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Where You'll Make Money in Housing

For years, investors and homeowners alike have tried to call the bottom in the housing market. So far, home prices haven't cooperated. But looking at the way that home buyers have behaved recently reveals some insight into what the future of housing may look like -- and where you should concentrate your attention when it comes to investing.

A tale of two housing markets
You don't have to look hard to find dour indicators of just how bad off the housing industry is right now. Just last week, government data came out on February sales of new homes, which dropped to a record low annualized rate of just 250,000. Looking back over the past 12 months, only 349,000 new homes sold, which was also a record low. The inventory of new homes for sale rose to nearly nine months.

Source: Census Bureau.

The continuing weakness in new home sales has weighed on the stocks of homebuilders for a long time. Although Toll Brothers (NYSE: TOL  ) , Lennar (NYSE: LEN  ) , and KB Home (NYSE: KBH  ) have seen some share gains in recent months, they still trade well below their highs from five years ago, as the housing boom came to an end.

Yet despite the attention that new home sales receive, they really represent only a small portion of overall sales. Similar figures on sales of existing homes, while still weak, aren't nearly as pessimistic. The corresponding numbers for February showed an annual sales rate of 4.88 million existing homes, with 8.6 months of supply in the inventory of existing homes for sale as inventory began its annual rise in preparation for the spring sales season. That's well off the highs of around 7 million during the housing boom, but it also represents a big rebound from lows below 4 million in the middle of last year.

Source: National Association of Realtors.

Looking for value?
The typical conclusion to draw from the supremacy of existing home sales over new homes focuses on what homeowners have to do before putting their homes up for sale in a buyer's market for housing. With prospective buyers able to pick the cream of the crop, sellers competing with each other have to renovate their homes to make the cut, driving up business at Home Depot (NYSE: HD  ) , Lowe's (NYSE: LOW  ) , and Lumber Liquidators (NYSE: LL  ) . Indeed, some of the more hopeful predictions for these stocks rely on continuing interest in renovating rather than an outright rebound in housing overall.

That conclusion makes it seem as if the current state of the housing industry is just cyclical and that eventually new home sales will rebound. But looking at consumer behavior in an entirely different industry -- auto sales -- suggests a more overarching trend.

Lately, used-car prices have risen to record high levels, even as new-car sales have remained low. With cash-strapped car buyers struggling to make ends meet, saving even a small amount on a good-condition used car makes more sense than paying up for a new one. Though counterintuitive, this has actually helped Ford (NYSE: F  ) and General Motors, because even with somewhat weak sales, the upward pressure on used-car prices has also supported new-car prices, allowing them to keep margins relatively high.

If that phenomenon repeats itself in the housing industry, what you should look for first is for existing home prices to rise. Only once that happens will homebuilders be in a position to benefit -- but the benefits may come sooner than you'd expect if you just look at raw data on new home sales.

The right move in real estate
With home prices for existing and new homes still low, perhaps the best way to profit from the housing downturn is simply to buy real estate directly. If you can afford the time and expense involved, you can take advantage of high inventory and weak demand to get the home of your dreams -- or a big prospective moneymaker.

But if you prefer to invest passively, the time isn't ripe for homebuilding stocks yet. Until market conditions change, homebuilders will continue rising and falling in fits and starts.

Track the status of the housing market by starting a watchlist and adding your favorite homebuilder stocks. Our new service keeps you in touch with all your favorite stocks. Sign up now and you'll get immediate access to a new special report, "6 Stocks to Watch From David and Tom Gardner." Click here to get started -- it's all free.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger is glad to have a roof over his head. He doesn't own shares of the companies mentioned in this article. General Motors, Home Depot, and Lowe's are Motley Fool Inside Value selections. Lumber Liquidators is a Motley Fool Rule Breakers recommendation. Ford is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended writing covered calls on Lowe's. The Fool owns shares of Ford and Lumber Liquidators. Motley Fool Alpha LLC has written calls on KB Home, which is a Motley Fool Big Short short-sale recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you shelter.


Read/Post Comments (2) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 28, 2011, at 5:29 PM, xetn wrote:

    Another area to address is who is maintaining the huge inventory of vacant homes that underwater owners walked away from. Is it the lenders?

    Just curious. I am sure there are many of them "going to seed".

  • Report this Comment On March 28, 2011, at 5:34 PM, rocketman67 wrote:

    Ahhhhh.........KB Homes! I remember when I bought my Villa/Townhouse/Condo about 3 years ago I got what I thought was a good deal because the housing market was slowing down here in SW Fla.They had two left so I made an offer and they took it. Little did me and a lot of other buyers out there know how much it was going to tank.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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