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Prefab Gains Signal Housing Pain


With home sales no longer soaring and inventories on the rise, there's little doubt that the housing market is cooling. But for the holdouts who need more evidence before they admit the party's over, the manufactured homes industry is worth close attention. One might assume the two move in tandem. Not so: Strength in manufactured housing often signals tough times for the larger housing market. And with no less an investor than Warren Buffett voicing support now, the stocks of the handful of publicly traded companies in the prefab sector might soon be due for a lift.

Demand for manufactured homes -- built in factories and transported to sites -- has been brisk since Hurricane Katrina hit last August. The government has paid almost $900 million for about 25,000 mobile and modular homes to provide dislocated residents roofs over their heads while they rebuild. But the industry's growth spurt isn't just disaster-related: Affordability is driving orders as well. And that's bad news for the rest of the housing industry, says Barbara Allen, first vice-president with Avondale Partners, a Nashville-based investment bank. She says housing starts, or the number of residential building projects begun, and the number of manufactured housing units sold have tended to move in opposite directions since the 1970s, but especially since the mid-'90s (chart). "It's countercyclical," agrees Paul Nouri, equity analyst with New York research shop Sidoti & Co.

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Why do gains in the manufactured housing industry come at the expense of the larger housing market? Prefab homes are 10% to 25% cheaper than traditional "stick-built" homes, not including land. "You're seeing the people who missed out on the housing boom buying smaller houses," says Ivan Feinseth, director of research for MatrixUSA (MUSA), an institutional research and brokerage firm in New York.

What's more, as interest rates rise, household budgets will get squeezed, and some owners will begin to trade down to cheaper manufactured homes. The up cycles can last several years; the last one ran from 1991 to 1998.

The industry doesn't have a sterling reputation on Wall Street. It crashed in the late '90s after lenders loosened standards, allowing people to buy more house than they could afford. "They'd finance just about anyone who would walk in the door," says Nouri. Shipments hit an all-time high of 370,000 units in 1998; a wave of defaults followed. Lenders fled the sector, and homes were repossessed at a fraction of their loan values. By 2002, delinquencies peaked at 30% of all manufactured home owners. Units sold fell 65% from peak to trough, says Allen.

Out-of-favor industries attract deep-value investors. Buffett might have timed things perfectly. In 2003 he paid $1.7 billion for Maryville (Tenn.)-based Clayton Homes (BRK), one of the largest manufacturers. Clayton, along with Champion (CHB) and Fleetwood Enterprises (FLE), together control around 80% of the $7 billion market. "Clayton could be the biggest homebuilder in the U.S. in a few years," Buffett said to shareholders on May 6. "The industry is slowly working through its hangover." Delinquencies are now just 2%.

Demographics are on the industry's side. Orders are flowing in from Arizona, Florida, and California, once-fervid real estate markets that are cooling off fast. Retired baby boomers on fixed budgets are expected to continue to drive sales in the Sunbelt. And demand in the New Orleans market should be strong for years to come.

Right now, investors might not be appreciating the full potential of manufactured home stocks. "We're in the early stages of an upswing," says Jay McCanless, a research associate at Avondale, which recommends a handful of manufactured housing stocks, some traded by Avondale as a market-maker. It pegs Champion, for example, at a price of 19, up from its current 13. If these stocks start ticking up, it could be a sign that traditional homebuilder stocks such as Hovnanian Enterprises Inc. (HOV) and Pulte Homes Inc. (PHB), and the larger housing market, are on a shaky foundation.

By Mara Der Hovanesian


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