Builders tend to say "yes," and they continue to do so. That's the case, despite the paroxysms going on at a global economic level and on Wall Street right now, along with distinct signs that mechanisms that have been motoring along with momentum may have begun grinding into a lower gear.
They're more optimistic, however, about what they're selling versus what they have to to buy.
Four plus-side forces buoy their optimism.
- Interest rates, low and heading lower
- Mix shift to smaller, more value-engineered, lower-price new homes
- Discounts, buy-downs, free options, and upgrades
- An economy that is growing, and fully-employed
These four positives do little to nothing to address supply constraints. Lots, labor, and capital lending dynamics continue to force costs up faster than household earnings can keep pace with.
Taken together through early August, however, builders sense that this quartet--economic strength, rates, mix shift, and promotional incentives--give them the switches and levers they need for agency. To paraphrase the oft-quoted conditional "Field of Dreams" message from on high: "if you build it [at the affordable end of the spectrum, and goose the deal a bit in favor of a buyer's getting off the sidelines], they will come." So, they feel lucky. Housing starts and permits data released this past Friday--at least for single-family units--bear out this sense of optimism, as does the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) reading, which came out a day before the Census' housing starts release.
Housing oracle Ivy Zelman's data tells her that's a correct take on the outlook as well as the present moment. The Zelman & Associates team tracks builders' mix shift and the lower tiers of the pricing spectrum around the country by looking at square footage ranges of new-home inventory, where lower square footage totals typically align with lower asking price ranges.
Zelman wrote in a blog post last week:
In 2Q19, 20% of for-sale new construction inventory was less than 1,800 square feet in size, up a robust 540 basis points year over year. Additionally, homes sized 1,800-2,249 square feet accounted for 27% of the total versus less than 20% when we began our analysis in 1Q15. In fact, gains have been accelerating of late as builders have become more comfortable pursuing affordable submarkets targeted at the entry- level price point and entry-level demand has proven to be very strong.
If home builders wanted a clear signal their beliefs and optimism are well-founded, that the turbulence rocking Wall Street and the structural soundness of structural domestic demand for new homes are two separate, independently active economic force-fields, they got it in the form of Main Street exuberance, reflected here in consumer retail sales in July.
Builder confidence in demand fundamentals is just that. Confidence. They saw sales absorptions hit a soft spot in the back half of last year, and then spike back upward as rates eased and their own mechanisms--lower-priced offerings and discounts--kicked into gear.
What actually happens in the months ahead, irrespective of inverted yield curves, rough-going on the international trade front, and an unrelenting news cycle of shrill, highly-polarizing rhetoric, may show U.S. consumer household strength--or weakness--that could neutralize the current drama rocking investors right now.
The first sign of reasons to worry, such that it may be, may come in the form of a pivot in consumer confidence, which as KB Home ceo Jeff Mezger notes here, "means more than rates to the home buying decision."
How might builders detect such a sign--get the signal--amidst all the noise and histrionics flashing through capital investment and media networks right now?
Could such signals be staring us in the face, with data last week from the National Association of Home Builders on a third consecutive "year-over-year decline in the share of adults thinking about buying a home," Or with an about-face in the University of Michigan's preliminary consumer sentiment reading for August, which came in this past Friday well below consensus estimates?
A late summer stock market swoon, a quantum order of magnitude increase in volatility, and a host of technical, corporate debt-related indicators appear--to date--contained to internationally-exposed investment and market arenas. Still, New York Times economics correspondent Neil Irwin notes that the containment may be vulnerable, and therefore temporary. Irwin writes:
If the downturn remains confined to business spending, it will be hard — just as a matter of arithmetic — for an overall contraction to result. Consumer spending accounts for more than two-thirds of the American economy, versus about 14 percent for business investment.
So far, American consumers are spending enthusiastically, driving overall growth. But there are a few ways the freeze-up in business confidence could change that.
Turbulence in global markets — and the news reports attached to that turbulence — could reduce consumer confidence, and lead Americans to pull back on their buying. The University of Michigan survey of consumer sentiment fell sharply in its August reading, announced Friday.
Or more directly, if businesses pull back on investment spending, they may also make moves that reduce consumers’ incomes, including layoffs, hiring freezes and cuts to overtime.
If that’s the worst of it — trade wars, slower business spending and weaker overseas economies — the United States could probably weather it without falling into contraction. But there are risks out there that could multiply those shocks.
One is the buildup of corporate debt. Businesses have taken on more debt in an era of low interest rates, which leaves them more vulnerable to failure if the economy were to soften or interest rates were to rise. A pullback because of trade wars could cause a wave of bankruptcies that turns a mild slowdown into something worse.
“A highly leveraged business sector could amplify any economic downturn as companies are forced to lay off workers and cut back on investments,” the Federal Reserve chair, Jerome Powell, said in a May speech.
Will business leader and investor anxiety take on a life of its own and, eventually, weigh on consumer confidence? Or will U.S. households' belief that the timing is right to turn on the jets of home purchase, remodeling, and mobility rekindle business investment and improve CEOs' sense of confidence in renewed growth?
Our sibling analytics and advisory company Meyers Research director of economics Ali Wolf offers a critical nugget of sage counsel for a moment whose mixed signals and cross-currents are far too complicated a riddle for most mortals to interpret. Her advice? It's simple. Listen. And listen well. Wolf concurs with Mezger, in asserting that rates, even dirt-cheap rates, may be overrated. She writes:
Do you know what buyers do track on a daily basis? Text alerts, shared articles on Facebook, and front-page news from Yahoo, Bloomberg, WSJ, CNBC, etc, which throughout this year, haven't painted the rosiest picture.
- July marked the longest expansion on record - sounds like it needs to end, right?
- Stock market volatility has picked up - whether or not Americans have money in equities, most people assume the stock market and the economy are the same thing. Ergo, volatile stock market = cautious consumer
- Talk of home prices returning to peak levels - I know what happened last time, I can just wait for prices to drop before buying
- 2020 recession talks - 2020 is no longer far away...
Wolf's wisdom--for business strategists--resonates on two solid planes. One is the abundantly clear insight that home builders have more work to do to improve their buying--of land, materials, labor, and capital--if they expect to sustain agency to continue to tap "strong fundamental demand." As she notes, historically low rates have been around so long they're very nearly a "table stakes" expectation, no longer the catalyst they once were. Those with the ability to profitably take prices down a notch or two more will be ones who'll extend their growth outlook beyond that of peers.
The other gem from Ali Wolf here goes back to how builders can discern a pivot in consumer confidence or sentiment with foresight rather than hindsight.
A big lesson we took away from builders who went into and came out of the Great Recession intact and able to thrive had to do with their early read and reckoning with where the market was headed before it fully destabilized. For many of those who were resilient and prospered, it was a simple matter of listening well versus wishful thinking. Listening carefully and actively--to customers, lenders, business partners, and altogether different industry executives--is critical when signals are so mixed as they are now.
Listening is a kind of trade-off. You exchange experience and knowledge for learning. You give up a bit of reliance on a known direction, and in return, you open to the opportunity that comes from stepping into an intersection of options.
To make the future, you change the present. Don't forget what you know, but be willing to set it aside so that you can learn what you need to in order to flourish, improve, and be around for the next series of wild gyrations in the marketplace.
