This is the autumn of our discontent. Winter has arrived early for the home building industry. With house prices continuing to slide, inventories still high, and mortgage lenders pulling back, housing is in the deepfreeze. The fallout from aggressive subprime lending late in the cycle is just the latest wave to come crashing down. No one knows what may come next.
Eric Belsky Exhausted, many in the industry are wondering what to do now. The industry is long on questions and short on answers. You are likely wondering how long this freeze will last, how you can hunker down so you are ready for whatever the next season may serve, and what you can do that will have lasting benefits in an upturn if this downturn turns out to be a prolonged one.

Looking Back

Yogi Berra once famously said, "It's hard to make predictions, especially about the future." In these uncertain times, we look to the past for lessons learned and to economic forecasters for their best guesses about the future.

Certainly, most forecasters failed to call the intensity and length of the downturn when it started. Nearly every month since the middle of 2006, the consensus forecast for housing starts has been lowered. Maybe we all should have seen some of the waves that hit the industry coming–like the too-high investor loan share or the inevitable unwinding of the excesses in the credit markets–but even if we had, it would not have been clear exactly when and how they would come barreling down on the industry. Forecasters warned of such possibilities but did not–and, in fact, could not–build them into their models in a reliable way.

Builders must draw their own conclusions when looking to the past because it only provides clues, not definitive answers. Although no two housing downturns are exactly alike, the average length of the eight downturns since 1950 is 26.8 months. All three major housing corrections since 1972 have lasted a minimum of two years. The downturn that started in 1972 lasted 27 months from the seasonally adjusted monthly peak in starts to the seasonally adjusted monthly trough. But the downturn that started in 1978 lasted a longer 43 months, and the 1986 downturn lasted a depressing 60 months. We are only about 22 months into this downturn, and there is no sign yet of inventories coming down.

The last three big corrections also saw a larger drop in seasonally adjusted starts from peak to trough than this market has dropped so far. In the downturn that began in 1972, starts plummeted 64 percent from monthly peak to trough. In 1978, starts fell a similar 62 percent, and in 1986, the descent hovered at 60 percent once again. While past is not necessarily prologue and starts this cycle have fallen much farther sooner than in the three previous cycles, the lack of progress in paring down inventories suggests a protracted downturn. Unless lenders loosen the purse strings to mortgage credit or interest rates fall considerably, the spring buying season could be disappointing.

Another reason to expect the downturn may last longer is that all but one of the seven previous major housing corrections since 1959 were followed by a recession and did not end until the economy was either in the first quarter of its recovery or near the end of the recession. The only silver lining in this cloudy fact from the past is that when the turnarounds did come, they were swift and strong. The historical tendency is for starts to fall to levels below sustainable demand and stay there even after an oversupply has been worked off, then come roaring back to make up for a period of undersupply. This builds in the potential for a large upside.

But don't let that lull you into believing that starts will rebound at the first signs of stabilization or a slight uptick in home sales. Instead, as the accompanying chart shows, false bottoms are common when the market is in the process of heading down. Look no further than the behavior of some builders in the first months of 2007 to learn this lesson. Encouraged by upticks in sales and downticks in cancellations, some builders took their foot off the brake just long enough to inflict further pain on themselves when the market eroded again in the second quarter of the year.

The future course of this downturn remains unclear. Eighteen months into the housing downturn that began in 1986, new-home sales had fallen 24 percent. This time, new-home sales have fallen a very similar 27 percent. But last time, housing starts had only fallen 14 percent from their monthly peak 1.5 years into the cycle while, this time around, starts had fallen a whopping 42 percent. In September of this year, they were down an even greater 48 percent from their January 2006 peak. Thus, it is possible that the market will right itself far faster from the current downturn. In fact, the last time starts turned down this fast was in 1972. That downturn ended after 27 months. Most forecasters are now betting that starts will rebound in the back half of 2008–about 30 months into this correction.

Beyond trying to draw their own conclusions from both a complicated past and shifting forecasts, these additional proactive steps may help home builders to make the best of the bad times for as long as they last and position home builders better, both for the next expansion and the next contraction.

Focus On Customers

It is never a bad time to focus on your customers and do what you can to better understand their needs and preferences. Amidst all the gloom, thinking of how you can add value for your customers and differentiate your product can provide a morale boost for your employees. It can also keep your team focused on how to cut costs in the downturn without compromising your brand and your reputation with your customers. Now is not the time to lose sight of quality as you lower costs.

Also, it pays to realize that under the present circumstances, a large part of move-up buyer resistance has less to do with the price you can offer them on the home you are selling than with the difficulty of selling their existing home at the price they want. Undoubtedly, their real estate agent is telling them to lower their price. You should point out the advantages of buying a new home now, which has already seen a significant price reduction, and selling their home at somewhat less than they may have hoped before prices on existing homes fall even farther. Prices are sticky going down–look no further than the time it took many home builders to lower prices to a point where they could move inventory. Existing homeowners are slowest of all to drop their prices and need some encouragement to recognize that the fast drop in new-home prices is a benefit if they act before existing-home prices start falling as far.

Your customers are also having a harder time qualifying for credit, especially if they are in the market for a jumbo loan. Yet jumbo loan performance remains solid, and the spreads on jumbos are quite attractive. Searching for lenders that see the value in originating loans and working through them will help your customers. In general, there has never been a time when it is more important to secure a reliable source of financing should your customers come to you without a loan in hand.

Linked In

Now is also the time to partner with, rather than simply beat up on, your suppliers. Partnering with your suppliers to cut costs by making distribution and production more efficient without forcing either party to give up its margin is a win-win-win: a win for you, your suppliers, and your customers. It will pay especially rich dividends when the market turns up if your competitors have failed to follow suit. It will also lessen the pain during the downturn. The larger companies you work with have expertise in value engineering, marketing, and lean production you can draw upon to improve the process of building a home. Getting together to problem solve with your business partners can reveal significant opportunities that, in a time of plenty, are left unexploited. Now is the time to look for and seize those opportunities. You will be pleasantly surprised.

Improve Continuously

More broadly, continuous improvement efforts often take a back seat to the logistical challenges of churning out as many homes as possible when markets are booming. Sourcing product, finding and scheduling labor, and finding land deals take priority above all else. Now, though, the benefits of efficient operations become more obvious and more important. You should sit down with your team to look for ways to build safer and more efficiently. When the turnaround comes, you will be glad that you did.

Yes, times are tough. But by planning prudently and focusing on the things that matter, your company will be leaner and better when the blows finally stop raining down on the home building industry.