Is it Time to Move into Homebuilder Stocks?

Tracking regional market changes can help investors decide.

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Housing prices look to remain soft in most markets in 2012. That's confirmed with a drive through new subdivisions scattered across the country, where a home might be surrounded by unoccupied structures or weedy lots.

Still, depressed home prices, down some 33 percent from 2007, equate to low homebuilder stock prices. These stocks suffered double-digit drops in 2011 but experienced a late-year bounce. The 2011 discount may prove to be an attractive entry point to risk-tolerant investors, especially if housing continues its slow and bumpy recovery indicated in recent statistics.

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Among those brighter industry figures, a National Association of Realtors report said pending home sales hit a 19-month high in November, up 7.3 percent from a month earlier. That report included a 14.9 percent jump in the West, where some of the biggest bubble bursts in parts of California, Arizona, and Nevada fronted national declines. The news lifted homebuilder stocks including PulteGroup (symbol: PHM), D.R. Horton (DHI), KB Home (KBH), Beazer Homes (BZH), and Toll Brothers (TOL).

Goldman Sachs economists said in a recent outlook that housing prices are likely to continue to ease into the second half of the year, as excess inventory is worked off. But the economists are willing to say that "the housing price bottom is probably in sight."

A deeper look into the market is still sobering. Much of the housing improvement boost is credited to the multi-family sector. Existing home sales, which rose in November, are still at a low annual rate of about four million. Single-family housing starts rose in November but are still down some 1.5 percent from year-ago levels. The median sales price for a new home fell 3.8 percent to $214,100 last month. Compared with November, the median price was down 2.5 percent.

Risks to the optimistic forecast persist. There's a difference between a housing market that is improving from weak levels, which is more like saying it is stabilizing, and a market that is truly strengthening.

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And, there have been false bottoms. It's a recovery aggravated by the number of foreclosures and the arduous process for some applicants to obtain financing. There have been some three million mortgage defaults recorded since 2007, according to RealtyTrac. In fact, the reluctance for some analysts to call a bottom hinges on the fact that foreclosures are still working their way through a back-logged system.

U.S. economic data on jobs, consumer confidence, and manufacturing are pointing up, but outlying factors like the European debt crisis could still scuttle the domestic recovery. The Federal Reserve has urged Congress to act to ease the burden on the mortgage market from so many underwater loans and has pledged to keep interest rates low into at least 2013. "Restoring the health of the housing market is a necessary part of a broader strategy for economic recovery," Federal Reserve Chairman Ben Bernanke said in a letter to the top lawmakers on the Senate Banking and House Financial Services committees. The Fed's attention on the housing recovery could prove to be a bonus for homebuilder stocks in the coming year.

Location, location, location. Industry veterans have long argued that real estate headlines often miss the mark because they don't capture regional differences in housing markets. But during the financial and housing implosion, real estate was a national story. Now, a spotty recovery that's stronger in some areas than others is likely and calls for investors to analyze relative strength within micro markets.

"In 2008 and 2009, it was a national housing market. Everything was collapsing together," says David Blitzer, chairman of the Index Committee at S&P Indices, including the S&P/Case-Shiller Home Price Indices.

"One thing that's happened in the past couple of years is that it's going back to being more of a local market phenomenon," says Blitzer. "The old adage 'location, location, location' is coming back to have a lot of meaning. Three years ago, it didn't matter where you were looking at housing in the United States—prices were collapsing. Now when you look around the country, you find some differences."