Home Builders Not Out of The Woods Yet

New York, NY, July 24, 2009--Home builders carry some big pitfalls for investors, write David Goldberg and Susan Maklari, analysts at investment bank UBS .

Most of the big home builder firms report earnings in the next two weeks. While they are likely to show that demand kept up through the second quarter, Goldberg and Maklari are skeptical about the second half of the year.

For one, prices continue to fall and they think home values have another 5% to 10% before the market bottoms later this year.

For home buyers, some major incentives are lapsing. A $10,000 tax credit offered by California on new homes has been exhausted. The federal government's $8,000 credit for first-time buyers ends in December.

Mortgage rates, which had fallen sharply along with borrowing rates for banks, have begun to rise again, which usually slows the pace of home sales.

Another stumbling block is that banks are just now starting to flood the market with foreclosed homes they’ve been hoarding, driving supply up and prices down. The two analysts also guess that the pace of foreclosures is accelerating now that federal and state moratoriums have expired.

That makes the economics of buying land and building hundreds of homes difficult to justify. "In a number of housing markets today, builders can't purchase raw dirt, entitle, develop and build a home on it and generate positive free cash flow," say the analysts.

Debt is another looming problem for several firms.

They do, however, recommend two companies. High-end builder Toll Brothers, which has the lowest debt-to-capital ratio of all the national firms, and the Ryland Group, with the second-lowest debt level.