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Legalized Gambling In Homebuilders

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Homebuilders are so beat up that if you are long you are betting they survive. Short and you're betting they don't.

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Buying shares of homebuilders is becoming nothing more than legalized gambling. The same logic can be applied to other sectors, but the cyclical nature of housing as well as insider details makes it a standout candidate for discussion.

See if you can follow my logic starting with Lennar's (LEN) mothball strategy as described in Mothball Housing Strategy Doomed To Fail:

Lennar plans to finish building 259 homes -- the first phase of a 1,100-unit development in Irvine -- but it has decided not to sell any of them until the constrained mortgage market and swollen housing inventory improves."I feel the same about that strategy today as I did then: "Sitting on homes until swollen housing inventory improves is begging for trouble."


Lennar seems to be betting that things are going to get much better. I do not see much hope here even though the National Association of Homebuilders says "there clearly are signs of stabilization".

It just so happens that Professor Depew was talking about stabilization in point number 2 of Monday's Five Things, NAHB Index "Stabilizes":

In addition to the decline in housing starts, which we are told is actually a positive also going for us is the good news that home builder sentiment stabilized in December.

  • The bad news is that it stabilized at a record low.
  • The National Association of Home Builders said yesterday its NAHB/Wells Fargo Housing Market Index was unchanged at 19 in December, the lowest level since the index began in 1985. On the bright side, the index of sales expected in the next six months rose to 26 from 24, but that's down from 49 a year earlier and from 53 in February.
  • Readings below 50 indicate more builders view market conditions as poor than favorable.
  • Meanwhile, the prospective-buyer traffic measure fell to 14 from 17, below 23 a year ago and the 2007 high of 29 set in February.
  • "Today's report shows that builders' views of housing market conditions haven't changed in the past several months, and there clearly are signs of stabilization in the HMI," NAHB Chief Economist David Seiders said.


Thankfully things stabilized before the index fell to zero. But what about that prospective buyer traffic? If traffic isn't bad enough in and of itself, consider that pricing makes California one of the worst states to be building in or getting financing for. Nonetheless, Lennar is determined to keep building anyway.


Mothballing Vs. Auctions In Practice

Compare Lennar's strategy with that of homebuilder Roger Pollock. Pollock sold 141 homes for a total of $65 million at real estate auction:

Pollock turned to the auction when the housing market slowed this fall and his sales turned to a trickle. Rather than pay interest on his construction loans for a year or more until the homes sold, Pollock opted for the auction.

Although the homes looked especially attractive with super-low starting bids, some brokers were concerned that the homes had a higher, undisclosed "reserve price" that was the lowest Pollock was obligated to accept. But Pollock said about 96 percent of the homes he sold went for below the reserve price. The reserve price, he said, was equal to his costs.

"We didn't make any money on these homes," Pollock said. "We lost money."


Pollock still has another 99 homes to sell, but if he is aggressive enough he will. Don't cry for Pollock, as he made millions over the years. Furthermore, with his strategy firmly in place, I am confident Pollock will survive to build again. While Pollock opted to reduce his interest expenses and holding costs, Lennar's was dramatically increased.


Lennar Insider Transactions

With that in mind, let's turn our focus to insider transactions. Scrolling through insider transactions at Lennar, this is a small sample of what I see:


Click to enlarge


Perhaps that chart explains why Lennar keeps building but Pollock is opting out. Who would want to give up the right to acquire shares for $0 and sell them for countless millions of dollars over the years? Except for paltry dividends, all the profits have gone to the insiders as share prices crash towards zero.

Some say there is "Pent up demand for homebuilding". I say "nonsense" and offer pictorial proof in Pent Up Housing Demand In Pictures.

Builders build until they go bust. It's the same every cycle and it's the same for all of them:

  • Standard Pacific (SPF)
  • WCI Communities (WCI)
  • Beazer Homes (BZH)
  • Hovnanian (HOV)
  • Lennar (LEN)
  • Pulte (PHM)
  • KB Homes (KBH)
  • DR Horton (DHI)
  • Centex (CTX)
  • Ryland (RYL)
  • Toll Brothers (TOL)


In light of the above, why any shareholders want to own any homebuilders over the long haul other than the greater fool theory is beyond me.

At this point, the prices of many homebuilders are so beat up that if you are long you are betting they survive. If you are short, you are betting they don't. Those on the sidelines waiting to make a bet on when housing will bottom may wish to consider When Will Housing Bottom?

Meanwhile, insiders are cashing out options hand over fist for as long as they can. What a racket. The whole game is nothing more than legalized gambling but sadly most of the participants don't even realize it.

No positions in stocks mentioned.
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