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Ventures

Home Builders, Preparing for a Thaw

Richard J. Dugas Jr. of Pulte Homes says there’s a movement toward smaller houses. Credit...Fabrizio Costantini for the New York Times

THE long-awaited revival for home builders has been put on hold again.

While business was bleak last year, few in the industry foresaw the further turmoil ahead: a worsening credit crisis, sky-high foreclosure rates and plunging home values, not to mention a deepening recession.

“I think the picture from a year ago has certainly been tougher than most of us would have imagined,” said Ivy Zelman, the chief executive of Zelman & Associates, a housing research firm.

Beleaguered builders, meanwhile, have again ramped up their defensive strategies to bolster their balance sheets and share prices, as they ride out the economic storm. To thin inventories — and to counter competition from bank-owned houses and existing homes on the market, as well as houses from bankrupt builders — many companies have sweetened the incentive pot, offering not only upgrades and discounts but also financing and payment protection programs. To cut costs, some are scaling back the size of the houses they build.

At the same time, the federal government has intervened. The new economic stimulus package includes an $8,000 tax credit for certain first-time home buyers for this year, while the Federal Housing Administration has stepped in with attractive loan terms.

By some accounts, these measures seem to be helping somewhat. “Instead of being six feet under, we’re in critical condition,” Ms. Zelman said of the new-home sector these days.

Indeed, share prices of home builders are up slightly from the start of the year, after falling sharply in early March. An exchange-traded fund, SPDR S.& P. Homebuilders, which tries to replicate the performance of all publicly traded home building companies, was up about 8 percent for 2009 as of Thursday.

Even builders are a bit more sanguine. The National Association of Home Builders/Wells Fargo Housing Market Index, which measures industry confidence, rose to 14 in April from 9 in March — the first time it has been in double digits since October (when it was also at 14). The index, though, is still far below the level of 50 at which more builders are considered more optimistic than pessimistic.

New-home sales have been showing signs of improvement. Last week, the Commerce Department reported that March sales were off just 0.6 percent, exceeding analysts’ expectations, after climbing in February.

Investors in home-builder shares may be wondering whether the housing market is near its nadir or — finally — on the way to recovery.

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A rendering of a model home by Centex in Boerne, Tex.Credit...Centex Corporation

Industry analysts are at least open to the latter possibility, with some pointing to this month’s announcement by Pulte Homes that it would acquire the Centex Corporation for $1.3 billion in stock, creating the nation’s largest home builder.

“I can’t imagine them making a move like this if they thought things are going to continue to deteriorate,” said Paul Puryear of Raymond James & Associates.

Mr. Puryear, however, was dubious about the next recovery, which many housing experts don’t expect to occur until late this year or early next. “Even if we are seeing signs that we’re at a bottom, that doesn’t mean home builders will run out and start building a lot of houses anytime soon,” he said. “It’s going to be a very long, slow recovery.”

Mr. Puryear says the market needs to absorb as many as 1.1 million excess housing units “before we get back to normal levels of inventory.” And that, he said, doesn’t even count the number of houses that would have been up for sale had the market been in better shape.

The most recent census figures indicate that there was a 12.2-month supply of new homes for sale in February, or roughly double the average supply.

Still, some market experts predict that the new-home sector will be the first to recover in the housing market. Working in its favor, they point out, are less expensive construction materials and land, with a significant slowdown in building. (Housing starts plummeted 10.8 percent in March, to the second-lowest annual rate in records dating back 50 years, according to the Commerce Department.)

“There’s not a lot of speculative building happening,” said Megan McGrath, an analyst at Barclays Capital. “Most builders are only starting construction for a home on which they have an order.”

Shifting demographics also augur well for builders. “This is a market that is increasingly dominated by first-time buyers,” said Nishu Sood, a real estate analyst at Deutsche Bank Securities.

He noted that this market segment, which encompasses adult offspring of the baby boomers, is unencumbered by a home to sell or a mortgage under water. Further, these buyers can take advantage of a rising number of builder financing programs, along with lower prices and interest rates and the $8,000 credit. (California offers an additional $10,000 credit for buyers of new homes; in Utah, there’s a similar, $6,000 tax credit.)

As a result, demand for entry-level homes is expected to increase. That is why Ms. McGrath says she favors companies like D. R. Horton and KB Home, which are focused on building smaller, less expensive houses. She said she also liked Toll Brothers because of its relatively low debt level, and because the company will probably benefit from pent-up demand for the luxury homes it builds after the market recovers.

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A rendering of a clubhouse in a Del Webb adult community in Taneytown, Md.Credit...Pulte Homes

But even the more established buyers are scaling back right now. “What you’re seeing in the new-home market is a preference for simpler homes,” Mr. Puryear said. “Over-the-top finishes are out.”

Pulte Homes has embraced the trend toward simplicity.

“There’s a bit of a move toward a smaller product nationwide in our communities,” Richard J. Dugas Jr., the president and chief executive, said in a recent interview. He explained that floor plans for some of its new homes are more basic, and their architectural features less elaborate, than those the company once specialized in, with a greater focus on energy efficiency.

Pulte’s purchase of Centex would provide a strong foothold in the entry-level market, thereby allowing the company to cover all demographic and geographic bases when combined with other brands like its Del Webb active-adult communities.

Included in the Centex portfolio are an abundance of buildable lots. “Half of the lots are fully finished; we don’t have to put any more cash into them in order to build homes on them,” Mr. Dugas explained.

Wall Street has been generally positive about the merger, with analysts calling it a good fit. Home builders’ shares rose after the announcement.

In acquiring Centex, Pulte inherits around $1.7 billion in cash, doubling its cash reserve, said Vicki Bryan, a senior analyst at Gimme Credit, a bond research firm. “The most valuable thing about that transaction is getting the cash,” she said.

Mr. Sood of Deutsche Bank Securities agreed, “They have combined resources to survive through the downturn with a greater cash balance.”

The companies with the strongest liquidity are, in fact, the best positioned, he said. “It’s like a sand timer — the more cash they have, the more time they have,” he said, and a Pulte-Centex combination makes for “a pretty enormous sand timer.”

Could further consolidation follow in the industry? Ms. Zelman says potential takeover targets could include the Ryland Group and Richmond American Homes, while possible buyers include D. R. Horton, the Lennar Corporation and NVR Inc.

“NVR has the best business model,” Ms. Zelman said, explaining that the company buys housing lots only when it’s ready to build. Of limited interest are Hovnanian Enterprises and Beazer Homes USA, she said; both are highly leveraged.

And Toll Brothers? “Toll is a survivor,” she said. “But are they going to give me good returns? I’m all about the returns.”

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