First Parade magazine, that bastion of economic analysis, and gossip, tells America in a cover story that it’s a great time to buy a house. Then an editorial writer for The Wall Street Journal lends credibility to the belief by calling an end to the housing downturn. All of which leads one to speculate: Maybe the end is finally in sight.
Even within the industry, consensus appears to be building around reaching bottom late this year or early in 2009, though this thinking seems to be based largely on the notion that the recession must end soon because it’s been going on for so long. Wall Street investors certainly believe something’s afoot—they have bid up public builder stocks covered by Zelman and Associates 14 percent since the beginning of the year.
The sunny prospects come as little consolation to builders trying to work through the dark clouds that hover over the business. Stories abound of lenders who are not reauthorizing loans, leaving builders in the lurch. Others are remargining loans, asking builders to put in more equity. By one report, a quarter of all residential land deals could fail if they were marked to market.
Unlike the celebrities profiled in Parade, this isn’t a pretty situation. When public builders impair (mark to current value) their land assets, it hardly seems to hurt their chances. For private builders, marking down land assets is an issue of financial life and death. Where do they find additional equity?
Many private builders are already all in. The only thing left to do, given the illiquidity of the debt market, is to take in outside equity. That’s a tough one to swallow, given that the value of private home building companies is depressed right now. Yet, as any vulture fund manager will tell you, these builders have little choice.
Wading a Rising Tide
Despite the media’s newfound optimism, it would be a mistake to run a company today based on a belief that conditions will make a big turnaround anytime soon. Even analysts who are calling a bottom are wary of the impact of a deepening pool of resales, fed by rising foreclosures.
There are roughly 3.4 million existing homes for sale today, about 40 percent above normal levels. It will take 9.5 months to burn through them. Plus, at least another million homes remain in phantom inventory, with owners presumably waiting for market recovery before listing them. There are plenty of homes for sale for people who want to buy one.
For that reason and others, CEOs who spoke at our Builder 100 Conference last month expect the industry, once it reaches the bottom, to bounce around for a while, rather than rebound sharply as has been the case in previous upturns. Consensus also seems to be building around the notion that long-term expectations need to change. A normalized rate of starts is closer to 1.5 million than the levels achieved during the boom.
The problem for private builders is that when the market does turn, public companies are likely to step in with a vengeance. They have been building cash reserves that they will quickly deploy to gobble up assets at the bottom of the market. And they will do so at a time when many private builders are on the ropes, unsure whether they even want to get back into the middle of the ring.
Builder bankruptcies have picked up noticeably in recent months. In some cases, builders are filing to protect perfectly good developments from the banks. In other cases, they can no longer make their finances work with a 60 percent reduction in sales volume. The first two years largely took down companies that made reckless mistakes during the boom. In the last several months, we’ve seen well-managed companies go out, victims of the credit-crunch.
It may be a good time to be a home buyer or a housing stock investor, if you have some cash. But this is going to be a very tough year for home builders, maybe even more difficult than the last two.