Time To Short Home Builders (TOL)?

[pcoulter]

I am a firm believer that long rates will rise more than most expect over the next year, as foreign central banks become less willing to finance our consumption binge, which will (hopefully) burst this credit bubble. I also have a bearish outlook for equities this year, and would like to position for the downside. I was thinking about shorting home builders such as Toll Brothers (TOL). Anyone have any comments or suggestions?

[HenryTo]

Thanks for the info, nodoodahs.

Following is a good article on the slowing housing market in the UK from CNN. I fully expect the homebuilders to be "a short" eventually - will keep all of you updated! Have a good weekend.
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Homes: U.K. went cold; U.S. could too

U.S. homeowners can learn a lot from the housing slowdown in the U.K. market.
May 4, 2005: 4:58 PM EDT
Sarah Max, CNN/Money senior writer

SALEM, Ore. (CNN/Money) Americans aren't the only ones who've gotten rich off real estate. In fact, home price gains in the United Kingdom dwarf those of the United States.

Between the fourth quarter of 2000 and 2004, U.K. home prices increased 88 percent, on average, according to the Halifax house price index. U.S. home prices, meanwhile, increased 35 percent during that time, according to the National Association of Realtors.

The U.K. housing market started to gain steam in the late 1990s, beginning with the higher-priced properties in London and spilling over to virtually every region and every type of housing. "Buy-to-let" became all the rage as investors shifted funds from their traditional portfolios into rental properties.

"Every week there were stories in the paper about people making more on their property than going into the office," said Ed Stansfield, property economist at Capital Economics in London.

Then, with little warning, the market cooled.

"It was rising at a 20 percent annual rate and then suddenly stopped in its tracks," said John Calverley, chief economist and strategist of American Express Bank in London and author of "Bubbles and How to Survive Them."

While economists disagree on whether the U.K. is experiencing a temporary lull or the beginning of a housing bust, buyers there seem to be waking up to the idea that double-digit price gains can't last forever. Prices overall have been flat, with small increases in some areas and declines in others.

Speculators seem to be having second thoughts. Sellers are wondering where all the buyers went. Retailers say that "house rich" shoppers are sitting on their wallets.

"My sense is that the U.K. market is two or three years ahead of the U.S. market," said Calverley. Every market has its own dynamic, but there are lessons to be learned from what's playing out across the pond.

Lesson: Rising rates do take a toll
During the U.K. housing heyday, most experts agreed that higher interest rates would probably dampen buyer enthusiasm. As in the United States, many argued that the effects wouldn't be drastic because higher rates usually go hand-in-hand with an improving economy.

Yet, U.K. buyers -- who typically finance with monthly adjustable-rate loans -- did eventually take notice after the Bank of England started raising rates. By most measures, housing prices started declining in June 2004 after the bank's third quarter-point rate increase.

The Federal Reserve's eight quarter-point rate increases have done little to scare away U.S. buyers, who unlike their U.K. counterparts have the option of getting a fixed-rate mortgage. In the priciest markets, however, many buyers are resorting to interest-only loans in order to afford the monthly payment. These buyers are most vulnerable to the double-whammy of rising rates and declining home prices.

"In the U.S., the markets that are most risky are those where there is a higher proportion of buyers using adjustable loans and interest-only loans," said Thomas Skinner, managing partner of Redbrick Partners, a U.S. investment management firm that invests in single-family housing and is modeled after similar U.K. firms.

Lesson: Speculators are a fickle bunch
Investors who bought property with the idea of flipping it for a quick profit or renting it out played a key role in driving up U.K. housing prices.

Now they appear to be on an extended holiday.

According to the Council of Mortgage Lenders, lending to "buy-to-let" investors dropped 18 percent between the first and second half of 2004 compared with only a 3 percent drop for owner-occupied buyers. During that time, the number of such investors unable to meet their mortgage payments increased 50 percent.

"People were buying thinking they'd rent it out and make 15 or 20 percent appreciation, but now they're left with only the rental yield," said Stansfield at Capital Economics.

Investors haven't rushed out to sell property, he said, but demand for the type of property favored by investors is quite weak. If prices remain flat or decline, "you'll probably see a round of investors who decide they're overexposed and need to unload some of their property."

Lesson: Supply isn't so limited after all
A year ago, everyone believed the supply of houses for sale simply could not keep up with demand. It was a sellers' market.

"There was a view that prices would keep going up forever," said American Express' Calverley.

Today, it appears buyers have the upper hand. According to the Royal Institution of Chartered Surveyors, the supply of houses for sale in March is fully a third greater than it was a year ago.

"In these markets there is a herd instinct where people rush out to buy but then as soon as people think differently suddenly there are no buyers," said Calverley.

There is a backlog of property for sale, more is coming up for sale and so sellers who usually prefer to keep houses on the market rather than lower their asking price are starting to rethink that strategy.

The impact of psychology on the housing market is slower than in the stock market, Redbrick's Skinner added. But if people are buying with the expectation of prices going up 15 percent, he said, demand will drop off the moment the expectation changes.

Lesson: When the going gets tough, some foreclose
When the U.K. market was hot, said Stansfield, lenders became increasingly lenient in their credit standards, allowing for higher debt-to-income ratios, smaller down payments and more creative financing.

"The mortgage industry took great pleasure in the fact that the number of people in arrears was very low and possessions (foreclosures) were at an all-time low," he said.

But as rates rise and double-digit price gains disappear, borrowers are starting to feel the squeeze. As of February, the number of mortgage repossession actions in the courts was at the highest level in five years, and many expect it to rise further.

"What we're seeing now is the first signs of stress," said Stansfield.

Lesson: Housing woes affect the rest of the economy
The U.K. housing market hasn't gone bust. But homeowners can no longer rely on double-digit price gains to prop up their standard of living -- and that reality is trickling through to the rest of the economy.

According to an article in the Financial Times, High Street retailers are finding a "sober mood" among consumers, while demand for big-ticket items, such as cars, has dropped off sharply. Households have suffered from a "money illusion," said one economist quoted in the article, and are only now realizing that they actually aren't richer.

"You have a lot of people here [in the United States] consuming housing wealth," said Skinner explaining that some homeowners are either spending their home equity or saving less because they assume their rising property values will fund their retirement for them. "Even just a slowdown in appreciation would probably impact spending," said Skinner.

[nodoodahs]

The Toll brothers themselves have sold $154 million worth of stock since the beginning of the year. Other insiders have sold $22 million since 1/1.

These are not sales to put their kids through college, folks.

[HenryTo]

KB Home's Chairman and CEO selected to be the featured speaker/mentor on a new reality show on CNN. Time for the homebuilding bubble to burst? Anyone remember how popular Donald Trump immediately before his business went bust in the early 1990s?
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KB Home Chairman and CEO Bruce Karatz Mentors on CNN's 'The TurnAround'
Friday April 29, 11:30 am ET
CNN's First Reality Program Pairs a Small-Business Owner With a High-Profile Mentor in a Three Day Business Makeover


LOS ANGELES, April 29 /PRNewswire-FirstCall/ -- KB Home (NYSE: KBH - News), one of the nation's premier homebuilders, announced today that its Chairman and CEO Bruce Karatz, will be the featured mentor on CNN's business-focused reality show, "The TurnAround," which airs Saturday April 30 at 11:00 a.m. (Eastern Time).

The cable news network's first foray into reality programming, "The TurnAround " pairs a small business owner looking to take his/her business to the next level with an industry heavyweight. The mentor has just three days to overhaul the company's trajectory.

Saturday's episode will match Fortune 500 CEO Karatz, a 30-year homebuilding veteran with Benjamin Morey, founder of Morey Construction. Karatz will evaluate the current state of Morey Construction and offer practical tips for improving their marketing efforts and overall business plan to create brand awareness, improve the sales experience, and build a loyal and satisfied customer base.

"We could not have asked for a better owner to mentor than Ben," said Karatz. "This is a man who cares about his customers and always exemplifies the highest level of professionalism, quality craftsmanship and ethics. It was a pleasure working so closely with Morey Construction, and I hope we were able to make a difference in our desire to enhance the company's productivity, reputation and profitability."

Considered the true voice and leader of the homebuilding industry, Karatz led KB Home to build 31,646 homes in 2004 compared to fewer than 4,000 when he became CEO in 1986 and less than 7,000 when he was named Chairman in 1993. In 2004 Karatz was ranked the top homebuilding executive on Builder magazine's list of the most influential people in homebuilding, coming in sixth behind Alan Greenspan, Franklin Raines, President George W. Bush, Jerry Howard and Andres Duany. Karatz currently serves on the board of directors at Edison International and Honeywell International. In addition, he is Vice Chairman of the Board of Trustees for RAND Corporation, Vice Chair of the Board of Councilors of USC Law Center, and serves on the Board of Directors for the California Commission for Jobs and Economic Growth.

[HenryTo]

Guess I was wrong. Homebuilders decisively broke down today. It is probably time to go on the defensive should you choose to stay in equities. PFE and MRK sound like good picks at the moment.

[HenryTo]

Still too early to say whether we're heading for a secular decline here. The numbers were not great, but the homebuilders were oversold and so now they are heading upward as a group.

I think homebuilders can go up more here, even to an all-time high. They are pretty much the only group (besides oil) which haven't really broken down yet.

[HenryTo]

Homebuilders are actively cracking down on the flippers here.
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U.S. home builders try to thwart speculators
Tue Apr 12, 2005 12:53 PM ET

By Ilaina Jonas
NEW YORK, April 12 (Reuters) - U.S. home builders have armed themselves with punitive measures to combat speculative buying in certain markets, but questions remain about whether some of the stronger measures will stand up in court.

"The whole legal aspect of of this has not been tested," said Roger Cregg, chief financial officer of Pulte Homes Inc._(PHM.N: Quote, Profile, Research) , the No. 2 U.S. home builder.

The anti-speculation measures prohibit buyers from selling contracts and renting or selling a house for a year. If the ban is violated, the home builder takes the profit or imposes a penalty.

In the 1980s, New York home builders successfully defended their policy prohibiting assigning contracts, or selling a contract to another person. But policies that govern what a buyer can do after the purchase is completed remain untested.

One Nevada investor is fighting a $50,000 fine imposed for violating the contract by selling a house within a year after purchasing it, Pulte said.

"A one-year prohibition against reselling without including the builder in for a piece of the profit, is that an undo restraint of free sale of real property?" said Robert LePome, a Las Vegas real estate attorney.

U.S. home builders say high investment sales threaten neighborhood values and also compete with the home builders themselves.

"We call those flippers," Cregg said. "A flipper is looking to make a lot of money very quickly."

Home builders began adopting the policies about two years ago, when rapidly rising California home prices attracted the investment buyers. The rise in speculative buying spread to other markets, such as Phoenix, Arizona, parts of Florida and Las Vegas and Reno, Nevada, where prices have increased by more than 20 percent a year.

Speculators are more prone to be unstable buyers, who may bolt at the first sign of softening prices and flood the market with homes at cut rate prices, or cancel contracts, leaving home builder with an inventory of unsold houses.

"If the market were to soften in the future, someone buying a home and needing a home is more likely to stay with the purchase than an investor, even though the investor would lose their deposit," Lennar Corp._(LEN.N: Quote, Profile, Research) Chief Operating Officer Jonathan Jaffe said.

Even in a strong market, speculators pose a threat to the home builders by taking advantage of rapidly increasing home prices. Flippers sell a contract for a home even before the home is built under the current market rate, but higher than they paid months ago

"It's the flippers who want to take advantage of escalation of the price that become competitors of ours that we're trying to discourage," Cregg said.

Speculative, or investment, buying changes the character of the neighborhoods the builders are creating because the buyer usually rents the home until it is sold, home builders said.

"From a community point of view, we really don't want a bunch of 'For Rent' signs and homes that possibly wouldn't be maintained well," said Jeffrey Mezger, KB Home (KBH.N: Quote, Profile, Research) chief operating officer.

The home builders said the policies seem to be working, despite a recent survey by the National Association of Realtors that showed nearly a quarter of the homes sold in 2004 were purchased as investment property. Newly constructed home sales comprise about 15 percent of the market.

"I can't sit here and say we have no investors in our backlog today," Mezger said, referring to KB's backlog of homes under contract. "I think that would be naive. It certainly has diminished significantly from the period prior to our policy."

[Dubious]

Wow another stock that has broken down technically - they are so hard to find . Will hold up to the fed minutes are released. Recommending getting your finger close to the trigger on this one - the insiders are . Dumping it like it on fire (housing joke ). If you do not sell prior to the fed minutes are passed down from the Ivory Tower...get ready for a shovel to the mouth.

Talking heads will tell you this is the cadallac of stocks - hey GM sucks too . Stocks are pieces of paper - this paper is one that needs to be put in the OUT box.

Good luck!

Dubious

[HenryTo]

pcoulter,

I apologize - I meant flight to quality!

I definitely think that at some point this year, hedge funds and investors alike will dump their foreign debt, high yield debt, in exchange for a more stable fixed income investment such as U.S. Treasuries.

In this current environment, I am not sure that the yield of the U.S. Treasuries is a good indicator of inflationary expectations. Everything is about supply and demand - and demand has certainly been strong for U.S. Treasuries even as our current account and federal budget deficits hit new highs over the last few years. I see it stablizing here with a "blowoff" to the upside during the "flight to quality" stage - and only then will I go ahead and short U.S. Treasury bonds.

Best of luck!

Henry

[pcoulter]

Henry,
Can you explain this "flight of quality" a little more? Are you saying people will dump emerging market debt for US debt? I'm short the TLT right now, and was planning on this to be a longer term hold because of my belief that inflation is rising much faster than the government will tell us with their BS CPI.

Thanks!

[HenryTo]

I also think long rates will rise over the longer-term but right now, my "scenario" calls for a "blowoff" sometime this year in U.S. Treasuries as the "flight of quality" from the emerging markets materialize sometime this year.

Not sure about the homebuilders (KBH still okay although it isn't making an all-time high this morning) but the mortgage financiers have definitely broken down.