Builders who think the financial meltdown happening on Wall Street this week won't affect them should think again.
The capital to run their businesses—acquisition, development, and construction (ADC)—is likely to become less available and more expensive. The mortgages that consumers require to purchase a new home will become even harder to get, despite the recent federal takeover of mortgage finance firms Fannie Mae and Freddie Mac. And the number of jobs that Americans need to qualify for and pay those home loans will continue to shrink if banks are reluctant to give businesses the credit they need to expand and hire more workers.
"What recent events do, or are likely to do, is worsen the underlying factors" involved in the current economic maelstrom, according to Nigel Gault, chief U.S. economist at research firm Global Insight, which held an online conference call Tuesday to discuss the unfolding financial crisis of the past two weeks. What are those underlying factors? A fragile economy. A banking system battered by write-offs. A gaggle of skittish investors around the globe. A housing market struggling with declining home prices, high levels of inventory in both new and existing homes, and extraordinary numbers of foreclosures from California to Florida.
"What is different today [from past housing downturns] is that you have an overall market problem—it's not isolated to any one geographic area or several geographic areas. It's almost a systemic problem," John Bittner, a partner at Grant Thornton, told BUILDER this week. "What you are seeing now is a much more protracted decline in the housing market because of the situation in the financial markets."
Bittner should know. A partner in Grant Thornton's corporate advisory and restructuring group, he has been involved in workouts for residential and commercial builders for the past 18 years.
He's not the only one who thinks so. "The problem appears to be bigger than we thought," Nariman Behravesh, Global Insight's chief economist, said at the start of the Lexington, Mass.-based firm's conference call.
Bittner, like others, foresees credit becoming even more difficult to get for builders in the months to come. "Credit will only be available to those with the most pristine of balance sheets, and if it's available, it won't be cheap," he predicted to BUILDER. "And the restrictions and covenants placed on the loans will be considerable."
Such a situation does not bode well for builders, who have been fighting for survival and cash flow for months. In a market where firms such as WCI, Woodside Homes, Neumann Homes, Kimball Hill Homes, and others are going bankrupt, what home building companies have such clean balance sheets? "That's the problem," Bittner said. "Very few of them have. They're long in land, and they have a significant amount of debt on their balance sheet. The larger publicly traded home builders, the smaller privately owned home builders with $100 million to $500 million in revenue—they all bought into [the boom] when times were good. Very few, if any, have the balance sheet to go out and get credit these days."
Even worse, the housing slump that spread to the financial markets now appears to have put the overall economy at risk. "We are entering the most dangerous phase of this crisis because if we look at the underlying state of the economy, it has weakened," said Brian Bethune, chief U.S. financial economist at Global Insight during Tuesday's online conference call, where he advocated for an interest rate cut by the Federal Reserve. Such a decision, he explained, would improve liquidity and make banks more willing to lend money, staving off any looming solvency problems.
With the economy reeling, consumers rethinking their spending, and banks reducing their own financial exposure by lending less money, builders will likely start feeling the pain of the overall economic tumult as well as the effects of the ongoing housing downturn. Even if home prices stabilize, thereby making the purchase of a house more attractive to Americans, "we will have a real drag on the housing market in terms of what is happening in the rest of the economy," said Gault, who doesn't expect housing to rebound until 2010.
Alison Rice is senior editor, online, at BUILDER magazine.
How is your company coping with the current economic situation? Let us know.