George Leong writes: The housing market continues to hold. But there are some warning signs. Famed investor Warren Buffett suggested the housing market was overvalued and due for an adjustment.

Now, while there are some indications of an overhyped housing market, I’m not convinced it’s bubble-like quite yet. But be warned: mortgage rates and interest rates are heading higher. This means it will become more expensive to finance mortgages going forward.

We are already seeing some fragility in the housing market on nearly all fronts. Home prices continue to edge higher across the nation, but that’s because of the limited inventory in the housing market.

Pending home sales, a good indicator of what is to happen on the horizon, fell eight percent in March based on data from the National Association of Realtors (NAR).

Housing starts were weaker than expected in March, with 946,000 annualized starts in the month, below the consensus 970,000. Worse yet was the March building permits reading that showed an annualized 990,000 in the pipeline, below the consensus estimate of 1.01 million and the 1.018 million in February. The soft showing is a red flag that points to some stalling ahead.

Of course, the horrible winter conditions across the country were largely blamed, but with the warmer months ahead of us, there will be little excuse if we see weaker numbers. This is especially true since the jobs market is showing some increasing strength.

Given what we’re seeing in the housing market, I would be hesitant to jump in and buy the homebuilders. A good alternative in the housing market would be to play the companies in the area of home construction and renovation, since these areas of the housing market appear to remain strong.

Home owners with access to low financing rates will likely continue to improve their existing homes, and this can only bode well for the building supplies companies.

In this area, you cannot go wrong with the best of the best—a stock like The Home Depot, Inc. (NYSE/HD), which has beaten earnings-per-share (EPS) estimates in the past four straight quarters.

Now, if you are looking for a more speculative investment, a stock like small-cap Builders FirstSource, Inc. (NASDAQ/BLDR) is worth a look. With a market cap of $762 million, the company is much smaller than The Home Depot, but it also affords better upside potential.

Builders FirstSource focuses on the residential new-home construction housing market. The company produces structural and related building products, such as roof and floor trusses, wall panels, stairs, aluminum and vinyl windows, custom millwork, and pre-hung doors. In the company’s network are 53 distribution centers and 47 manufacturing facilities that are situated primarily in the southern and eastern United States housing markets.

Chart courtesy of www.StockCharts.com

The company has managed to expand its annual revenues over the past four years to 2013, including revenue growth of more than 40% to $1.59 billion in 2013. The next few years are also looking good, with an estimated revenue growth of 15.7% to $1.72 billion this year, followed by a 16.8% jump to $2.01 billion in 2015, according to Thomson Financial.

At the end of the day, while the homebuilder stocks look fragile, I continue to like the building supplies companies, such as The Home Depot and Builders FirstSource, as an investment opportunity.

This article Profitable Investment Opportunities in a Fragile Housing Market was originally posted at Daily Gains Letter

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