Is the Bell Tolling for Housing?

The news that Toll Brothers' orders are down may seem to signal a bursting bubble. More likely the air is coming out slowly

USA (By Pete Coy, BusinessWeek) February 7, 2006 —

People who own homebuilder stocks -- who, of course, naturally tend to be bullish on the sector -- weren't overly alarmed by Toll Brothers' report. The shares of the Horsham (Pa.)-based homebuilder fell on the news but were down only about 5% in late trading, falling by $1.71, to $29.49. Other major homebuilders, including D.R. Horton, Lennar, and Pulte Homes, were down 2% to 4%.

Real estate brokers, too, dismiss the housing bubble talk as overblown. Brenda B. Shipplett, president and chief operating officer of Long & Foster Companies in Fairfax, Va., which serves the mid-Atlantic, says she's expecting 2006 to be the second-best year ever. Yes, unit sales are down 6% to 7% so far this year, she says, but prices are up, leaving dollar volume about level.

Business is even better in Connecticut, according to Peter G. Helie, CEO of Prudential Connecticut Realty in Rocky Hill, Conn. He said his firm's unit sales in January were about 25% higher than those of a year earlier, while prices were up around 8%.

High End Cooling 

The truth is, even if Toll Brothers is showing signs of fatigue, it may not be the best bellwether for homebuilders. In a research note today, J.P. Morgan analyst Michael Rehaut called Toll Brothers "the outlier in the group," saying it's the most exposed to the Washington (D.C.) and New Jersey markets, which were once extremely strong but have cooled.

Rehaut also said Toll Brothers suffers from its concentration at the high end of the market. "Over the last two years, when a previously robust market cools, the high end experiences a disproportionate negative impact," he wrote, rating the stock underweight.

In a press release, Toll Brothers CEO Robert I. Toll put the best face on the order downturn. He noted that the number of contracts at the end of the first quarter, while down from a year earlier, was nonetheless the second highest in company history. Orders had risen 60% in last year's first quarter, creating a tough standard of comparison.

Lower Forecasts 

In addition, he said, Toll Brothers' business has been so strong that it has had to put some customers off. And not all are willing to wait. "We believe when expectations of home-price appreciation are strong, buyers are willing to wait a year or more for their homes," he said. "When their expectations are more modest, they are less willing to commit so far in the future."

It would be unwise to ignore the downbeat news. Toll acknowledged that the 2006 market won't be as strong as it had been forecasting. It lowered by 3% its forecast of how many homes it will deliver in fiscal 2006 (to a range of 9,200 to 9,900, instead of 9,500 to 10,200, as previously expected).

The bearish case for housing over the long term is that the market has been infected by speculation. Prices have gotten too high, while supply threatens to outpace demand. Merrill Lynch & Co.'s chief North American economist, David Rosenberg, noted on Feb. 6 that the value of real estate assets owned by Americans has zoomed to $19 trillion from $10 trillion.

Slow Leak

At the same time, ownership of equities hasn't budged. And while some of that increase can be explained by the growth of the housing stock, at least 60% is a price change is unrelated to fundamentals, Rosenberg says.

Rosenberg says that housing, unlike stocks, is a slow-moving asset. Bull and bear markets in real estate tend to last years, not months. He figures that housing hit its peak sometime last summer. If that's the case, then today's caution from Toll Brothers is just one of many likely to come in the months and years ahead. A slowing market? Yes. A bursting bubble? No.