We are in the fifth year of the housing and slowly-rolling home building recovery. If business textbooks are correct and economic cycles are normally 7-8 years, are we halfway through the home building cycle?
Here are six observations based on discussions with our 100+ regional and national home builder customers, and business observations of their current operations and markets.
Prices have recovered; Absorption and volume, not so much.
While average home prices in some markets (coastal California, Dallas-Fort Worth, parts of Florida, et al.) have surged past the peaks of the 2005-2007 era, and others still trail prior highs by substantial margins (suburban/exurban markets, Chicago, Inland Empire, Detroit, Las Vegas, et al.), generally speaking U.S. home prices have recovered smoothly from the depths of the 2008-2010 despair. This is largely due to three things:
- Massive absorption of foreclosed homes from the recession by single-family investment and private equity firms
- Limited inventories
- New home supply being delivered in middle/upper price points rather than entry-level price points for first-time home buyers
Volume growth: what’s up (or not!)?
New home volume has doubled from its 2010-2011 lows. But, according to our Wells Fargo Securities Economists, the 40-year average for U.S. single-family home starts is 1.04 million. It was 710,000 in 2015. We have only reached approximately 70% of a very long-term average and lower than that to the specific numbers built in 10-year intervals of 1976, 1986, 1996 and 2006. Total housing starts (single-family & multifamily) were 1.1 million in 2015 vs. a 40-year average of 1.4 million. Multifamily starts in 2015 just hit the 40-year average of approximately 350,000 units, so the current gap on total starts all comes from the single-family side of the spectrum.
What about all those apartments… is this a bubble?
Across the U.S. and in most individual metropolitan statistical areas, we are seeing elevated construction of new apartments. This is relative to family formation, population growth, job recovery and historical norms. The potential problem is that all the new supply is seemingly being built in the same urban submarket profile: a top 20 “institutional” city, high cachet with higher rents, age target 23-40, urban/infill, near city jobs and/or transit systems. It feels like we are nearing “full” supply levels in many of these submarkets. I expect rents and occupancy to flatten out, though it is a bit of a paradox. These are generally the “strongest” submarkets that will garner the most liquidity and lower relative cap rates over time. That said, there’s been a stampede towards them for the last 3-5 years and more supply is coming. I hope we will begin to see new supply in different spots at lower rents.
Millennials: Craft beer, boutique burger joints and in-town apartments
There’s a lot of talk about millennials and home purchases right now. So when do they buy a house? Same as always. When they have a mate and some kids! Based on the recession delay, student debt, and social issues, they just seem to be starting the family/kid/owner part a little later. The purchase wave is coming and some builders are reporting that it is already underway. Homeownership rates may never hit the subprime induced faux-peak of 2007, and there is indeed rising interest and opportunity for urban living. But homeownership is still attractive and appealing. I lived as an in-town renter from ages 22-29 in the 80’s! So did the rest of my peers and friends. A lot of what is happening in-town today is not a new phenomenon, it is just a larger segment of the population than it was in my day.
First-time home buyers are making a comeback
It has been slow. Slow as a turtle skating with galoshes in molasses. But where supply is provided, demand seems to be there. The legacy recession “C” and “D” developed lots, often found farther out in exurban markets, are now being built (and sold) after being acquired earlier in distressed sales. The very low lot cost basis affords delivery of affordable homes. Replacing them is the next industry challenge. Land and development, entitlement, and municipal/governmental expenses are all more voluminous, restrictive and costly. It is now much harder to deliver housing at affordable pricing levels. A lot of it is based on regulatory costs. We have creative minds and the most entrepreneurial spirit in business today as the backbone of our home building and land development industry, so I am optimistic that solutions will be found.
Hats off to the spirited, entrepreneurial builders
They embody most good things about American effort, integrity, and free enterprise. The grass roots, at-the-site, construction, land, labor, political, subcontractor, financial, planning and execution problems they tackle every day are daunting and impressive. The ones in business today are survivors. They endured a 70% drop in business volume combined with a 30% drop in pricing circa 2008-2011. Now comfortably beyond survival, we are witnessing the fun parts: the operations and execution. While success today is still partially influenced by capital structure and legacy land holdings, their weighting in that success formula is far lower now after four years of recovery. We are seeing some builders distinguish themselves the old fashioned way. Many builders learned lean efficiency in the downturn and now they are running larger divisions with lower headcount. The “best” are beginning to distinguish themselves with profitability and returns.
How? Better capital? Better plans? Better land? Not really. Just better operators.
Consumer sentiment and confidence have been slowly improving, along with the same slow pace of economic recovery overall. More absorption is coming. Mortgage markets are balanced and market makers (agencies, banks, investors) are developing reasonable new products. If builders and developers can work with municipalities and other regulatory bodies to find ways to more efficiently deliver entry-level and lower priced suburban and exurban homes, there is a lot of room to run. Look for the pricing inflation of the last few years to taper as volume growth moves modestly upwards.