Call it seven years of bad luck. At just about this time of
year, in 2005, homebuilders rode over the falls and into the
industry's longest, steepest decline in a generation.
Over the past several quarters, housing and real estate
markets have begun flickering to life. Housing starts, building
permits, builder confidence and other monthly data continue to
saw back and forth. But some positive trends appear to be
There is much debate over whether those trends constitute a
recovery, but economists and analysts have begun to agree that
the correcting market has at least put in place a floor.
"If you look at the actual raw numbers on a year-to-date basis
and take out monthly swings, there's no doubt we are better than
a year ago," said analyst Megan McGrath of MKM Partners. "We're
still at historically low levels vs. any kind of measure of
long-term averages. But we have clearly come off the bottom."
The recovery has been stubborn, not holding to the industry
tradition of a quick rebound off housing-market lows. It's true
that new-home starts across the first two quarters were 15%
higher than a year ago; new-home sales are up 20%, McGrath says.
But the rebound is less bouncy than previous cyclical
"It doesn't look to be as dramatic this go-around," said Fitch
Ratings managing director Robert Curran. "Typically in new
construction, recoveries tend to be V-shaped. This so far is a
The homebuilding industry struggling to crawl out of that
U-shaped slump also looks very different than it did going in.
With cash cushions and access to capital, and by managing labor
costs and real estate strategies, the leading publicly traded
builders survived. Countless ranks of smaller and regional
That new command of market share might possibly be gaining
traction. Eight of 15 U.S. builders topped analyst earnings
projections for the second quarter, most by triple-digit margins.
On the revenue side, nearly all fell short of forecasts.
Investors, for the most part, didn't seem to mind. Rising
share prices of publicly owned builders, includingD.R. Horton (
) andToll Bros. (
), have kept the Building Residential-Commercial industry group
in a top five ranking among IBD's 197 industry groups since
Beazer Homes (
) andRyland Group (RYL) were among the few publicly traded
builders to fall short of Wall Street's second-quarter earnings
Lennar and D.R. Horton swept past expectations -- with a
little boost from the IRS. Both qualified, through relatively
healthy orders and profits, for a break called a "tax asset
"It wasn't that they earned that much extra cash," said Greg
Harrison, research analyst at Thomson Reuters. But "even though
it's not all cash earnings, it's still a positive sign."
Without the tax break, D.R. Horton would have earned 23 cents
a share instead of $2.23, beating estimates by 3 cents instead of
by more than $2. Of the $2.06 reported by Lennar, $1.85 came from
the tax benefit. Even without the benefit, Lennar would have beat
by 4 cents.
Revenue is another thing. Of 13 U.S. homebuilders in IBD's
industry group, nine missed Wall Street revenue views in Q2,
according to Thomson Reuters. The four that beat: Lennar,Meritage
(MTH),KB Home (KBH) andHovnanian (HOV).
"The earnings beat rate is slightly higher than normal,"
Harrison said. "The revenue beat rate is far below normal."
The builders are adept at paring labor forces and other
cost-cutting measures to bolster earnings. On the flip side, that
can leave them shorthanded when it comes to churning out new
Revenues were light during the quarter, in part, because it's
taking builders longer to complete homes. As new orders start to
rise, builders report rising backlogs.
Another factor: Builders are putting up fewer homes on
speculation. The industry is geared to raising entire
subdivisions on speculation, then selling into a healthy market.
Building homes only after a contract is signed, and according to
customer specifications, is less efficient, piecemeal work. Such
homes can take at least 90 days to deliver.
This is why revenue in the building industry is a lagging
indicator, says Wells Fargo Securities analyst Adam Rudiger.
"Orders come first and revenue follows," Rudiger said.
"Revenue is a reflection of order activity from three months
Cancellations also figure into the mix.
NVR 's (NVR) 16% cancel rate in Q2 stood out. Its shares fell
14% on July 19, the day quarterly results were reported. Rudiger
says NVR's order growth of 6% -- slow vs. its peers -- was a
larger factor in the sell-off. Shares have since recovered to 5%
below their July 16 high.
In June, Lennar also reported a 16% cancellation rate for the
quarter, but vs. a 40% increase in new orders. On July 26, Pulte
put its cancellation rate at 14%, down from 19% a year earlier
and vs. a 32% gain in new orders in the second quarter.
The major builders saw markets blip to life two years ago when
the homebuyer's tax credit generated a surge in demand. But
first-time homebuyers retreated when the credit ended in April
2010. Move-up buyers are now the more active customers for
publicly traded builders.
Interest rates are at record lows. But first-time buyers
continue to have trouble qualifying for mortgages and scraping
together the down payments to meet tougher lending
Move-up buyers often use proceeds from the sale of their home
to buy a larger one. They generally have better credit histories,
and qualify for lower-interest mortgages.
Tougher appraisal standards have become a hurdle across the
industry. When appraisals come in well below the sale price of a
home, as they often do these days, mortgage lenders may require
borrowers to make up the difference with larger down payments.
Move-up buyers are typically more able than first-time buyers to
meet such demands.
First-time buyers typically make up close to 40% of home
sales. The tax credit briefly lifted that share to near 50%,
Curran says. First-time buyers now account for just over 30% of
the total market.
"In Texas first-time buyers tend to be more prominent,
particularly because of low prices and population and job
growth," Curran said.
First-time buyers have a tougher time cracking pricey markets
such as the Washington, D.C., area. D.C. typically holds up
better than others in downturns because of steady federal
But Curran says orders for new homes in the D.C. market were
not as robust in the second quarter as in the first quarter.
Uncertainty over the upcoming presidential election, and
potential staffing changes, could be a factor.
New homes compete with existing-home sales, the latter a far
larger market and now larger still counting distressed
"Normally, the existing home market is 5-1/2 times the size of
the new-home market. Presently it's more than 10 times higher,"
And if distressed inventory isn't enough to keep a lid on home
prices, the ability of existing homeowners to sell their home is
hampered by first-time homebuyers' inability to buy one.
"Who does the trade-up buyer sell their house to? Oftentimes
it's a first-time buyer," said Curran.
The big question for homebuilders, Rudiger says, is "where do
you go from here?
"A lot of the demand we've seen this year is low-hanging fruit
from qualified buyers," he said. "So growth rates could slow a
A strong recovery won't likely take hold until employment
improves, he says. In July, the jobless rate ticked up a notch to
Fitch Ratings predicts that single-family housing starts will
rise 12% this year over last and go up another 14% next year. In
new-home sales, the ratings agency forecasts a 10.5% gain in 2012
and 12% in 2013.
But an uptick in foreclosures looms as the system works
through the backlog. "It's sort of like the pig (being swallowed
by) the snake," Curran said.
McGrath added: "We have this big overhang of foreclosed
properties and underwater homes that may be slowing the pace of
She says it could take another two years to absorb excess
And macroeconomic uncertainties in the U.S. and overseas
"We're keeping a watchful eye on the macro trends, which
ultimately need to turn more positive for the recovery to expand
further," said Pulte CEO Richard Dugas in a Q2 conference call in
Toll Bros.' CEO Doug Yearley told analysts and investors in a
second-quarter earnings call that Europe remained a big question
mark hanging over the market.
"We're one really big European headline away from buyers going
back under a rock," he said.