Buffett bets on prefab homes

By Michael Brush

Few would call Warren Buffett unwise with his money. It takes some smarts to build a fortune of $46 billion, after all.

So what's he doing raising money in the housing sector? Specifically, why is he helping put three-quarters of a billion dollars into manufactured homes, those humble, modestly priced abodes that come shipped in prefabricated components, ready for assembly?

Sales of manufactured homes have been sluggish for years because the industry missed out on the lift from subprime loans. Now, with mortgage lending tightening up and the entire housing market in the dumps, sales of factory-built homes are the lowest they've been in 45 years.

So what's a smart investor like Warren Buffett doing here?

A month ago, Berkshire Hathaway (BRK.A, news, msgs) used its AAA credit rating to raise $750 million through a debt offering for Clayton Homes, a provider of factory-built homes that's in the Oracle of Omaha's portfolio of holdings.

This means it may be time for long-term investors to begin putting money into prefab-home stocks, says Robert Robotti of Robotti & Co. investment advisers, which already holds several of the stocks. Robotti is worth listening to because he's a value investor like Buffett, with Buffett-like returns. His shop has posted after-fee compound annual returns of 20% for the past five calendar years, compared with gains of 11.4% for the Russell 2000 Index ($RUT.X).

"To me this is classic contrarian investing in the sense that you become aggressive when everyone else is pulling back," says another index-beating value investor, Robert Rodriguez, whose First Pacific Advisors also has exposure to the sector. "I was encouraged to see that capital was being allocated to this industry. I view that as a positive."

The bank of Buffett

Rodriguez and other observers, including top managers at some of the key factory-built-home producers, think Clayton will use the money to back mortgage lending in the space. Given the casualties among other home mortgage lenders, it makes sense for Buffett to borrow money at the reasonable rates he can get because of his stellar credit rating and take advantage of rising rates in this corner of the mortgage market.

Clayton has two financing divisions, Vanderbilt and 21st Mortgage, that make loans in the sector. "By raising this capital they become the dominant financer of this industry," says Rodriguez. "I think it is intriguing that he is doing this."

At least two other big factory-built-home suppliers, Fleetwood Enterprises (FLE, news, msgs) and Champion Enterprises (CHB, news, msgs), say they are seeing more sales through Clayton's retail divisions, thanks to Buffett's presence in the space.

Here are two other reasons to like the sector:

• The factory-built group went through its version of the subprime lending debacle about seven years ago. Since then, easy-credit home mortgages have been off limits, so the group isn't getting directly hit by a subprime crisis now. "The fact that we have not had that crazy financing means that we should not suffer the way the site-built industry is suffering," says Cavco Industries (CVCO, news, msgs) CEO Joseph Stegmayer. "At least we don't have that to fight going forward."

• For the past few years, the traditional customers for factory-built housing were able to use subprime financing to trade up into homes they really couldn't afford. Now that subprime lending has vanished, those customers will return to the factory-built sector. "The playing field for manufactured homes is leveling dramatically," says Robotti. "The business is positioned to reclaim its portion of the market."

It's easy to see why factory-built homes fill the affordable-housing niche. Manufactured homes typically sell for $100,000 or less. They go for less than half the cost of a site-built home: $39.06 per square foot compared with $90.63 per square foot, based on 2005 numbers. And the quality has risen to the point where manufactured homes no longer deserve double-wide derision.

Some factory-built-home suppliers are already getting a lift from the return of traditional buyers. "In many areas of the country we are seeing some additional strength," says Fleetwood Enterprises CEO Boyd Plowman.

Patience required

If you buy stocks in this group, keep in mind they aren't a quick trade. You'll be investing alongside patient value investors like Buffett, Robotti and Rodriguez, who don't mind waiting years for the big payoff in a position.

One challenge for the group lies in the absence of a key customer for factory-built houses: retired empty-nesters looking to downsize. "They are still holding out for yesterday's prices because they haven't gone through the denial stage about what their homes are worth," says Plowman. Until they sell their traditional homes, this source of demand for factory-built homes is on hold.

Then there's the overhang of regular homes that are cheap enough to offer an alternative to manufactured homes. And despite the injection of capital by Buffett, mortgage lending for factory-built homes is still tight.

Continued: Some signs of hope

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