Whether the housing horror show has come and gone is one of the most hotly debated issues on Wall Street.

After last Tuesday’s report from the Mortgage Bankers Association about ballooning home foreclosures and delinquencies, it is hard to accept the case some economists and money managers are pushing — namely that the worst is over, that housing is now in the process of stabilizing, and that bloodied homebuilding stocks are among the best buys in the market.

Some buy this sunny outlook, but a Florida investment adviser, Michael Larson, who is no stranger to this column because of his numerous on-the-money forecasts, says the housing horror show is only in the intermission stage. He cites bulging inventories, rapidly slowing sales, and weakening prices,

Last April, Mr. Larson, the associate editor of Safe Money Report, a monthly newsletter out of Jupiter, Fla., said subprime mortgage firms “were indiscriminately lending to anyone who had a pulse.” At the same time, he recommended the sale of the shares of the industry’s third largest firm, New Century Financial. At the time, the shares were trading at around $45. It was a super call; the stock is now trading under $2.

While Wall Street is heavily focused on the latest housing debacle, notably any company with exposure to the $1.2 trillion worth of outstanding subprime mortgages, Mr. Larson sees yet another sector rife with risk — apartment real estate investment trusts, notably those rental-oriented firms that build, own, and manage apartment complexes.

“They could be a major housing problem, the next big shoe to drop,” he says. Or put another way, it could be Act II of the housing horror show.

Maybe so, but you couldn’t detect that from the blistering showing of apartment REITs, one of the stock market’s hottest sectors over the past three years. In this period, many have racked up sizzling gains, including reinvested dividends, of roughly 100% to 150%. That, in turn, drove up the market capitalization of the 19 largest apartment REITs to $65.8 billion as of the end of last month.

But that was yesterday; today, Mr. Larson observes, these REITs face swelling problems, chief among them increasing supply, rising vacancies, and slowing demand, all of which, he adds, point to diminishing rental growth. And he sees rising rental competition from the many speculators who hoped to make fast killings by buying and flipping condominiums, single-family homes, and townhouses. With housing slumping, many flippers, unable to flip, have resorted to renting, thus putting increased pressure on the rental market.

The declining vigor of the apartment rental market can be seen in the latest study of the National Multi-Housing Council, which conducts quarterly surveys to determine whether the market is tightening or weakening. An index reading above 50 indicates tightening; below 50 suggests weakening.

The latest reading showed a drop to 54 in January, the lowest level in three years. The peak was 87 in October 2005. Some say indications point to another decline in April, possibly to below 50.

Among the apartment REITs Mr. Larson views as especially vulnerable are Apartment Investment & Management, AvalonBay Communities, and Equity Residential, which, over the past three years, have risen to 170% from 97%, including dividend reinvestments.

“These stocks are overvalued and should be sold; they’ve had a great run, but their run is over,” he contends. In fact, Mr. Larson thinks risk-oriented investors might well consider shorting them (a bet their stock prices will fall).

What about the homebuilding stocks, a number of which have either broken through their summer lows or are in the process of doing so?

“I still wouldn’t bottom fish,” Mr. Larson says. “We’re in a multiyear housing bubble, and there’s more risk on the downside than there is potential on the downside.” He’s especially bearish on two of the industry’s leading lights, Centex and Lennar Corp., both of which, he says, “I would sell right now.”

An obvious question: Suppose the Fed cuts short-term interest rates?

“It will help, but only temporarily,” Mr. Larson says, “because it’ll still be swimming against the tide as a result of the huge oversupply.”

The $64,000 question, he notes, is whether the subprime mortgage problems spill over into conventional mortgages, leading lenders to cut back on all sorts of loans and create a credit crunch. The jury, as he sees it, is still out on that one.

dandordan@aol.com