While there is very little good to be found in the current downturn in housing, it does provide the opportunity to look back and learn. What were the signs that if heeded, would have provided your organization with a competitive advantage?
As we entered 2005, all of the traditional drivers of the home building industry looked good. Unemployment was low, job growth was strong, mortgage rates had risen just slightly off of historical lows, and the overall economy was strong. So what did we miss? Were there any warning signs that foretold the pending downturn?
In business school, case studies are used as an effective learning tool. The case study methodology presents a set of circumstances from an actual company without disclosing its identity. Real data is used to provide a real life learning experience.
I would like to thank Hanley Wood Market Intelligence for providing the majority of the historical information. Hanley Wood Market Intelligence provides market specific information on the majority of major home building markets nationwide and makes this information available on a subscription basis.
As you review this market information, the goal should be to determine what critical information do you need to know in order to make strategic decisions allowing your organization to take advantage of the given market conditions.
The chart provides real market data. This specific market has a number of characteristics. Its climate is such that it attracts visitors from around the world because of its year round warmth. Tourism is a major economic engine and recent improvements to the international airport have had a major impact on the number of visitors.
Since there is no state income tax the state and the market enjoy significant in-migration from individuals who have sold their home in more expensive parts of the country and moved into the market. As the population has increased and tourism has blossomed, employment has grown.
So where do we start? Well we know population and employment growth drive the need for homes, so let's look at population growth and employment growth versus the number of homes being built.
The Employment Growth to Permit Ratio (E/P Ratio) looks at the number of permits being pulled per new job. The general rule of thumb is a ratio of 1:1 is equilibrium; less than 1:1 indicates oversupply, while over 1:1 may indicate under supply.
It's interesting to note that over the last ten years this market's historical E/P Ratio is significantly below 1:1 having peaked in 2000 at .79:1 Historical trends are critical in understanding a market. In this case, an E/P Ratio of .65 is the 10 year average.
The Population Growth to Permits Ratio (Pop/P Ratio) looks at the number of permits pulled per growth in population. Over the last ten years the market has averaged one new building permit for every 1.4 in population growth. From 2000 through 2002, the Pop/P Ratio was generally inline with the long-term trend, but beginning in 2003 and 2004, one building permit was pulled for 1.26 and 1.29 in population growth. In 2005, it fell to nearly one permit for each new person who moved into the market, significantly below the long-term trend.
Speaking of permits, the growth in permits has been significant. In the late 1990s, this market averaged nearly 7,500 permits and saw growth to over 11,000 permits pulled in 2002. Beginning in 2003, permits started to rise significantly with over 15,000 permits pulled in 2003, over 20,000 permits pulled in 2004, and nearly 30,000 permits pulled in 2005. The growth in permits between 2003 through 2005 was unprecedented given historical trends. By 2005, permits had nearly tripled over 2002.
The growth in median home price looks at how single-family real estate prices have risen or declined. Median home prices rose moderately through 2000 except for 1997 when the median price of a home grew 8.9 percent. Starting in 2001, the median price of a home grew at double-digit rates. In 2004 and 2005, the rate of increase was an incredible 23.2 percent and 43.8 percent, respectively.
Was the growth in incomes keeping up with the growth in the median price of homes? Well, one thing we can look at is the Affordability Ratio. The Affordability Ratio depicts the percentage of the population that can afford the median priced home. Through 1999, this ratio indicates that approximately 70 percent or more of the population could afford the median priced home. Beginning in 2000, this began to change. In 2004, less than 50 percent of the population could afford the median priced home and in 2005 only slightly more than 30 percent could, a decrease of over 50 percent since the late 1990s.
This market is clearly a thriving market with strong employment and population growth. Employment growth peaked in 2005 at 17,200. Population growth continues to increase and is leveling off above 30,000 per year in 2005 and 2006.
While the employment and population growth is encouraging, there are a number of alarming factors in the market. Most concerning is the rapid rate of permit growth given affordability, population and employment growth.
Affordability has been on a steady decline. Ten years ago, 77 percent of the population could afford the median priced home, today only 31 percent can. Second, the E/P ratio has fallen to .6 jobs per permit. While this market has historically been lower than 1:1, .6 is below the long-term historical trend. Additionally, the market pulled 1 permit for every new resident in 2005 far below the 10-year trend line. This would suggest the Pop/P ratio will need to return to the mean. Unless population growth increases at a more rapid rate, building permits will decline.
The dramatic increase in the median price of a home is of concern. Are there market factors supporting the rapid growth from an average of $115,000 in 2001 to an average of $269,200 in 2005 actually peaking at $322,000 at the end of 2005? The market is correcting as the median price home has decreased to $256,100 in February 2007, a decline of 21 percent from the peak.
The Housing Growth Ratio (permits per 1,000 population) has increased dramatically during this period. This ratio increased nearly 400 percent between 1997 and the peak in 2005. The problem is population, employment, or median incomes did not increase in like proportions. These drivers of homebuilding activity were not keeping pace.
One piece of data I recently started to track is the number of homes offered for sale in relation to the number of homes being sold. Unfortunately, I've found historical data hard to obtain. It would be helpful to know the historical trends of homes offered for sale versus homes sold and homes offered for sale versus permits pulled. In February 2007, this market had 16,875 homes offered for sale and 423 sales, a 40 month supply.
This market is clearly struggling. Existing inventory does not bode well as pricing pressure must ensue. Affordability, which has deteriorated significantly, will actually improve as the median price of homes moves lower. The excessive inventory will discourage builders from pulling building permits so permit ratios can move back towards the mean. This is a market that is struggling significantly and will continue to struggle until equilibrium is restored. This market is Fort Myers, Florida.
Home building is tough enough with competition as it is, worries about mortgage rates, and the constant challenges presented by local government. Builders who understand market conditions create a competitive advantage over those who blindly move forward.
Builders who understood the Fort Myers market was overheated could have shrunk inventory positions including land and specs increasing cash flow and improving their balance sheet in order to position themselves to take advantage of the downturn. Those builders who failed to understand the market are most likely finding themselves in a very difficult financial predicament.
–Jamie M. Pirrello is the President and CEO of Vision Homes USA. He can be contacted at firstname.lastname@example.org.