By Daniel Walker Guido
As David Hill surveyed the field of battle late in the third quarter, everything that could go wrong had for the housing industry. "Consumer confidence dropped as a worldwide recession took hold, and unemployment jumped higher than expected," says the CEO of Kimball-Hill Homes of Rolling Meadows, Ill. "Sept. 11 was the coup de gras that should have ended hopes of avoiding a deep recession," Hill says. The only thing was, housing failed to concede the field. "We all just kept selling homes."
So what has kept home building from falling into the same rut as the rest of the economy? Low interest rates. Affordable rates not only ensured monthly mortgage payments on new homes were lower than rent for many first-time home buyers, they also made existing homes more attainable, allowing move-up buyers to buy new homes.
As 2001 wound down, existing homes were selling 2 percent above last year's record. Meanwhile, new-homes sales were on track to become the highest ever. Having learned their lesson during the 1991 recession, builders had fewer spec homes and had lowered their land inventories.
"By rebounding so quickly after the terrorist strikes and the waves of bad news that engulfed everyone shortly thereafter, the housing industry has shown resiliency rarely seen in a routinely cyclical industry," says Isaac Heimbinder, a Houston-based housing industry consultant and the former co-CEO of U.S. Home. "With fewer spec homes and more reliance on land options than outright purchases, builders are better prepared now for cyclical downturns."
"If we can start the year on a high note and keep the momentum going into spring, the industry could chug right on through this recession," says David Seiders, the NAHB's chief economist. Even if interest rates begin to increase by the second quarter, Bob Hawksley, president of Fischer Homes of Crestview Hills, Ky., does not expect sales will suffer. "Buyers are positive and seem more secure about their jobs. Recessions typically last around 11 months, so hopefully this one is about spent."
With Congress having rescued the airlines, maybe about to do the same for the insurance industry, reading a huge economic stimulus package, "plus all the dollars that will be spent to replenish military supplies and to build new weapon systems, there is a great deal of new spending coming down the pike early in 2002," says Gordon Milne, CFO for The Ryland Group of Calabasas, Calif. "All those dollars can only help business by, if nothing else, helping the consumer feel more confident to make big ticket purchases."
Of all the home builders, economists, housing industry consultants, and Wall Street analysts interviewed, none sounded a negative note for prospects of strong sales in the first two quarters of this year--with two stipulations. All agreed that another unforeseen major terrorist attack could devastate consumer confidence and send the economy into a tailspin. And a worsening insurance crisis brought on by increasing mold lawsuits and Sept. 11 insurance industry losses could leave smaller home builders and subcontractors uninsured.
"But how do you figure in a terrorist strike? You don't," says Ed Langley, CEO of Excel Homes of Liverpool, Penn. "You just make your plans with all the economic indicators in mind and leave it at that." A modular home builder, Langley credits not only low interest rates and strong demand but also an unseasonably warm winter in much of the nation as helping maintain sales. Insurance rates could increase again, but Langley is counting on congressional action to stave off an affordability crisis.
"There are so many positives out there as the year draws to a close," Langley says. "The stock market, which is a six-month leading indicator, has rallied time and again and is trending up. Oil prices are dropping, partially due to the warmer than expected weather. The manufacturing sector is starting to pick up. The labor supply is in good shape. Inflation is nearly nonexistent, and there isn't a whole lot of inventory on industry shelves. Car dealers are selling everything they make, and the president has engineered substantial geo-political success."
With most interviewed expecting the Federal Reserve to cut rates once more before the end of the first quarter, all systems are go for a slow but steady escalation in sales,
For several weeks after Sept. 11, John Stanley, home building analyst for Wall Street investment bank UBS Warburg, was the loneliest guy in town. The sole remaining bull among bears covering housing, Stanley argued those initial declines in sales and traffic in late September were only a reaction to the terrorist incident and not a sign of a deeper malaise in the new-home market. At one point in early October, he squared off against the NAHB, arguing that the home builder association--typically the industry's cheerleader--was being "too negative" in it's review of the September sales slump.
Always bold, Stanley declared on Oct. 17 that the housing market "has recovered to its pre-attack levels," and the NAHB's more cautious reports were caused because its monthly survey of builders was a lagging indicator that was surpassed by his "real-time builder inputs" that are "more indicative of current market conditions." Builders, declared Stanley, were reporting orders had recovered in late September and early October.
Meanwhile, Ivy Zelman, home building analyst at Wall Street investment bank Credit Suisse First Boston, and Ian Jacobs, her counterpart at Goldman Sachs, both sounded much more cautionary notes. Zelman recommended investors "stay on the sidelines for housing-related stocks until confidence is reinstated for our nation." Jacobs warned that with declining consumer confidence, increasing unemployment, and so many other negative indicators, housing sales could be down through the second quarter.
But in early November, Stephen Kim, home building analyst for Wall Street investment bank Salomon Smith Barney, took his first tentative steps back into the bull ring. He declared Nov. 5 that housing had overcome the worst.
"Over the past several weeks, we have fielded a number of questions from investors regarding a curious disparity between several of the nation's most widely followed housing indicators," Kim wrote. "On one hand, existing-home sales, the builder sentiment index, and the public home builders' order trends all declined markedly in September. On the other hand, housing starts and new-home sales posted surprisingly strong results."
By month's end, Salomon had upgraded its rating of several public home builders. "Overall, we were surprised by the strength indicated" by a 2 percent gain in housing starts in October, as "we expected October's housing starts would reflect more definitive weakness. Investors should probably begin to consider the possibility that housing demand may not drop significantly before an economic recovery."
On Nov. 29, Kim had come full circle, issuing "A Bullish Call on Builders." Salomon had decided "the current environment looks very similar to the late '87 to mid-'89 period, during which time the group rallied while the Fed was raising rates."
Barring a late season blitz of blizzards, ice, and bone-chilling cold, all those interviewed expect housing will continue to recover from its September slump and enter the spring busy season on pace to record a solid, if not spectacular, year in sales.
"Keeping in mind that the past two years have been record-setters, even if we end 2002 behind 2001's sales pace, the industry will still be in very good shape," Heimbinder says. "In the mid-to-late 1990s, everything looked good, everywhere. But we could go back to the more typical situation where housing is okay, but some regions are better than others."
Areas hard hit by the current recession, such as Northern California, Orlando, Fla., and Las Vegas, will come back, including "Texas, where increased military spending should benefit the state's economy," says John McIlwain, senior resident fellow for housing at the Urban Land Institute. "All Sept. 11 did to the economy was accelerate whatever trends had already begun. If a stimulus package is created that gets money directly into the hands of the people who are going to spend it, the economy should quickly recover. Demographics show there are a lot of young people and immigrants getting ready to buy their firsthomes."
Profits should do well also, with low interest rates prompting many buyers to load up on options they otherwise could not afford. "They know how much they can pay monthly, and with near-record low rates, many first and second move-up buyers are adding more options," Hill reports.
"There is no reason that at the least, entry-level and first-time, move-up sales should do anything but increase," says Sam Fuller, CFO of D.R. Horton of Arlington, Texas. Having acquired Schuler Homes of Honolulu in 2001, Fuller says he foresees consolidations will continue this year. "I don't think we'll see the merging of two top 10 builders like Wall Street has been calling for, but more of mid-size builders like Schuler being acquired by the big builders."