Does lender can-kicking harm the starter-home market?

The next generation of entry-level housing won’t be built if lenders burden the available land with bad bubble-era loans.

residentia_versus_commercialThe valuation of land used for residential housing is mysterious and often misunderstood. The valuation of lots and raw land requires a detailed knowledge of construction and marketing costs as well as a good estimate of the sales price of the final product: a residential housing unit. In short, the value of a lot is the total revenue (sales price of the home) minus the costs of production and the necessary profit. Land value is a residual calculation.

The value of a piece of land is whatever is “left over” after all the other costs of production and profits are subtracted from revenue. This is a key point. Land for residential home use has no intrinsic value. It is a commodity useful for the production of houses just like lumber or concrete. For a given price level, if the cost of house construction increases, the value of land decreases; if the cost of house construction decreases, the value of land increases. This last point is often confusing as the inverse relationship between building cost and land value does not seem intuitive, but since land value is a residual calculation, this relationship is the reality of the marketplace. The value of a piece of land used for residential housing is directly tied to the revenues and costs of house construction.

That background understanding of land value is critical to see how lender can-kicking may be killing the starter home market.

The conventional wisdom is that Millennials aren’t buying homes, so builders aren’t building for them. The first-time homebuyer participation rate recently hit a three-decade low, so there is no question that the starter-home market suffers; however, the cause may not be a lack of demand by Millennials. The problem may be the inability of builders to supply demand at the entry level.

Can-kicking land loans

The plethora of well-publicized loan modification programs establish that lenders kick the can whenever they get bad loans. As one might expect, their behavior is little different with respect to commercial loans; in fact, lenders have always can-kicked commercial loans when necessary, and it’s only been during the housing bust that they transferred this long-established behavior to residential loans.cram_down

Land loans are commercial loans. Further, since the value of land is notoriously volatile, lenders can-kick these loans whenever possible — and the housing bust made this possible very often because underwater borrowers on land loans strategically default (or cram down lenders) at very high rates.

So how does this impact the starter home market? Well, if lender can kicking created cloud inventory, and if cloud inventory suspends prices at higher than market values, the market doesn’t provide lots at a low enough price to allow builders to provide entry-level housing.

Most of the finished or entitled lots in California and in many other markets are tied up with bad debts from the development process during the housing bubble. Rather than clear out these bad loans and recycle the land to make it available at prices low enough for builders to provide entry-level housing, the banks can-kicked these loans, kept them off the market, and as a result, the builders are unable to provide entry level housing even if that market were strong.

This problem will only grow worse as mortgage interest rates rise. Even if a resurging economy created many new high-paying jobs for Millennials, the floods of new buyers won’t help if these buyers can’t finance the sums required to support prices high enough for builders to supply entry-level housing. In other words, if you give a thousand buyers a dime, it won’t help them when houses cost a dollar.

It’s problems like these that historically prompted regulators to force banks to liquidate bad loans and recycle the encumbered assets through foreclosure. Bad debt is a scourge that burdens otherwise good assets by applying an unrealistic value to them. This is one of the many reasons our economy foundered over the last eight years.


Are New Starter Homes History?

Since World War II ended, builders lured buyers with new houses priced to vie with resale, but better built. They may now be extinct.

By Les Shaverforeclosure_ends_misery

If you’re an American home builder of an age, here’s something you know: If you can build and sell new homes for two-and-a-half times median household income in a neighborhood, people line up around the block to buy them. Bill and Al Levitt knew it, and when they first put their stripped-down two-bedroom, one-bath, single-story Cape on the for-sale market near Hempstead, N.Y., in March 1949 for $6,990, they had 1,000 couples show up on the grand-opening weekend with their $60 first payment in hand. Median household income in 1949 was around $3,100—so two-and-a-half times that wage got you into homeownership. In today’s dollars, two-and-a-half-times the median household wage gets you to $130,000. Not a home builder out there, save for a few isolated markets, can sell a new home for that price and keep his or her shirt. Question is, can home builders build for the low-end buyer any more at all?

The idea of two-and-a-half times median household income buying a house is a relic of a bygone era. Buyers today are lucky if they don’t have to borrow five-times their current income if they want to buy something comparable to a rental. Such is the impact of 25 years of steadily declining mortgage rates.

Another question is, what does American society, the economy, and the culture itself risk if the iconic badge of the American dream—the pristine and new, if unashamedly modest, starter home—is allowed to become a figment of history rather than part of a entrepreneurial solution to housing’s all-too-anemic clutch at recovery?

How do we sustain a move-up market long-term if the entry level buyer is gone?


Can homebuilding regain full strength without providing homes to what has historically been the largest segment of the market?

One decade ago, at the crest of the last real estate boom, the number of new homes sold for less than $200,000 totaled 297,012. Each year since 2005, the number of single-family homes sold for less than $200,000 has declined, cratering to 46,718 in 2014.

Making a $200,000 home work as a home builder is junior-high–level arithmetic. Solving for profit—say, 20%—land and building direct costs can not exceed $160,000. Problem is, a 20% margin on a sub-$200,000 house has become frighteningly elusive in the past decade.

“The lowest build cost is around a $50 a foot,” says David Goldberg, a home building and building products manufacturers analyst for UBS, New York. “If you do a 2,000-square-foot house, which is what you’d have to do to compete with existing stock, that leaves you with $100,000 of sticks-and-bricks cost. The maximum cost on the land would be $60,000.” …

Goldberg says. “If you got your land for free, you can make it work. If the municipality waives permitting fees, I can make it work. It’s the confluence of everything.” …

permanently_high_plateauLand doesn’t have to be free, but the finished lot cost certainly needs to be lower than $60,000 to make the math work — and that’s why suspending all those lots in cloud inventory hurts homebuilding. No entry level home will ever be built on a lot burdened by a can-kicked bubble-era loan.

Cates says. “The days of developing an entry-level home [site] for $25,000 are over. Now, it’s $50,000. You can’t build a $175,000 home on a $50,000 lot. The numbers don’t work.” …

Still, any quest for a below-$200,000 home starts on the ground. “Land is step one, if you can’t do that, you don’t have a shot at step two,” Callahan says. …

But finding land at a price that works for a sub-$200,000 selling price means going to deeper suburbs and outlying areas, which is something many customers—including the coveted millennial—say they’d avoid if they can. “You need to fill up with gas before you go look at [these communities],” East says. …

If we simply bypass and ignore all encumbered lots in the market, by necessity builders move out to the hinterlands to find unencumbered land to restart the entitlement process. However, this will take many years, and it will push entry-level housing into areas far away from employment centers.

no matter how daunting it appears now, builders eventually will figure out how to meet this high-volume below-$200,000 market.

Builders are an ingenious group, and if given the chance, they would find a way to provide entry-level housing; however, if those entrepreneurial instincts are thwarted by intransigent lenders tying up good land with bad loans, these entreprenuers won’t get a chance, and an entire generation of entry-level housing simply won’t get built.


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