Good News From Homebuilders, But Investors Should Be Cautious

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Home Builder Lennar Posts First Quarterly Profit In Two Years
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Lennar (LEN) and KB Home (KBH) are the latest homebuilders to step up with their quarterly results, and the numbers are generally pretty flattering.

KB Home moved higher on Wednesday after posting a larger-than-expected profit. Revenue climbed 11 percent to $450.7 million as strong growth in the Southwest, Central and Southeast regions were more than enough to offset a decline in the West.

The 1,442 homes it delivered during the quarter that ended in February was fewer than the 1,485 properties it handed over a year earlier. The key to the revenue growth is that the average selling price rose 12 percent to $305,200.

It was an even better story for Lennar on Thursday morning. Revenue soared 38 percent to $1.4 billion as a 13 percent increase in home deliveries was boosted by the fact that the average selling price was 18 percent higher than it was a year earlier. Profitability also blew past analyst expectations.

Since prices for new homes are climbing faster than the actual raw materials and building costs, most real estate developers are posting explosive growth on the bottom line. Everything seems to be going right for the homebuilders, but let's approach reports with caution.

Reasons to Worry

Homebuilders have been rallying in recent years. Lennar shares have popped 12-fold since bottoming out at $3.42 a little less than six years ago. KB Home has seen its stock more than triple since hitting rock bottom at $5.02 less than three years ago.

Investors can never forget that these same companies were trading a lot higher than they are right now in 2006 and 2007, just before the real estate market collapsed to trigger the financial crisis that was felt around the world. No one is predicting that we're approaching that kind of asset bubble, but it should be clear that the housing market has been outrunning its fundamentals lately.

Zillow's Home Value Index shows that real estate prices have moved 5.6 percent higher over the past year. The markets that fell the hardest during the crisis -- Las Vegas, Phoenix and Miami -- are all growing a lot faster than the national average. But the growth is starting to slow. It was just a 0.1 percent gain over the past month and a 0.7 percent spurt over the past three months.

A good reason for the price growth deceleration is that it's more expensive to buy a home. Freddie Mac reports that the average interest rate on a 30-year mortgage clocked in at 4.3 percent last month, up sharply from the 3.53 percent average a year earlier. If every mortgaged dollar costs 21.8 percent more in financing than it did a year ago and home prices are also higher, it doesn't take much of a leap of faith to predict that something's got to give.

Open House

Right now, Lennar, KB Home and their peers are doing great. However, things can sour fairly quickly. New Federal Reserve chief Janet Yellen struck a cautious tone in her first comments at the helm on Wednesday afternoon. The Fed was already starting to taper its massive bond-buying stimulus plan that was keeping rates low, and Yellen suggested that the program could end completely later this year. That would be followed by the Fed raising rates by early next year.

KB Home and Lennar shares rallied through her comments, even though it should be clear that housing prices can't keep moving higher the way they have in the past couple of years if mortgage rates become more prohibitive. After all, one of the great things about home prices heading higher is that folks don't cancel their contracts the way they did in 2008 and 2009.

Lennar closed out its latest quarter with a backlog of 5,662 homes to deliver, up 15 percent on a unit basis and an even heartier 33 percent on a dollar value basis. KB Home also has a growing backlog of homes to deliver at higher price points.

The moment that mortgage rates have moved too high will be the moment that home prices stop inching higher. We're starting to see that stabilize in recent months. That's fine, but the moment that home prices begin to retreat will be the time when folks go back to walking away from the open contracts with the homebuilders.

Investors and potential homebuyers that wait until those signs are obvious will probably be too late. It's time for homebuilders to start scaling back and being more conservative. They wouldn't want to repeat their mistakes of the past.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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