The Home Start Numbers Are Not a Positive

Anybody in the residential real estate biz can tell you that rentals compete with sales. Sales boom, rentals suffer. Rentals suffer, sales boom. Unless you have an overall crappy macro scene, then everything can suffer some.

Well, with the housing boom, raw land became much too expensive to justify building rentals, which effectively have an annuity stream in lieu of the lump sum paybacks of the actual sales. As the market broke, land got cheaper and when combined with the tight housing market caused rents to rise in urban areas, allowed apartment builders to jump into the fray.

We haven't even broached the volatility of these numbers, being revised up, down, and all around. This is a BAD thing for homebuilders! This is a BAD thing for extant housing inventory looking for sales! This is a BAD thing for banks trying to move REOs! Basically, this just more supply added to a glutted market. For those who even consider buying the builders or banks on this news, caveat emptor! The homebuilders are at a historical low in terms of sentiment - do you think they are lying to themselves?

From the WSJ :
Home construction turned up unexpectedly in April and showed
surprising vigor, making the biggest increase in two years, while
building permits also rose, a sign of optimism for the sickly housing
sector. How so?!

Housing starts increased 8.2% to a seasonally adjusted 1.032 million
annual rate, driven higher by a surge in apartment building
construction, the Commerce Department said Friday. Starts plunged
13.8% in March to 954,000, the data showed; Commerce initially
estimated March starts down 11.9% to 947,000.
Economists surveyed by Dow Jones Newswires expected April starts to
drop by 1.4% to a 934,000-unit annual rate. The 8.2% increase was the
largest monthly climb since a 14.0% jump in January 2006.
But year over year, housing starts were 30.6% below the level of
construction in April 2007.
Builders have been reluctant to build because demand for new homes has
plunged and the supply of unsold property remained high. Reference my
descriptions of apartment building motivation above. The latest data
show new-home sales, for March, were down 36.6% from a year earlier.
On Thursday, the National Association of Home Builders reported its
index for sales of new, single-family homes slipped to 19 in May from
20. OK, so home sales are down, yet housing starts are up. So in
addition to not being able to sell homes in a sluggish economy, we
also have additional inventory added to supply - all the while
homebuilders are struggling to survive with devalued inventory,
excessive debt and banks and existing homeowners competing with them
to dump thier inventory as the mortgage market locks up and banks
squeeze lending. Remember, the financial barrier to renting is much
lower than that of buying so this is a credible source of competition
to the extant homeowners, builders and banks! The gauge is based on a
survey of builders asked about prospects for sales.
"The magnitude of the housing bubble was unprecedented, and the
corrective process promises to be a long and painful one," MFR Inc.
Joshua Shapiro said of the NAHB data. "Hence, it is hardly surprising
that builder sentiment is still languishing very near its all-time low."

It's about time someone spoke with a modicum of common sense!

Earlier this week, luxury-home builder Toll Brothers Inc. released
preliminary results of its fiscal second quarter and reported a 30%
drop in home-building revenue. Its chief, Robert I. Toll, said current
customer traffic is "the worst we've ever seen" and characterized
would-be buyers as "scared." Can you blame them. I'm scared too, and
I'm not even a prospective buyer.

Lehman Brothers analyst Michelle Meyer on Thursday said, "We think
home sales won't bottom until the end of the third quarter, leaving
builders gloomy and cutting construction through the end of the year."
Yet Friday's data showed building permits rose in April by 4.9% to a
978,000 annual rate in April. Analysts expected a drop of 1.8% to
910,000. March permits decreased by 5.0% to 932,000. Permits are a
precursor to actual building.

Oh yeah, that government data. It's about as reliable as Paulson's bullshi,,, er, assertions:

April single-family housing starts decreased 1.7% to 692,000.
Construction of housing with two or more units soared 36.0% to
340,000; (I'm glad that ain't my money) within that category,
groundbreakings of homes with five or more units -- or multi-family --
were 40.5% higher.

Regionally, housing starts increased 24.4% in the Midwest, 3.6% in the
South, and 18.5% in the West. Starts in the Northeast fell 12.7%.
Nationwide, an estimated 92,400 houses were actually started in April,
based on figures not seasonally adjusted. An estimated 89,000 building
permits were issued last month, also based on unadjusted figures.

Comments

[VP ofCommon Sense]

Reggie,

I think you hammered all the way around the nail without hitting it. If you back out the 36% growth in multi units, single family new permits and starts were down again. Further, the growth in multi-units makes perfect sense given your initial thesis (3rd sentence of article).

Thus, the median home price will likely continue to fall. *sigh*

[Tim Plaehn]

The median price tends to be skewed by the fact that it is very difficult for anyone to get a jumbo mortgage i.e. Toll Brothers homes vs. hot selling low price homes.

I read a market report on the Sacramento region concerning April sales (I am familiar with the area) and homes for sale under $250k, especially foreclosures are getting multiple offers and selling in hours while there is a 20 month supply of homes over $580k. Sales in the region grew 28% in April from March, mostly in the lower price region, pulling the median price down.

Note: per square foot pricing in Sacramento has fallen 25% since 2006, so real prices are down also. Just do not mix apples and oranges.

[jf]

there is a micro boom in new apartments in many markets. based on the normal business cycle for that porduct, that should end in about 18 months with a glut of newish units

[iThinkBig]

Yeah, lots of displaced, overleveraged Americans will need to rent, think this one will last longer then 18 months jf as the single family homes foreclosures are now reached a tipping point and accelerating, but Reggie is right it adds another layer of problems in excess inventory further down the road. Don't worry though, the responsible U.S. taxpayer will eventually pay for it all (sarcasm off).

[jstratt]

Good article. You provided an interesting analysis to the reported housing starts. JS

[fatcat]

Reggie,I like your fresh down to earth view... with that said,it's like a shit sandwich, and we all have to take a bite..

[Chorniki]

Reggie:
Enjoyed the article. I give you credit for knowing the following and you
probably edited the info to save space:
Every building department is loaded with wannabee or failed engineers, architects, urban planners, landscape planners, you name it. So what?
By the time your typical builder runs the gauntlet of all these nice people, perhaps a year or two will have passed. Meaning obviously that these multiple family homes, i.e. apartments, were on the planning boards eighteen to twenty four months ago. Not building is
not an option. BK looms on the horizon if you make that choice. So
the builder puts his head down and charges ahead hoping for the best. His banker is right along side him probably because he made the builder a "loan to own".

[drmalaka]

Thanks Reggie, great article as always.

[Developer...Wondering]

Reggie's view shows use of "uncommonly good sense (cents)". As a residential developer of finished lots with the high level cost basis that precludes any small homebuilder from buying, I am better donating the lots to the banks. As a custom homebuilder for homes exceeding a retail value of $3,000,000.00 for the HNW client whose stock portolio and IRA values have fallen I am better not building. As a financier to small builders, developers and ranchers, I am preparing to take huge write offs like smaller banks. Those analysts who develop calls and advice without personal risk should be viewed under suspect terms. I've vetted Reggie's and the outtake is that of high marks and consumate use of "uncommonly good cents". Kudos (Oregon/California Developer)

[RBO]

as somebody that was in the process of building a vacation home, it is now cheaper to buy an existing property and re-tool it than to build new, as long as that equation holds the builders will have a challenge

[Bill W.]

Thanks for another great article.

[Tom Lindmark]

Got to agree with the first comment. You danced all around the subject but never got to the point. Your analysis of the rent v. own dynamic was too simplistic. For example, how do you explain Phoenix with a glut of for sale houses experiencing historically high vacancy rates in certain classes of apartments? There's an answer but you have to dig down to find it. You have to look at more than just a couple sets of data points to reach valid conclusions.

As for home builder sentiment and all of the poor mouthing they were doing this week about the state of their business. Remember that they are lining up for a piece of the bailout pie. They're not going to say business is wonderful when looking for a handout.

[DCM]

With the exception of possibly a very few number of markets, adding more units of any type will only exacerbate an already certain protracted downturn in real estate. A positive sign would be a significant percentage increase in the number of first home buyers. Thanks to Economics 101, we all know price is a function of supply and demand. In most markets, supply far outweighs demand. If builders and lenders were not so greedy in the last 5 years or so, we would not be in this mess. Please tell me what lesson has been learned when apparently lenders continue to loan money to builders to create more housing? Indeed, the home start numbers are not a positive!!!

[jimau]

The problem with all these numbers is the denial of the facts. Fact No 1 OECD members have been living beyond their means for 2 decades exporting inflation and importing deflation this has lead to many bubbles e.g. lending, consumption of cheap worthless goods and by hostrical measures an excessive run up in home equity appreciation as well as other asset prices and this drawing down on equity has fueled growth and created a false sense of wealth in the domestic and commercial arena. Fact No 2 Risk levels and the criteria that determines risk have been ignored to the point that the financial system froze and now will have to undergo a massive de leveraging of that risk at the expense of the masses that gorged on this orgy. Fact No 3 the reliance on the American dollar as a standard of world currency is coming under threat and more decoupling will get underway this will force the indebted consumer driven economies to cut back and create a surplus buffer or at least a narrowing of trade deficits at expense of emerging markets. Fact No 4 Inflation is raising its ugly head and holding economies that are affected by this curse to ransom because by fuelling growth so as to balance risk is to add more pressure to prices which in turn fuels more inflation and un affordability which in turn will add more risk. Fact No 5 The only reason we have averted deep economic pain in the past is because of the emerging economies story, they have to this point exported deflation allowing the OECD economies to spend on more with less until the addiction to spending and expansion has out stripped income growth which when measured by historical income/debt ratios is at unsustainable levels and must correct to bring about sustained growth with low inflation. Fact No 6 The key to profit is the proper utilization of assets. When you generate turnover in environment that has asset prices inflation with debt that is leveraged from that inflated asset the risk of default goes up because the inflated assets may have to be written down in poor economic or a corrective environment.

[johngonole]

I haven't looked at builder balance sheets but I did in the late 90's early 2000's and only invested for a short time because the public homebuilders took all of their cash flows from earnings and sunk them right back into real estate. In essence thier net worth is always the value of their land holdings. Of course holding the lands cost money too via debt interest payments and taxes. They do not have the luxury of simply stopping construction to let the supply glut dwindle. They must now try to convert their land holdings back into cash to pay for these costs. Again I haven't looked at homebuilder balance sheets lately. For individual homebuilder the real question becomes what is their land worth.

For the macro economic question of where house prices are headed thier are some contraints to consider.

1) Is there really a glut of homes....By this I mean is their a housing supply (apts and homes) far greater then the number of people requiring housing?

2) Homebuilders will be forced to stop building if the cost of building the home exceeds the price they can sell it for. Which leads to the next question

3) Are they still profitable on a per unit basis. That is how much lower can they lower house prices and still make money on the house not including interest expenses, property taxe expenses, etc... This would set the price below which they must stop building. Current homebuilders are showing losses but much of this is due to property value right downs and other overhead expenses.

4) How many people are immigrating to the US every year that will require housing.

5) How aggresively are apartment builders building and going to build.

I'm sure there are other factors to consider and the answers to the above questions are probably impossible to answer. Everyone pretty much basis his or her thesis on price action. Right now that is telling us their is a glut. But this could also just be emotional.

What I do know is that a large amount of people simply can't afford the currrent prices. Builders continue to build. Prices have come down a bit nationwide. Our currency is being depreciated. Builders still own lots of land. Governments are also buying land not helping land prices go down.

My bet is that everyone is just guessing. The builder faced with the choice of bleeding to death slowly is likely to build to the point that he feels he can float the cost of materials. At that point he will stop till the house sells. In my area of Gainesville Florida where employment levels are still great I've seen a slow increase in the number of new homes for sale. The builders have slowed the rate of building but their are several large developements with roads and everything built out. In otherwords supply of unoccupied finished homes is up. The building rate is much slower. The backlog of developed land is up so new homes will come on the market quickly after vacant homes are sold.

My guess is that house prices will continue to fall after which they will remain flat for quite some time.

[johngonole]

Jimau - Those were some really good points. What happens as economies deleverage from the dollar. What happens when those exported dollars come back to the US. It will cause massive inflation that could cause great civil unrest as senior citizens are wiped out with a portion of the middle class who has managed to save. The poor will be no better off. This could be a good time to pay off our federal debt which could be a deflationary force to offset the inflation.

On the otherhand when have politicians ever been so bold. We could end up with a whipsaw effect causing massive deflation if everyone penny pinches and tries to....

Interesting times indeed. I agree though we have imported deflation and exported inflation. The opposite could happen though too. We could import manufacturing once again and export deflation ourselves (In the sense that the world views the dollar as worthless and will spend it to import american goods)

[jimau]

johngonole-I agree with your analysis of builders balance sheets even if it was a few years back I don't think much would have changed but very open to clarification.
At this point in time can the emerging markets afford to in any significant amount buy anything other than cheaply manufactured goods from their own countries that would see that shift in trade balances? Have these economies build up their middle class sufficiently to take on this advantage of a deflated US dollar. The prospects for a stronger US economy long term are great just because of the economies of scale issue but on a short term prospect if emerging economies try to build their middle class consumption to soon in an already overheating environment inflation will tick up and a more serious problem will arise globally as the already stretched and debt dependent consumer tackles inflation, slow growth, job uncertainty and deflating equity cushion at home.

[Kunst]

It may be a good time to buy rentals. But buying a home is an act of faith, faith that the future will bring improvement in one's financial situation and security. That does not exist for most of the US population at this time. Sentiment numbers shout it, but all you have to do is talk to people to understand that confidence and security are not where it's at.

Anyone self-employed will tell you that business is down. The standardly employed are hunkering down, waiting to see what happens and how secure their jobs are. Until employment improves and incomes outpace inflation, very few people are going to be willing to take the risk of buying a home in the current environment. I'm talking about the first-time buyer, who is the bottom of the food chain. Without those folks coming in to buy the empties, the housing market cannot improve.