Oct302012

Restricting MLS inventory is reviving homebuilding

Homebuilding usually leads the economy out of recession. The Great Recession did not end with a building boom largely because of overbuilding during the housing bubble. A false price signal triggered excessive homebuilding, and it took five years to work off the inventories. The collapse of the housing bubble saw new home sales and construction fall to the lowest levels ever recorded — and those records go back to the 1960s. To make matters worse, rather than experiencing a sudden drop and a “V” bottom leading to a new boom, new home sales flat-lined at record lows for five straight years. This basically wiped out the homebuilding industry. A few years ago, I heard the Riverside County manager of KB Home quip, “I’m building 10% of the homes with 10% of the staff I had in 2006.” That’s no exaggeration.

The other key point to take away from the chart above is the magnitude of the so-called recovery. Housing starts and sales may be up by large percentages from the bottom, but current new-home sales levels are still below the lowest low since 1963. Think about that for a moment. We have many more people today than we had in 1963, yet we are building fewer homes. When you factor in the changes in population, a grimmer picture emerges.

Over the last five years, new construction has matched the level of obsolesce. In other words, we have tore down as many as we built. Population is still growing, and the empty houses from the bubble are being absorbed, although this is still an overhanging problem. As some point, population pressures will contribute to new home demand — or at least new home desire. Until the next generation gets a job that pays enough to service their student loan debts and enables them to move out the basement in their parent’s house, population pressure will not translate to demand for new housing.

2012 and homebuilding’s recovery

The homebuilding industry is slowly recovering. New home sales are brisk in Orange County and across the Southwest despite high levels of mortgage delinquency. Pundits like to proclaim a large uptick in demand because increasing demand really would mark the turning point in the housing recovery. Unfortunately, that isn’t reality. The real reason homebuilding is recovering is because new homes are a substitute for the lack of inventory on the MLS. Demand is up slightly, but restricted MLS supply is really what’s driving the homebuilding recovery. And a recovery in homebuilding will lead to a broader economic recovery because many people will go back to work.

Why Housing Construction Is Rebounding

By Nick Timiraos — October 17, 2012, 1:13 PM

Housing construction was depressed to such a low level for so long that it wasn’t going to take much to boost the ailing sector.

What it needed was for demand to recover. Now, with consumer confidence rising and mortgage rates falling to their lowest levels on record, buyers are coming back.

Unfortunately, that just isn’t true, certainly not for owner-occupants.

Despite the lead touting the increase in demand, the rest of the article talks about the supply issues that are really driving the recovery.

It began earlier this year as investors scooped up properties at big discounts that they could rent at a profit—often buying homes out of foreclosure before they were taken back by banks.

Consider the case of Sacramento, Calif. The supply of previously owned homes listed for sale in September was down by 60% from one year ago, led largely by big declines in bank-owned listings.

That’s why homebuilding is rebounding. People who would ordinarily be purchasing resales are not able to get the properties they want, so they are turning to new homes as a source of substitute supply.

Now, builders are benefiting from sharp declines in the share of foreclosed properties. Just 14% of local home sales in September were foreclosures, the lowest in more than five years and down from nearly 50% as recently as February 2011.

If the lack of inventory were due to a lack of delinquent borrowers, I would be celebrating the new recovery, but that isn’t the case.

In fact, the problem is getting worse: September delinquencies skyrocket 7.72%, foreclosure filings decline 20.4%, shadow inventory grows.

Many traditional sellers are underwater—they owe more than their homes are worth—or aren’t willing to list their homes at prices that are down sharply from five years ago.

That’s putting home buyers in a bind. “People are running out of options,” says Veronica Roberson, vice president of sales and marketing at home builder Taylor Morrison. “We’re down to less than a month of supply, so buyers are coming to new homes pretty urgently.”

New home sales are not traditionally a supply substitute. People generally buy new homes — and pay a premium for them — because they want new construction. It’s similar to new car buyers. People want to be the first and only owner. Imagine what would happen to new car sales if 50% of the used cars suddenly disappeared from the market.

This has big implications for homebuilders. The demand driving new home sales is not the sustainable kind from buyers with traditional motivations for new construction. The buyers who are substituting to new homes because MLS inventories are so low will disappear the moment MLS inventories return. Are lenders planning to keep inventory off the market indefinitely to keep  homebuilders active? Do we want or need a plethora of new homes? This isn’t a free-market signal, so we are causing yet another distortion the market will eventually have to absorb.

At Taylor Morrison’s Sorrento East community in Dublin, Calif., where homes are priced from the mid-$600,000 range, sales have been running at a rate of five to six homes a month—more than double what was selling one year ago.

One growing concern in markets like Sacramento is that home sales volume is falling precisely because there aren’t enough homes for sale. Rising prices could lure more sellers. Phoenix, which has witnessed strong price growth, saw inventory pick up in September.

Any significant return of sellers to the market, whether organic sellers or banks with more REO, will cause new home sales to suffer. Expect to see new home sales proceed upward in a choppy manner with significant periods of low sales as MLS inventories fluctuate.

Even if sellers dither, builders won’t. Nationally, builders started construction on more units during September than any time in the past four years, after adjusting for seasonal factors, the Commerce Department said Wednesday. Single-family construction was up by 43% from last year’s anemic levels.

On a seasonally adjusted basis, the 141,000 newly built homes for sale at the end of August was the lowest since the government began its tally in 1963. Listings of previously owned homes are at a seven year low.

Meanwhile, applications for home-purchase mortgages last week hit their highest level since June and were 12% above their year-earlier reading, the Mortgage Bankers Association said on Wednesday.

Home purchase applications are stuck at 1990s levels, and they have been for the last three years.

The above graph is the best measure of market demand because it filters out the fickle cash buyers. Owner occupants borrowing money to buy properties is the foundation of housing market demand. Until we see a breakout of the tight range at the bottom of the chart and a sustained upward movement, I am not going to believe any of the arguments about increasing demand. The data simply doesn’t support it.

Gains in construction should lift the economy. Glenn Kelman, chief executive of real-estate brokerage Redfin, writes in an op-ed at Quartz that builders have been completing “half-built projects” with “skeleton crews” for much of the past year. That hasn’t done too much for job growth. “It takes fewer cooks to prepare leftovers for dinner,” he writes.

But as more new projects get underway, that will change. Perhaps 2013 will be the year that housing really helps the economy accelerate.

I believe 2013 will be the year residential construction starts to significantly contribute to economic growth and expansion. I am already seeing signs to life in the local land development industry, and this trend should continue. At this point, the industry is vulnerable to an increase in MLS supply, but the banks show no signs of increasing their REO acquisitions or liquidations, so the homebuilding industry will likely continue to benefit.