A Contrarian View on Housing

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You might not enjoy walking a mile in my shoes.

No matter which direction I go, however, I cannot walk away from my own perception that the worst of the financial crises is not yet behind us.

Although my expectations for prolonged impairment of the housing and construction sectors have not wavered, the prevailing sentiment of investors has turned from panic to confidence faster than I ever imagined possible under the circumstances.

Construction-related equities surged mightily last week. Shares of wallboard manufacturer USG (NYSE: USG  ) spiked 31% higher before settling for a 17% weekly surge. It appears investors are undeterred by USG's looming closure of 30 additional distribution centers. Mexico's Cemex (NYSE: CX  ) tacked on more than 16% before surrendering most of the gains after the weekend. Homebuilders like Pulte Homes (NYSE: PHM  ) moved in the same direction, albeit to a lesser degree.

The building blocks of recovery
Fueling this triumphant burst of optimism, data on U.S. housing starts released last week recorded another month of gains in August to a seasonally adjusted annualized rate of 598,000 units. At less than half the construction activity from a decade ago, we're not yet approaching any semblance of normalcy in the sector, but the ongoing string of sequential improvements marks a welcome bounce from the scariest levels reported earlier in the year.

Treasury Secretary Timothy Geithner then confirmed rumors last Thursday that the administration may extend the November deadline for the $8,000 tax credit for first-time homebuyers. Some 1.4 million taxpayers have applied for the credit thus far -- representing $11.2 billion in total incentives -- though one trade group estimates that only 350,000 of those transactions would not have occurred without it.

The industry fears an abrupt end to recovery momentum if the incentives are withdrawn, and is lobbying to extend the program through 2010 and expand it to all buyers, not just first-time buyers. If these requests are met even in part, we can expect some continued strength in related equities.

JP Morgan analyst Michael Rehaut may be counting on such an extension. The analyst lifted his homebuilding sector outlook Friday from negative to positive, and issued overweight ratings on builders Toll Brothers (NYSE: TOL  ) and KB Home (NYSE: KBH  ) . Rehaut believes the sector is "solidly past its trough," and sees "further upside to the current rally" over the next two years after a potentially bumpy start. I sure hope he's right, but unfortunately I continue to track a wide range of issues that present sweeping obstacles to continued momentum in the residential housing sector.

Cracks in the foundation
While the tax credit program has stoked demand the way Cash for Clunkers did for autos, another government program aimed at stemming the devastating tide of foreclosures has thus far had little impact. The $75 billion effort under way to promote renegotiations of troubled mortgages to stave off foreclosures is not having the desired effect. As I pointed out in June, between 55% and 75% of early renegotiated loans were returning to distressed states of delinquency within 60 days. The sustained pace of foreclosure activity, including 360,000 homes in July alone, suggests that the credit-related portion of the housing equation remains definitively in crisis mode.

Mark Zandi, chief economist at Moody's, believes that the program "probably will be overwhelmed by the magnitude of the problem." His company forecasts 4.6 million additional foreclosures by the end of 2010, and a cumulative total of 9 million homes lost by the end of 2011. Loan losses of this scale are not likely to inspire easy mortgage credit from the banks going forward, and the impact upon the existing inventory of available homes can scarcely be overstated.

With a resounding thud, the next shoe in the mortgage crisis is about to drop. I'm not talking about the commercial real estate shoe that has garnered so much attention already, but rather the payment option adjustable-rate mortgages that are due to reset in the coming months. In these resets, mortgage payments can balloon by fivefold to tenfold overnight, and this has federal and state officials acutely concerned about further acceleration in residential mortgage foreclosures.

The Foolish bottom line
With such conflicting forecasts for the residential housing market circulating, I propose that Fools determined to invest in the space consider companies with exposure to a broader range of drivers for construction demand. If my expectations for prolonged impairment of the housing sector pan out, then shares of homebuilders like Pulte Homes may not offer much shelter. With exposure to anticipated demand from stimulus spending in roads and other infrastructure, however, aggregates suppliers like Vulcan Materials (NYSE: VMC  ) and Martin Marietta (NYSE: MLM  ) could stand to gain handsomely. If I am wrong, however, and a sustainable recovery in housing materializes sooner rather than later, this aggregates segment could be expected to participate as well.

These stone-crushing aggregates producers are seldom in the limelight. Vulcan Materials is a $7 billion company, but only 465 out of 140,000-plus CAPS members have voiced their opinion. Two-star-rated Martin Marietta, with only 178 picks, remains even more obscure. With spending from the $787 billion stimulus program set to accelerate soon, where do you stand? Join CAPS for free and discover the value of community intelligence.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly in the CAPS community under the user name TMFSinchiruna. He tweets. He owns no shares in the companies mentioned. Cemex is a Motley Fool Stock Advisor selection. USG and Vulcan Materials are Motley Fool Inside Value recommendations. The Fool owns shares of Cemex. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool lives inside a single-family disclosure policy.

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  • Report this Comment On September 23, 2009, at 7:29 PM, TyAz wrote:

    "A Contrarian View on Housing"

    I don't see this as a contrarian view at all, it is the reality I live in every day.

    I live in AZ, Phoenix to be exact. I used to develop Real Estate. Needless to say, I am out of work in that arena.

    So now, I buy and sell foreclosures and short sales to entertain myself, make a little money, and just maybe assist in cleaning up the mess and help a few people along the way.

    It is not slowing down. The supply is not drying up, don't get me wrong, there is a very active market for inexpensive houses (30 to 50% of mortgage value), investors are buying them to rent, some groups are buying in very large numbers. But the houses keep coming, a past article from The Fool wrote about the Prime Mortgage Crisis. It was spot on. I know whose houses I am buying, the first round was the speculators who had the down payment on their already extended credit card, then it was the people that had a little money and wanted to get in on the money-making and bought one or two rentals, now it is real, hard working people that had/have good jobs, kids family and love(ed) their home. It is epidemic, it is a virus that is not going to stop. One lovely lady from a two job 3 child household who's house I recently saved her from pointed out, "why should I cut back on food when my mortgage is double my house's value and I can rent the same house across the street for half my mortgage payment." She has moved on in her life and her house is on the investor circuit with the bank eating 50% of their mortgage value..

    This is not going to stop. It is just starting.

    Pulte and KB are selling some houses, sounds good, some jobs and economic activity. We have millions of empty houses, Pulte and KB need to stop, once again, the government is spending billions to stimulate a market and instead of solving the problem they are making it worse. We don't need more houses, we need millions less houses so that real demand can start again. So into debt we go, making an already massive problem worse.

    So, the Construction Sector? I don't think so, like everything else going on, it is all smoke and mirrors, lies and fabrications to keep the people happy and pay alms to the almighty god of Consumer Confidence. Smoke and mirrors putting it all off by making it worse.

    Ty in AZ

  • Report this Comment On September 23, 2009, at 7:48 PM, PsycheDaddy wrote:

    I also live in the SW, New Mexico. I was in real estate all my life until 1995 when I got into retail for a change in life. I have a lot of friends still in real estate and it is slow. Nothing selling but the low priced homes and bargains. I think this current market is as bad as 1978-79 when mortgage rates got up to 21% under Carter. The current gains in housing starts are only to keep a business going and keep the employees working and try to simulate some sort of business. This housing crisis is for real and the worst I have ever seen. It is not over by no long shot. When you can't sell homes at 5% mortgage rates, the market is in trouble. That should tell you something.

  • Report this Comment On September 23, 2009, at 11:34 PM, agrigold wrote:

    Here in the Inland Empire of California it is estimated that there over 55,000 homes held by banks that have not hit the market. The estimate of loans not performing but not yet in foreclosure is estimated at 1.2 M on a national level. When these homes hit the market the prices will come down. Then when new loans have to have apprisals these lower prices lower the value of all homes. The housing market is not going to get better for at least two years.

  • Report this Comment On September 24, 2009, at 12:48 AM, PsycheDaddy wrote:


    I had friends that built many homes in the Southern California. They tell me the stories of what happened when they dropped the SSN from being on FNMA and FDMC loan application. All they had to do was

    to get an illegal immigrant with copies of his unemployment checks, down to the bank and they qualified for a new home. Made it very easy to sell homes and(not thinking about it) create toxic assets, as they call it. 50% of foreclosed homes in California were sold to illegal immigrants. 45% in Colorado and so on. I never could imagine that government could actually do this until it happened.

  • Report this Comment On September 24, 2009, at 3:43 PM, carjjc wrote:

    I am a bit confused. Why will the the rates reset to a higher interest rate?

  • Report this Comment On September 24, 2009, at 4:17 PM, TyAz wrote:

    Question: "I am a bit confused. Why will the the rates reset to a higher interest rate?"

    During the good old days, people were jumping on the housing flip band wagon, they knew that if they bought a house held if for 6 months they could make money.

    Mortgage lenders jumped in with low payment loans that had a fixed rate for 1, 2, 3 or 5 years. That way, you could buy a house that you couldn't really afford and defer the interest payments out a few years. Well, here we are, those few years are now with us and those cheap payment loans are due. Bad news, no more cheap payments, now you need to catch up on all that deferred interest.

    Poof, foreclosure.

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