDC) and Ryland. At some point, some of the better builders become buying opportunities. But it is still too early to buy the group, says Dean Frankel, a portfolio manager at Urdang Securities Management, which invests in real estate securities for institutions. Frankel expects more "ugliness to come" in housing because of the unfolding of the subprime mortgage problems. "When I feel more comfortable we're close to a bottom, I'd be more comfortable to buy," he says.