WSJ Opinion. Housing Is Back—But Housing Stocks Are Due for a Fall

By BRETT ARENDS

Stock investors seem convinced that housing is headed for another boom. The shares of companies that build homes have rocketed in the past 18 months in anticipation of much better times.

But while signs for the housing market are indeed optimistic, housing stocks have risen too far, too fast. If you want to bet on rising home prices, you probably are better off investing directly in real estate, whether by buying your first home, trading up to a more expensive one or—if the math works—buying a rental property as an investment.

Your correspondent is kicking himself. Eighteen months ago, in the summer of 2011, I saw the housing market turn before my eyes while I was shopping for a condo in the Miami area. The smart move would have been to take leave of my real-estate agent, head for the nearest brokerage house and buy stocks in home-building companies instead.

Since August 2011, the Philadelphia Housing Sector index of U.S. home-building stocks has jumped about 140%, while the Standard & Poor's 500-stock index is up about 30%. U.S. house prices overall have risen by less than 10%.

The case for a housing turnaround—at long last—is strong. Experts say the U.S. needs to build more than 1.5 million new homes every year just to keep up with the creation of new households and to replace old buildings. For the past five years, the average has been 760,000. Last year, it was 650,000.

"We're still building housing at about half the rate that would be considered normal," says Michael Widner, a home-building analyst at investment firm Stifel Nicolaus, which has $136 billion in assets under management. He believes the boom will continue.

The industry has built too few homes recently because it spent years building too many. Most of the excess inventory now is gone, and what remains might not prove a drag on prices anyway. Much of it is in the wrong places: While vacancy rates remain high in Detroit and parts of Nevada and Florida, there are housing shortages elsewhere, such as in Silicon Valley. And some of the "inventory" built up during the bubble is unlivable.

Think of the speculative housing developments in Florida swampland that were never occupied, next to golf courses that never got built. In total, U.S. home construction over the past decade, encompassing both the boom and the aftermath, has averaged just 1.3 million units a year, below the rate needed.

There are other signs that the housing glut is at an end. According to U.S. Census data, the percentage of homes unoccupied is back down to where it was before the financial crisis. Rents nationwide have been edging up.

After five years of falling prices, housing is now inexpensive by several key measures. The Standard & Poor's/Case-Shiller national home-price index is back to 2003 levels. When compared with average wages, prices are at levels seen in the mid-1990s, long before the boom.

Most people buy homes with a mortgage, and rates for those have plummeted to record lows. A 30-year fixed-rate conventional mortgage is now 3.5% or less. All this makes housing cheap for people with jobs.

To be sure, plenty of risks remain. Economists note that U.S. unemployment remains stubbornly high. No matter how cheap houses might be, families won't be able to afford them without income.

If the housing market continues to recover, home-building companies should see strong profits, says Crispin Odey, chairman of $12 billion hedge fund firm Odey & Co. in London. Their operating profits will widen, their land holdings will rise in value, and they will sell their new homes much more quickly, saving on capital costs, he argues.

Mr. Odey is an investor in home builders PulteGroup , PHM +3.29% D.R. Horton DHI +0.18% and KB Home , KBH +1.42% and says the sector could continue to see substantial gains.

Yet investors should be cautious. At current levels, say analysts, home-building stocks have priced in much of the recovery ahead.

As the chart shows, the Philadelphia Stock Exchange Housing Sector Index has rebounded far more significantly than housing itself. Shares of D.R. Horton now trade at 1.9 times the per-share value of the company's net assets, approaching the 2.3 level seen in 2004-05. During the crash it sank as low as 0.6 times assets. PulteGroup has swelled to 3.7 times its per-share net assets, a record.

Those asset values have been depressed by the slump and will be revalued upward if house prices continue to recover.

Yet Stifel's Mr. Widner says the recovery "is already baked into prices." Even though expects the housing market to recover steadily over the next few years, he rates the stocks no better than a "hold" across the board.

For the average investor, housing surely offers a better bet than housing stocks. Prices are lower, and investors can benefit from leverage through a mortgage, putting down just 20% in cash for the chance to enjoy 100% of any later profits.

Sure, leverage was a disaster at the peak of the bubble, as investors were buying overpriced housing, often with risky flexible-rate loans. But buying inexpensive housing, with a low-cost, fixed-rate mortgage, offers a different balance of risks.

Real estate, famously, is about location, location, location. Each market is different. In some it is still cheaper to rent than to own. But in most of the country, real estate is now inexpensive. This is a good time to buy a first home, to trade up, or to buy a property as an investment.

At this point in the real-estate recovery, homes look like a much better investment than home-building stocks.