May052013

Home Speculation is not just for investors

The suppression of the housing inventory has resulted in some interesting home construction.  The lenders have suppressed many homes from entering the market place.  They have become shadow inventory and currently there are about 5 million of them.  Most media organizations have even lost interest in reporting these numbers. The lack of existing home inventory has generated a lot of demand even with a small pool of buyers.  Home builders have wasted no time to fill this void and started building more new homes.  Within this activity there is a much smaller subset of builders that are building homes without locking in home buyers during the pre-construction phase.  These homes are called speculation home building and it has reemerged in the market place.

With Home Listings Low, Spec Building Is Back

By: Diana Olick CNBC Real Estate Reporter

Stephen Paul said he is “confident” he will sell the brand new home that he just built in Bethesda, Maryland—a high-end suburb of Washington, DC.

The CEO of Maryland-based Mid-Atlantic Builders, Paul hasn’t been building homes that didn’t already have buyers in eight years. So-called “spec” homes (short for speculative) were all the rage for builders during the housing boom, but certainly not during the bust, when demand disappeared.

“We’ve seen the listings in the market drop dramatically. It’s been way, way down for months and months and months. The wave of foreclosures hasn’t come to us in a way that impacts the market. Investors are coming in and buying up inventory,” said Paul, who sees these factors as solid arguments for spec building.

The builders are not dumb, they are reading signals from the banks.  Lenders are not going to release a lot of housing supply on the market.  They fear too much supply will drive home prices down.  Investors are slowing down purchasing because many of these properties are having bidding wars and there are just getting too expensive.

Mid-Atlantic, a small Maryland builder with six communities, now has 10 percent of its backlog in spec homes, and they are not alone. The big public builders are heading back to spec as well.

I feel that builders feeling more confident and now starting to gamble on construction.  They see the home values increasing, so why lock in a lower sale price now, when their is potential for higher values in the future.  There are some dangers to this strategy if buying slows down.

“I think the biggest competitive advantage builders have right now is that they have product, and with existing inventory so low they need to take advantage of the fact that they actually have something to sell,” explained Megan McGrath, a home building analyst at MKM Partners. “When you’re starting to think about the first-time buyer coming back into the market, you may want to increase your spec inventory a little.”

Supplies of homes for sale are down across the nation. Inventory in March fell 17 percent from a year ago, according to the National Association of Realtors. Listings usually rise dramatically in the spring, but they have not kept pace with historical averages.

In its earnings release Monday Meritage Homes CEO Stephen J. Hilton noted, “Housing demand is greater than the supply of homes available for sale in many of the areas where we operate, causing home prices to increase.”

Builders love this situation.  They want to create a frenzy of people purchasing homes.  Tight supplies of home means sales and just a having a little bit of speculation inventory creates the urgency in buyers that they have to purchase these available home before another buyer beats them to it.

McGrath said DR Horton and Lennar are particularly adept in the spec market, while others have still not been able to crawl back after the crash.

“They know where to build it, what to put in the home, how many per community to build. If you don’t do it right you can end up with homes no one wants that sit too long and then you have to discount. KB Home tried it a few years ago and had to abandon the strategy pretty quickly.”

Spec is still only about 10-15 percent of those big builders’ sales, but it will likely grow as supplies dwindle further and demand rises.

I think the current economic condition will have builders re-thinking expanding their spec building.  It will remain a small percent, they want to risk being stuck with homes they have to sell at a discount.

As for Mid-Atlantic, their spec strategy is largely infill. They tear down and build back.

“We are going into high value neighborhoods where there is high demand and no new housing,” said Paul. “I’m recycling.”

The economy will determine how much speculative building will be out there on the market.  There is lack of supply and mortgage rate are near there ultra-lows again.  The employment is just a tad better.  However, the durable goods are down.  Why I’m a bring up durable goods, because the recovery in building should have sparked a increase in durable goods orders.   It’s not solid economic news.

I still think you see speculation building, because the shadow inventory won’t hit the market so buyer will be forced to look to new construction.  However, speculation building will be used by the various builder sparingly.  It’s good public relations to advertise housing lotteries, waiting lists, or other gimmicks, but you won’t see it increase has a percentage of new homes coming on the market.