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Lennar Corporation (LEN), D.R. Horton, Inc. (DHI), Toll Brothers Inc (TOL): Watching for a Downturn in the Home Market

The National Association of Realtors recently warned that home prices are moving to far too fast. The only thing that can help solve the problem is more construction. That will be good news for home builders, until it isn’t anymore.

The housing market was pummeled by the 2007 to 2009 recession, which had its roots in the finance and housing markets. Banks were lending too easily and home buyers were rushing to buy before prices got even higher. The end result was a massive housing market crash and years of stagnant home sales and moribund home prices.

The carnage, however, has started to clear as institutional investors like The Blackstone Group L.P. (NYSE:BX) stepped in to build institutional single-family home businesses. That removed much of the cheap existing inventory from the market. New home sales from builders like Lennar Corporation (NYSE:LEN), D.R. Horton, Inc. (NYSE:DHI), and Toll Brothers Inc (NYSE:TOL) have increased to pick up the slack in supply.

The good news

For now, the builders look to have solid businesses. However, the National Association of Realtors has come out to warn about the swift rise in home prices. The group was late to highlight the risks on the way up before the housing crash, which may be making them hyper sensitive the second time around. That said, there are increasing similarities between the two periods.

For example, investors are being pushed to act. While the boom years’ drive was to get in before home prices went up, now the impetus is to get in while prices and mortgage rates are still low. Seeing this, banks have become more accommodating by loosening their lending standards. The combination of these events could be pulling demand forward and setting up a downturn.

There is a distinct possibility of interest rates passing a tipping point where buyers can no longer afford homes and the market corrects again. Investors need to monitor this closely.

Looking for clues

The clues to a downturn at the publicly traded home builders can be found in home builders’ backlogs.

Lennar Corporation (NYSE:LEN)Lennar Corporation (NYSE:LEN) reported second quarter results in late June. It delivered 4,464 homes, an increase of 39% year over year. In the first quarter, the company delivered 3,186 homes. Clearly things are getting better. New orders in the second quarter totaled 5,705 homes, up 27%. The first quarter saw orders of 4,055 homes.

The company’s second quarter backlog stood at 6,163 homes, amounting to $1.9 billion. The first quarter’s backlog was 4,922 homes with a value of $1.5 billion.

These are the numbers to watch. As long as the trends here are positive, the company should continue to reward investors. Earnings went from $0.26 a share in the first quarter to $0.61, showing the leverage on the way up. However, earnings fell from over $3.50 a share in 2006 to a loss of more than $12 in 2007, showing that leverage can be a double edged sword.

D.R. Horton, Inc. (NYSE:DHI) reported its second quarter results in late April and is next up to report. It closed on 33% more homes on a year over year basis last quarter, with a total value 47% higher than the prior year. New orders were up 34% based on the number of homes and 52% based on the value of the homes. The home count in the backlog increased 54% with the value advancing 76%.

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