Real Estate's 7-Year Glitch

It doesn't look good. The housing data from this morning was bleak. New home sales fell by 3.9% last month, according to the U.S. Commerce Department. The seasonally adjusted annualized rate of 848,000 single-family homes sold is the lowest number since the summer of 2000.

You may remember that time as a point when the economy was hesitant and the dot-com bubble was starting to burst. It really wasn't all that bad, but let's put the past seven years into a perspective that investors in homebuilders can appreciate.

More gains than pains
If the industry is as cobweb-riddled as it was seven years ago, why are the stocks trading so much higher? It's a fair question. These are seven of the eight largest publicly traded domestic homebuilders (by market cap), and for all but one, their adjusted share prices have risen fivefold since that summer. Poor little Centex investors had to settle for a whopping 324% return in that time. If that's a laggard, sign me up for the parade.

A housing bear may be licking his chops. If the sector really has come full circle, one would think that the stocks have much further to fall to catch up to the market's apathetic demand for freshly built digs.

Don't bet on it. That's flawed reasoning, because these stocks aren't going back to their 2000 levels, my friend. What do you think has happened to all of these companies over the past seven years? When they feasted on record profits, they were able to beef up their balance sheets, buy back shares, and snap up smaller rivals in a highly fragmented sector. Regardless of the glut of existing homes that are flooding the market now, these makeovers don't wash away that easily.

You see that in MDC Holdings. The stock was recommended to Motley Fool Hidden Gems newsletter subscribers last summer. The investment-grade credit agency rankings and solid financials made it a sharp pick. A housing slowdown would eat away at its mortgage origination business, and runaway prices would hurt it -- what with its emphasis on starter homes -- yet that same industrial malaise should plant the seeds for a leaner sector when the market recovers.

Buy now or later
This doesn't mean that the entire sector is a screaming buy, either. The data from this morning is pretty disheartening. The drop last month follows a tumble of 15.8% -- the number was revised -- in January. And we're not just talking about moving fewer homes here. Median sale prices also dropped slightly in January and February.

You're not likely to shed a tear for the condo flipper or ritzy real estate agent who is smarting over an end to the gravy days. You may even welcome lower prices as a way to turn the real estate market into something sustainable.

The speculative froth and barrage of interest-only mortgage products were just baiting the subprime lending debacle to bite the hook. It did, of course. We're just getting started with the healing process.

Will the market recover? Yes. When? Good luck getting an answer on that one. Even the homebuilders can't see the light at the end of this tunnel. KB Home warned last week that it sees weakness continuing through at least the end of the year. The CEO of luxury homebuilder Toll Brothers, who a few months earlier was guardedly optimistic about the sector bottoming out, recently concluded that the spring selling season has been a bust for it.

This time of year is the industry's moment to shine. Single-family homes should sell briskly -- whether it's because of the tax refund checks rolling in or the desire to sign a deal for a new home that will be ready before the school year starts.

Those prospects are clouded by desperate sellers of used homes. In last week's data, existing home sales inched higher in February. With supply outpacing demand, it's a buyers' market, and they seem to be taking advantage of that by favoring the more flexible pricing in the resale market.

That too shall pass, but I wouldn't jump into the homebuilders until some of it settles. Earnings growth has deteriorated at a quicker pace than share prices have declined. Inventory levels remain chunky. By the time the dust clears, you're going to find some pretty amazing investment opportunities, yet they may come at even lower price points than today. There will be fewer homebuilders. They will have cleaner balance sheets. Even the stocks will have that new-home smell. That's what I would want in both a new home and a real estate developer.

You can have your own open house by going for a free 30-day trial subscription to Hidden Gems. If you are set on making that spring move, check out our Home Center for a collection of resources.

Longtime Fool contributor Rick Munarriz feels that owning a home is better than renting, but can admire folks who are renting now until housing prices drop to realistic levels. He does not own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.