Some home builder investors see light on horizon

NEW YORK (Reuters) - Since the housing market began its tailspin more than two years ago, investors tracking the U.S. home builder sector repeatedly drove up the shares in hopes the darkest days had passed -- only to see the stocks sink again.

The false dawns deceived some of the most astute investors, like Legg Mason's Bill Miller, Harris Associates' Bill Nygren and Tim Cohen of Fidelity Investments.

But investors showed renewed enthusiasm for home builder shares after a Federal Reserve interest rate cut last week, along with Congressional plans to make it easier to get mortgages.

The benchmark Dow Jones U.S. Home Construction Index .DJUSHB gained 32.4 percent by Tuesday in the week following the Fed's rate cut on January 22. But after a second cut on Wednesday, as stock markets fell, the construction index lost 6 percent.

The easing of interest rates by the Fed helped lower the 30-year fixed mortgage rate to levels unseen since March 2004. On Wednesday, the 30-year fixed rate was at 5.75 percent. If lower interest rates and U.S. government plans to stimulate the economy generate more home buyers, especially first-time buyers, the new-home market may be revitalized.

Short sellers covering bets against home builders accounted for part of the rise in the sector since the January 22 rate cut. But other investors think actions to turn around the credit market may eventually support the home construction industry, and they want to be ahead of any upturn.

"From a sentiment standpoint, we finally have some good news about housing," said Ivy Zelman, chief executive of independent research firm Zelman & Associates, and a long-time bear. "Will the stocks go back to their lows again? I wouldn't rule it out, but I don't think so."

Analysts and investors warned that home builders still face huge challenges. Most expect the U.S. housing market -- including existing homes, which comprise nearly 85 percent of the market -- to decline further. Zelman estimates the downturn could stretch into 2011.

"(The stocks) could give back some of the gains if in fact they don't see any improvement in fundamentals over the next six to nine months," Zelman said. "Our view would be to still be neutral."

Home builders continue to grapple with rising inventory, sinking demand and depressed prices.

But, said Zelman, "I do think new homes at the low end of the market could find a floor sooner than maybe the market is expecting."

Zelman said expectations that lower mortgage rates, along with continued Fed rate reductions and an easing of requirements for Federal Housing Authority (FHA) insured mortgages, will help significantly. FHA mortgages are backed by the U.S. Department of Housing and Urban Development. Investors are more likely to buy mortgages insured by the FHA.

Zelman estimates that demand for new homes could rise 10 percent if Congress lifts the cap for FHA-insured mortgages in low-cost markets to $271,100 from $200,200 and to $417,000 from $362,800 in high-cost markets.

Plans to raise the cap to $729,750 on jumbo mortgages that Fannie Mae (FNM.N) and Freddie Mac (FRE.N) could buy could support higher-end home builders.

Analysts who watch the housing sector say recovery of the existing and new home markets rests on the shoulders of first-time buyers who can cut into the massive inventory of new homes for sale, a glut that is depressing prices.

As a group, home builders' shares trade at about 0.9 times the weighted average of the land and inventory they own. That's up from about 0.7 times before the Fed's 3/4 point rate cut on January 22.

Zelman said some badly bruised shares have room to rise. Her firm values M/I Homes Inc (MHO.N) at $21, implying a 40.4 percent upside from its Wednesday closing price of $13.96. She said Standard Pacific Corp (SPF.N), whose shares closed down 8.9 percent on Wednesday, has a 143 percent upside and Lennar Corp (LEN.N), the No. 2 U.S. home builder, has about a 51 percent upside from its closing price of $18.20.

PLAYING STRENGTH

Last week, Raymond James analyst Buck Horne raised the rating on most of the home builders under his coverage to "market perform" from "underperform."

"If you want to play in the sector, play the strong balance sheets," Horne said.

Horne raised luxury home builder Toll Brothers Inc (TOL.N) to "outperform" from "market perform" and Ryland Group Inc (RYL.N) to "outperform" from "underperform."

"We're not advising anyone to buy the entire group wholesale," he said.

Home builders have cut prices by about 15 percent to 20 percent in former hot-bed markets Florida, Southern California and Arizona. In some areas, prices are down 50 percent.

But risk persists. Even most large home builders do not see themselves generating income this year.

"It's a bit premature thinking that cutting rates will give you buyers," said Frank Lee, senior analyst for CreditSights.

"What you need is fresh new buyers coming out. If we are in a recession, I don't think anybody is going do a lot of home buying."

That makes the upcoming spring selling season, which begins in February, even more crucial.

"We'll know within a very short order if it is working or not working," Horne said. "If it's not working, we'll probably go back to our very bearish outlook."

(Editing by Toni Reinhold)