Ivy Differs with Her Colleagues on the Street
Ivy Zelman, CEO, Zelman & Associates said that Wall Street seems to think that the industry has reached bottom based on how investors are bidding up builder stocks. Investors seem to think that a federal stimulus package will bring back the market. Zelman believes the optimism is premature.
First, Zelman said that a “whole backlog” of homes in foreclosure is starting to come to market from the banks. They’ve already started hitting the market in the Inland Empire. Also, she said, banks are only now awakening to problems in their AD&C portfolios.
Zelman thinks that the tax rebates in the Senate bill should indeed help the market. And so should a recent statement by Fed Chief Ben Bernanke, who suggested that banks provide forbearance rather than foreclose on mortgages. He argued that in the long run this would be less expensive for them.
At the same time, Zelman noted that bank regulators had picked up their activity. Some recently asked banks to put aside more equity to cover potential loan losses. “This is going to result in a massive capital call,” she said. “Twenty-five percent of loans could fail if they were marked to market.”
As a result of massive losses from failed loans, Zelman said that banks are taking action to reduce headcount, exit markets, and in some cases are completely eliminating all AD&C lending programs.
Zelman presented some startling figures that illustrate the banking industry’s dependence on real estate. Large commercial banks have 49 percent of their assets in real estate (16 percent commercial and 33 percent residential). Small commercial banks are even more exposed; they have 67 percent of their assets in real estate (46 percent commercial and 21 percent residential). “We’re in a lot of trouble with the banks,” Zelman said.
Meanwhile, delinquencies on AD&C loans are on the rise. Delinquencies have nearly doubled since 2005 to 3 percent. The percentage hasn’t been this high since 1990, according to data from the Federal Reserve. “Delinquencies are skyrocketing,” she said.
Zelman believes that in the short run unsold inventory of existing homes will continue to rise, foreclosures will mount, and unemployment will increase due to weakness in the economy. She presented numbers, derived from five sources, forecasting a huge increase in first mortgage loan defaults (from 1.4 million to 1.9 million) and lost homes (from 870,000 to 1.3 million)
“The most positive thing we have going for us is that we aren’t building speculative inventory,” Zelman said. “We’ve put the brakes on the industry.”
Nevertheless, Zelman predicted another 20 percent decline in housing starts this year, from 736,000 to 565,000, with a pickup in 2009. She also said that existing home prices would probably fall another 8 percent this year and 3 percent next year. From 2007 to 2010, she expects home prices to fall 24 percent, after they increased 65 percent from 1996 to 2006.
Even with declines in existing home prices, she thinks new homes will be in a strong competitive position “because the costs have come out.”
Zelman believes it’s tough to say how much land prices have deflated because there were very few comps in 2007. Nevertheless, she thinks finished lots are off about 40 percent and raw land is off 60 percent. Lennar sold its lots to Morgan Stanley last year for 37 cents on the dollar, but after tax benefits were added back in, it was more like 60 cents, she said.
Public builders still have a ways to go before they finish taking impairments, she said. They have only taken 60 percent of impairments--$14 billion on owned land, $20 billion in options.