A False Spring for U.S. Homebuilders?

The stock market's recent optimism about homebuilders, culminating in Pulte Homes' proposed merger with Centex, rests on a shaky foundation

By Ben Steverman

A couple of years into the housing slump, there are finally some news headlines to lift the spirits of long-suffering U.S. homebuilders. But that does not mean the problems in the home construction industry are solved, or that homebuilding stocks are a smart investment—not by a long shot.

Shares of larger homebuilders such as DR Horton (DHI), Toll Brothers (TOL), and Pulte Homes (PHM) are up 37% since the market lows of Mar. 9. That's far more than the 21% gain for the Standard & Poor's 500-stock index.

A 4.7% jump in new-home sales in February from the previous month raised hopes, even though sales were still down 41% from the year before. The number of homes on the market fell slightly, from 12.9 months of supply to 12.2 months. "The rate of new home sales may be close to its bottom," Deutsche Bank (DB) economist Joseph LaVorgna declared when the data came out in late March.

Centex CEO: "The Right Time for a Deal"

The latest feel-good story for the troubled sector: On Apr. 8, Pulte Homes announced it would merge with Centex (CTX). The $4.1 billion combination would replace DR Horton as the largest U.S. homebuilder.

Centex Chairman and Chief Executive Timothy Eller said in an Apr. 8 statement that this was the right time for a deal: "By acting decisively now, we're creating unrivaled firepower to capitalize on the opportunities in homebuilding that are now becoming visible on the horizon."

But not everyone sees what Eller sees. Although some investors, economists, and homebuilding executives are hopeful, many observers are not. Nor do many analysts believe the Centex-Pulte merger will kick off a wave of dealmaking in the homebuilding industry.

Raymond James (RJF) analyst Paul Puryear is blunt: "Building new homes today is just not a viable business."

Credit Remains Tight for Many Buyers

Low interest rates and the recent drop in home prices are often cited as reasons for optimism. But as JPMorgan Chase (JPM) analyst Michael Rehaut points out, a 4.6% fixed interest rate on a 30-year mortgage typically requires a 20% down payment and a high FICO credit score of at least 700.

Measures of affordability may look promising, but they are misleading because only some buyers have access to favorable terms, Rehaut wrote on Apr. 8. "Credit availability for first-time buyers remains tight and has even recently tightened further in some instances," he says. Jumbo home buyers—those seeking to borrow more than $417,000—also face higher interest rates.

And there are other factors keeping buyers out of the market: They justifiably fear that home values could continue falling after they purchase. Unemployment keeps rising, and the housing market is "very highly correlated with employment," says Eagle Asset Management research analyst Nik Legetic.

This is indisputably a gloomy time for the housing market. It could be a time of opportunity—time to prepare for the dawn of new growth in housing. Or is it just time to accept that it could be several years before the sun again rises on homebuilders?

Business Exchange related topics:
Residential Real Estate
U.S. Stock Market
U.S. Financial Crisis

Steverman is a reporter for BusinessWeek's Investing channel.

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