Signs of a national housing slowdown are gathering force. As isolated markets start to teeter, home builders face new tests. In the wake of the fierce demands of boom times, it's almost natural to forget the hard lessons of the past.
So, let's hit the books on lessons old and new. The laws of supply and demand haven't changed. As markets soften, the biggest peril will be building too high a volume, rather than reducing production. If builders fail to heed a declining market's warning to decelerate, inventories will swell fast, and things will get ugly.
The first lesson to draw from history: Slow production sooner than later. If sales stall, cancellations increase, and absorption times lengthen, throttle back. Don't wind up stuck with homes in the pipeline, and no buyers at the end of that line.
Builders bent on making numbers find it difficult to cut aggressively enough. So, the second lesson from history is that as inventories swell, your first loss is your best loss. The last to offer concessions gets hurt worse than the first. Finally: Be hyper-vigilant for a slowdown's first tremors. Curb production in time to thin inventory before price wars start. Restraint is the hardest of all lessons. It means walking away from market share,and profits in a booming market.
CHANGING TIMES Our next class segment—“The Times , They Are a Changing.” Big builders are different than they were when the markets dipped in 1999-2000. Further, conditions bear almost no resemblance to when housing tanked in the late 1980s. Back then, overbuilding was the rule; builders neither had as firm a grasp over land, nor were regionally diversified.
But make no mistake, speculative inventory is out there even if you and most of your competitors no longer build homes on spec. Granted, a deep reduction in the number of homes sold on speculation acts as a stabilizer. This should help keep a downturn shallow and short if the economy keeps expanding. Fact is, selling to speculators is tantamount to selling homes on spec. These homes quickly cycle back into the market. Investors are mercurial. Signs that investors were pulling out of markets emerged in 2005. Still, the investor share of prime loans surged nationally from 7 percent in 2003 to 10 percent in 2005. In markets such as Phoenix, Las Vegas, and Miami, investor share of prime loans ballooned to over 15 percent. NAHB reports that in the hottest markets in mid-2005, about 11 percent of single-family homes were being sold to speculators. It is flawed reasoning to think that sales figures inflated by an investor component reflect long-term underlying demand.
Another difference in this market's dynamics: Big builders have heft and land management focus they can parlay into clout with landowners. It makes sense to use this clout to push some of the pain of downturns back onto landowners by slowing land intake and renegotiating some options.
The third critical new lesson is that builders should take full advantage of their national footprints. The capacity to move swiftly to more fertile ground is the best example of how things have changed. In the past, a regional or even local downturn left most builders high and dry. They did not have the infrastructure to shift capital around with any agility. As a CFO of a major bank recently said to me, companies tend to fail not because of ineptitude but rather from plain lousy markets.
National builders now have the advantage of being able to shift focus, people, and investment out of troubled markets toward stable or even improving ones. That is ,of course, unless the whole country heads south at once. Let's hope it doesn't. Meantime, be ready to redeploy capital where it can earn higher returns.
Belsky is executive director, Joint Center for Housing Studies at Harvard University.