Homebuilding
2009: Now for your regularly
scheduled downturn...
Nishu Sood, CFA
Research Analyst
(1) 212 250 4756
nishu.sood@db.com
Rob Hansen
Research Associate
(1) 212 250 5182
rob.hansen@db.com
Fundamental, Industry, Thematic, Thought Leading
Deutsche Bank Company Research's Research Product Committee has deemed
this work F.I.T.T. for investors seeking differentiated ideas. In our outlook for the
homebuilding industry, we assess the path to recovery in the wake of deepening
economic turmoil and aggressive government action. Historical paradigms have illserved
investors to date, and we expect this to continue to be the case. Most
importantly, we conclude that for the first time the mortgage rate mechanism will
not work, leaving housing at the mercy of a deteriorating economy.
Deutsche Bank Securities Inc.
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LOCATED IN APPENDIX 1.
FITT Research
Top picks
Centex (CTX.N),USD10.60 Buy
Companies featured
Centex (CTX.N),USD10.60 Buy
2008A 2009E 2010E
EPS (USD) -21.71 -3.70 -1.16
P/E (x) – – –
EV/EBITDA (x) – – –
D.R. Horton (DHI.N),USD7.23 Hold
2008A 2009E 2010E
EPS (USD) -8.34 -0.47 -0.41
P/E (x) – – –
EV/EBITDA (x) – – –
K. Hovnanian (HOV.N),USD2.11 Hold
2008A 2009E 2010E
EPS (USD) -16.04 -3.39 -2.85
P/E (x) – – –
EV/EBITDA (x) – – –
Lennar (LEN.N),USD8.35 Hold
2008A 2009E 2010E
EPS (USD) -7.00 -0.80 -0.48
P/E (x) – – –
EV/EBITDA (x) – – –
Meritage Homes (MTH.N),USD12.05 Hold
2007A 2008E 2009E
EPS (USD) -11.01 -8.07 -0.83
P/E (x) – – –
EV/EBITDA (x) – – –
Pulte Homes (PHM.N),USD10.73 Hold
2007A 2008E 2009E
EPS (USD) -9.02 -4.49 -0.35
P/E (x) – – –
EV/EBITDA (x) – – 371.7
Ryland Homes (RYL.N),USD17.64 Hold
2007A 2008E 2009E
EPS (USD) -7.90 -7.97 -0.72
P/E (x) – – –
EV/EBITDA (x) – – –
Toll Brothers (TOL.N),USD19.52 Hold
2007A 2008E 2009E
EPS (USD) 0.22 -1.88 0.48
P/E (x) 126.0 – 40.6
EV/EBITDA (x) 25.4 – 14.4
Fundamental: A burst bubble gives way to a normal cyclical downturn
The bursting of the mortgage and home price bubbles are well underway, but the
historic lows they have wrought in many housing metrics shouldn’t be taken in
and of themselves as signs of a market bottom. The economic variables like job
and income loss that typically depress housing are just beginning to be felt and are
likely to be the principal determinants of housing’s trajectory from here.
Industry: Lower mortgage rates not likely to work their usual magic
Lowering mortgage rates has typically worked wonders in getting housing
demand going, but we don’t think it will this time around. There are too many
factors working against lower rates, including the smaller stimulus this time in
terms of payment reduction, falling home prices and tighter mortgage standards.
Thematic: Bottom fishing in housing will be in murky waters
Many housing cycles of the past have featured clean V-shaped inflection points,
with different volume and price data series closely correlated. That certainly
wasn’t the case when the housing market peaked in 2005, and we don’t think that
will be the case when the market bottoms, either.
Thought Leading: Some historical housing charts are actually still relevant
Past housing cycles have been of little value in gauging the current one because
we haven’t ever had a home price bubble like the one of the early 2000s. We think
the California experience in the early 1990s can serve as some guide – it argues
that a recovery in new housing volumes will be long and drawn out.
Until fundamentals improve, asset values a weak backstop for valuations
Builder stocks have traded below our estimates of fully impaired book values since
early October. That may be because our estimates aren’t dire enough; more likely
is that asset values no longer serve as a hard valuation backstop – widespread
financial distress means higher risk premiums for financial assets such as real
estate. Until housing fundamentals actually improve, builder valuations will likely
continue to fluctuate with changing perceptions of financial risk. Since we expect
new home volumes to stabilize in 2H09, we are cautiously optimistic about the
second half of the year. However, as the market bottom is murky and the valuation
backstop wobbly, we don’t expect builder stocks to follow their normal historical
pattern of being anticipatory.

Table of Contents
Executive summary ........................................................................... 3
Outlook – It’s round 3 and the referee’s whistle is broken .......................................................3
Valuation – Still cautious, but we see potential for hope in 2H09 .............................................4
Risks – With the bubble burst, macro risks come to the fore ...................................................4
Housing outlook ................................................................................ 5
Now for your regularly scheduled downturn… .........................................................................5
It’s hard to get housing going during a recession.....................................................................6
What will a housing bottom look like? ......................................................................................8
Housing forecasts ............................................................................ 12
New housing volumes – Slow recovery begins in 2010 .........................................................12
Resale housing volumes – still a long way down....................................................................15
Home prices – likely to overshoot “affordability” ...................................................................16
Mortgage rate mechanism.............................................................. 18
Blunt policy tools help drive down mortgage rates.................................................................18
The mortgage rate mechanism has historically worked..........................................................21
The mortgage rate mechanism may not work this time .........................................................22
Other government efforts ............................................................... 27
Government-sponsored mortgage market..............................................................................27
Foreclosure mitigation efforts have picked up steam .............................................................28
Homebuilder fundamentals ............................................................ 32
Volumes: Some hope for 2H09...............................................................................................32
Gross margins should continue to benefit from prior impairments ........................................34
We forecast significantly reduced cash flows in 2009............................................................36
Valuation .......................................................................................... 37
Outlook – Stocks prone to a disappointing spring season ......................................................37
As credit crisis rolls on, asset values a soft backstop .............................................................39
Valuation methodology and risks ............................................................................................39
Appendix A: Government actions .................................................. 41