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Is Now the Time to Buy Homebuilder Stocks?

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Demand for homes is strong, but the environment is challenging.

On the surface, now might seem like a great environment for homebuilders. Real estate prices have skyrocketed and there's a severe lack of housing inventory in many markets. However, in this Fool Live video clip, recorded on Nov. 4, Fool.com contributor Tyler Crowe explains to colleagues Jason Hall and Matt Frankel why it's not quite that simple.

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Matt Frankel: Awesome, so Tyler is now going to tell us about homebuilding. Tyler, on the surface, to a casual observer, this might seem like a great time to be a homebuilder. There's tons of demand for housing and home prices are going up and up and up. What should investors know about the homebuilding industry right now?

Tyler Crowe: I don't know if we have enough time for a subject that so few people like actually intently care about, it's a weirdly fascinating story. Here's the strangest thing about home builders. At least some of the ones I've looked at as of late. To be a good home builder, you have to do a few things well. You have to control costs. You have to maintain a steady pipeline of homes and homes for sale and basically be in the right places at the right time. One company that I follow up pretty intently because of this is LGI Homes (LGIH 0.41%). It's recommended in just a couple of services. It's fascinating to me because despite the fact that they are posting incredible earnings numbers, stock is down and has been trending down for a while.

Jason Hall: According to the National Association of Realtors and other sources, we're somewhere about 5 million homes short of inventory. That's that's new home construction. That's where home builders play. We could basically double our home builder production for three years and just get caught up on the shortfall in supply. That's where the opportunity lies right here. In particular, it's an entry-level starter properties,. Matt, that's the parts has been under built for the past decade. That's the price of coming out of the global financial crisis. That's where nobody was buying those properties so home builders, were not building in that area, so that's where the opportunity is. Matt, you want to hop in here too?

Crowe: I'm back, if you guys can hear me.

Frankel: There's Tyler. Tyler, go ahead.

Crowe: There's another interesting elements that play in. This is my opinion, and I can't 100% support this thesis. It always feels like with the home building business, there are the deep scars from the financial crisis and the recession, where any wave of bad news for something that appears to be bad news, can just send home builders tanking early up down.

The housing market is going down again. We had a particular instance of this LGI Homes just released earnings. The earnings were up significantly, sales were up, every number you looked at was up except for one which was net new orders. It was down quite a bit and management explained where they were getting so much demand. They had to refuse people because they didn't have enough houses built at the time to meet their demand. They didn't want to commit to sales before the houses being built to save from cost inflation and basically maintaining the margins. Because of that the stock sold off.

That's what's weird, it's like demand is immense for them. They normally forecast somewhere like six to seven homes sold per community per month. In some communities that was north of 14 this past quarter. They're just blowing through their inventory and it's going to take them maybe a few quarters to build that back up. I just look at this opportunity and say, there is a massive opportunity for home builders right now for the next three to five [years] and why every single whiff of bad news is sending the market running is still beyond me.

Tyler Crowe owns shares of LGI Homes. The Motley Fool owns shares of and recommends LGI Homes. The Motley Fool has a disclosure policy.

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