I kind of like the last weeks of the year, particularly the time between Christmas and New Year’s Day. Lots of people take time off. The phones go quiet. It kind of slows down.
For years I have used the time to tidy up; get all the emails put in the archive folders and clear out all of the paper that I have been holding on to (why?) all year.
I tend to read articles that come out each day on the various websites more than I normally would.
I also try to think about what did I learn this past year and how does it apply for the next couple of years.
Here are some of the more interesting articles that I pulled from the past couple of weeks and some thoughts on them:
- Less than half of U.S. kids today live in a “traditional family”. In 1960, 73 percent of children lived with two married parents in their first marriage. In 1980, the number had dropped to 61 percent and by 2013 it stood at 46 percent. On the other hand, children living with a single parent climbed from 9 percent in 1960 to 19 percent in 1980 to 34 percent in 2013. (During the same period, the proportion of kids living with two married parents (one or both remarried) has stayed steady at about 15 percent and the proportion with no parent in the house (usually living with grandparents) has also stayed steady at around 4 percent.) So not only are we as a country having fewer kids (and those kids later), but they are more and more in single parent households. As builders, we think of density in terms of units per acre. Perhaps, we should be thinking about it in terms of paychecks and quality of paychecks per house. The last 40 years has been marked by the rise of working women and, for the 70s and 80s, that translated into more dual income households that could support more expensive and larger homes. What is now apparent is that we are trending toward a higher proportion of households with kids only supported by one income again. I guess the corollary is that perhaps the housing preferences are changing, too. But are builders adapting to this in floor plans, target marketing, and pricing? Could a single parent household be designed to have a “granny flat” that is really an AirBnB rental that helps offset the cost of the house?
- After 50 Years of New Homes: Prices Rise, Sales Fall (Donna Howell: Investors Business Daily, December 24, 2014). The bottom line to this article is that new home sales (an annualized 438,000 in November) are 20 percent below where they were 50 years ago (with a much larger current population to house and a population living longer and needing housing longer, too). However, the median new home price (currently $280,000) is slightly under 15 times higher than it was in 1964 ($19,300). That was a good headline grabber, but it got me running to Google to find out what the median income was in 1964 (it was $6080) and what it is currently ($53,981). The ratio of median new home price to median income back in 1964 was 3.17.It is now 5.18.
Holy Beaver Cleaver, Batman!
No wonder the current new home sales number has an anchor. To have the same kind of rough proportion, new housing prices would have to have a median of about $171,000, or a drop of almost 40% from where they are now.
I know that the median is currently a little out of whack, due to the fact that the upper end of the income spectrum has the capacity to purchase now while a good chunk of the populace is shut out for a variety of reasons.
The bottom line is pretty clear, though. If pricing and incomes stay roughly where they are now, we will continue to have slow new home production and sales. If pricing has to come down by 40 percent, it probably means much smaller houses and definitely lower cost lots coupled with higher efficiency in production.
Since I don’t see improvement costs or impact fees dropping much, the conclusion is that land prices for new homes have to be considerably lower, most likely. Some of that land sitting on builder and developer books might be overvalued to achieve the velocities that people are projecting.
- Construction Costs Rising as Economy Improves (Peter Grant; The Wall Street Journal; December 23, 2014). Mr. Grant reports that building costs are rising at the fastest pace in six years. Over the past year, construction costs have gone up 5.2% while the CPI is up just 1.3%. Wages are slow rising, too. Jobs are growing again, that’s good. But, apparently, a lot of jobs are part time, making it hard to buy a house. I know that builders would like to push prices, but that’s getting tough. In many markets it is more about incentives again, rather than raising prices. Smells to me like margin pressure on the horizon.
- Rents Skyrocket Well Beyond Wages (Diana Olick; CNBC; November 6, 2014). That one was really buried by the time I found it. Ms. Olick notes that where jobs are and people want to live it is now common to see rental payments eating up one-half of income (in a world where sound underwriting for a mortgage says 30% is the maximum allowable for housing expenses). In those markets, rents are up nearly 8% annually and nationally rents for units listed are up 6%. What is more disturbing is that even though the economics of owning appear to be better than renting in many markets, the fact that both rents and home prices are out-climbing wages means that both become further out of reach and the steep rents inhibit people from saving the down-payments needed to purchase.
- Zillow: Renters paid $441 billion in rent in 2014 (Ben Lane; Housing Wire; December 30, 2014). It seems that total rents grew by 4.9% from 2013 to 2014. What was really stunning was that there were 770,000 additional US renters in 2014 than in 2013. Stan Humphries, Zillow’s Chief Economist notes that “[o]ver the past 14 years, rents have grown at twice the pace of income due to weak income growth, burgeoning rental demand, and insufficient growth in the supply of rental housing…Next year, we expect rents to rise even faster than home values, meaning that another increase in total rent paid similar to that seen this year isn’t out of the question, In fact, it’s probable.” What caught my eye here is that this is not a passing fad. The trend has been going for 14 years. How did for-sale builders miss that one? Could the single parent with children factor be at play here.
- Housing takes a breather; Why that’s good (Diana Olick; CNBC; December 29, 2014). Ms. Olick notes that although home prices are up 4.5%, the gains are shrinking every month, or decelerating. She argues that home prices became overheated in the early states of the recovery and a break is needed to get people back into the market. She also notes that home sales in November fell due to a dearth of homes for sale (we are talking existing homes here). A survey by Redfin, however, notes “just 11.3% of buyers said their biggest obstacle was lack of homes for sale while 32.6% cited affordability in the area I want to buy.” The National Association of Realtors commented that the only growth in home sales was on the higher end of the market…sales on the lowest end, where investors are strongest, fell 16%. What really caught my eye, though, was Ms. Olick’s observation that prices in some markets are poised to go negative in the short term. Although this makes sense if jobs are returning and more middle income people want to and can buy more moderately priced homes, the headline impact will be that posted median prices will drop because the buyer pool is finally skewing toward numbers more reflective of the population as a whole. What I hadn’t factored was that just as people are getting back in, the headlines will be screaming about prices falling. With the big drops of the recent past still in short term memory, this may freak some people out and put the brakes on for a few. Unless this data is reported with explanation, there is a chance for the housing recovery to be less than it should be while timid would-be buyers continue to rent for fear of losing their hard-saved down payment.
- Wells Fargo sued over mortgage securities (Bloomberg News; December 23, 2014). It seems that the National Credit Union Administration, the agency that oversees federal credit unions, has sued Wells Fargo for failing to protect investors while acting as trustee for 27 trusts that issued residential mortgage-backed securities. They now join Bank of America, US Bancorp, BlackRock and PIMCO as defendants. What got my mind going here is that 6 years after the crash the legal and financial fun just continues and no-one seems to know when it will end. The words of Robert Earl Keen “the road goes on forever and the party never ends” seem to apply. If I were a banker, I think that I would not even want to get close to dealing with mortgages and the government for a while. The risks just seem open ended and unknown. It is why the underwriting standards are as tough as they are. When credit standards trump the social agenda of pushing homeownership on the many, you get better quality loans and borrowers, albeit fewer of them and more skewed toward the high end. On the other hand, I am seeing flickers of the social agenda returning and will not be shocked to see some kind of pressure on the banks as part of settlements to-come regarding lending to lower quality candidates than they are now. With a presidential election coming in two years, helping “the little guy” at the expense of “big banks” would seem like natural politics that would also set the seed for the next round of credit problems.
So, after all of this reading, I come to some observations based on what appear to be longer-term trends:
- The size of the housing industry will continue to grow, but slowly.
- The mix will still be more slanted toward rental product, both apartments and the emerging single family for-rent sector, because that’s where the overall economics are driving people. Multifamily now constitutes about 30% of production compared to 18% in the 00s. This is the mix that occurred in the 70s and 80s as the baby boomers started hitting household stage, unsurprisingly.
- The housing needs of that growing single parent with children segment has to be addressed. Single incomes are usually less than dual incomes and the living costs aren’t a lot different. How it plays out in product, location and community amenities will be interesting to watch.
- We will continue to see unfulfilled demand for single family for-sale homes. The data says that Millennials want to own homes in the same proportion as previous generations, but that all of those other factors such as student debt, cell phone and cable bills, and incomes that are stagnant will interfere.
- Unless median selling prices drop considerably, we are going to be stuck in a rental world for a long time.
- If median selling prices do drop to a range that gives needed absorptions, current land prices, house sizes, and specification levels will have to adjust to accommodate that reality. Building companies with a lot of owned land on the balance sheet might be at some revaluation risk as will land developers. We could be into an interesting time of renegotiation of existing deals.
- Drive ‘til you qualify (that is, C and D lots) might be the solution in some markets, particularly as the opiate of lower gas prices helps in the economic calculation for a while. But how it plays out in markets where jobs are and people want to live will be different.
- However, we are in a long-view type of business. It takes years to find and entitle land and get a building operation up and running. The environment today will NOT be the environment a couple years from now.
- Finally, we have to recognize that we are in the business of creating shelter and community, whether it is for sale or for rent (or a mix of the two). I think that smart builders and developers will have to be both in the for-sale and the for-rent businesses to get away from the destructive cycles that destroy balance sheets and, more important, human capital. Underwriting land values as both a totally for-rent community (at relatively high velocities, but lower per unit gross profits) and a totally for-sale community (with lower absorptions, but higher gross profits) has to be part of any risk assessment. But I do not know of any builders thinking this way right now. The reality is that a community may be a mix of the two. But having the operational skill set to be running both types of businesses can mitigate both financial and operational cycle risks.
It was an interesting year. As I noted in my column a couple of weeks ago (Back to the Future….Again), we are seeing hints of what the business was like nearly 40 years ago and that the 90s and early 00s may have been an aberration caused by the confluence of baby boomers hitting maturity and high income earning years and a crazy financing market that won’t return for probably another 40 years.
The long view says that tomorrow may look more like far-away yesteryear than a decade or two ago and that understanding what the business looked like then, what made it work, and what were downfalls are good lessons for understanding what might be coming around the corner in 2015, 2016 and 2017.