Homebuilders Make a Nice Contrarian Play

The housing market is mired in a slump that shows no signs of letting up. Home values continue their slide. Foreclosures are at a record-setting pace. So why am I bullish on homebuilders?

Survivability, for one thing. Those that have lasted have shown that they can make it through the worst housing market in decades. Sure, their balance sheets are a mess and they may still have some unsold inventory – but, for the most part, they have likely weathered the worst of the storm.

When the market started to turn in late 2005/early 2006, builders were left with unfinished developments and an extreme oversupply of land and homes. Most of the homes that were under construction at the time were completed and sold, sometimes at a loss. The land that had been bought at the top of the market was sold, and huge losses were written off. But all that is pretty much over.

The remaining carnage is primarily in the condo market, since most of those condos are in high-rise towers that took longer to build and are just now being completed and sold.

The major builders, those with regional and/or national exposure that have survived, should be a relatively safe bet now. They have been battered long enough, and no real surprises remain in terms of massive write-offs and losses. Their stocks are near historical lows, and little downside is left. I like the Homebuilders ETF (the XHB) for these reasons, and perhaps as a contrarian play as well. In terms of individual builders, Toll Brothers (TOL) and Pulte Homes (PHM) are my favorites.