A rising tide lifts all boats, as the saying goes. And as the economy improves and housing inventory tightens, homebuilders are reaping some of the benefits — especially large public builders with access to the credit markets.
Sales of new single-family homes picked up considerably in January at a seasonally adjusted annual rate of 437,000 sales, 15.6% above the revised December rate of 378,000 units, according to data released in late February by the U.S. Census Bureau. The number topped market expectations for 381,000 sales and was 28.9% above the January 2012 figure of 339,000 units.
“The first two months have started out fantastic,” said John Burns, CEO of California-based John Burns Real Estate Consulting, which advises homebuilders. “(New homes) are selling well, and prices are up across the country an average of about 3% just over the first of the year.”
Recent statistics and anecdotal reports show the pace of home starts and permits at the beginning of 2013 is the strongest it’s been since the 2008 financial crisis.
In the West, where the housing market is red hot, new homes sold in January increased 60.3% over January 2012, according to the Census Bureau. The coastal areas of California are in high demand and places like the San Francisco Bay Area, for example, have only about a one-month supply of homes, said Scott Anderson, chief economist with Bank of the West.
While some other markets, like the Southeast and Midwest, aren’t quite so robust, most geographic markets should experience a boost in homebuilding this year, said Fitch Ratings Managing Director Robert Curran, a housing analyst. Other strong markets include Texas, Florida and Seattle.
“The economy is looking good — at least for housing,” noted Econoday analysts in a recent note to clients. “Low mortgage rates have supported sales, but a caveat is that large seasonal factors can exaggerate housing numbers during winter months.”
Low mortgage rates, a stabilized job market and improved consumer sentiment should boost the new-home market this year. Yet, fiscal uncertainties in Washington, combined with tight credit, may cause some headwinds. The sequester, the name given for automatic spending cuts that took place in early March, could have a negative effect on the homebuilding market if fiscal tightening lasts very long, said David Crowe, National Association of Home Builders’ chief economist.
“It would shave a little bit off our starts forecast,” he said. Still, Crowe said he expects a moderated effect due to pent-up demand emerging in the home-buying sector as people who have sat on the sidelines enter the market. “It’s not clear the sequester will delay that,” he said.
Curran said a persistent sequester, however, could affect the general economy and harm consumer confidence, and that could have a residual effect on housing. But, he too, said it would not be enough to stop an expansion over 2012 numbers.
New homes were in short supply as 2012 drew to a close and 2013 dawned — only 151,000 new homes were available in the entire country. Of those, only 43,000 were completed and ready to be occupied with the others not yet started or under construction, according to Census Bureau data. To put that into perspective, the number of completed new homes available today on a national level is smaller than one-year’s worth of typical new home sales in one large city during a normal homebuilding boom year.
The existing-home market might also add some fuel this spring and summer to the new-home market as lack of inventory for existing-home sales could push more buyers toward the new homes.
The National Association of Home Builders forecasts 658,000 new home starts this year, up about 23% over 2012. Fitch Ratings forecasts an increase of about 18%.
Single-family starts didn’t hit their low until 2011, when just 434,000 new homes were started. To be sure, the current pace of building remains considerably below the housing peak, when more than 1 million homes per year were being started. As a result, some industry experts expect double-digit growth in new home starts for the next couple of years, at least, but warn that the increases must be kept in perspective.
LABOR AND MATERIALS
As the market advances, homebuilders are complaining about material costs and labor shortages. Bottlenecks exist in some states where zoning and environmental requirements also slow the homebuilding process.
Prices on materials such as oriented strand board have risen sharply. Fiberboard, an alternative to plywood used in roof decking and house exteriors before the final finish is applied, has doubled in price over the last year, Crowe said. The price rise is mostly due to manufacturers reluctance to reopen idled plants. Re-opening factories costs money. If the housing market doesn’t continue to expand, then the capacity would go unused — a risk manufacturers aren’t willing to take, he said.
“It isn’t driven by any world demand or general inflation; none of those things are happening,” Crowe said.
Labor also remains constrained. Labor left after the housing crash as employees left for jobs in other industries. The shortage is more pronounced in the West, in places like Phoenix, where immigration policies have compounded the availability of Hispanic laborers, said Crowe.
“There is some return of construction workers, but I think the industry is going to have to recruit new people,” he said. “The collapse was six years long.” Some left for the booming energy industry where pay is strong and the employment stable. Those workers, despite the often dangerous work, are unlikely to return to the construction industry, Crowe predicted.
In June 2012, the NAHB surveyed builders and discovered the leading labor shortages were in framing crews and finished carpenters. Since then, several housing experts cited anecdotal evidence of shortages occurring with skilled tradesmen such as plumbers and electricians. The shortages remain isolated and are not a national issue at this point.
While labor shortages drive up the cost of subcontracted labor, homebuilders have been successful — so far — in passing those costs onto the consumer.
Higher wages are necessary to attract labor back into the housing industry, said John Burns, the real estate consultant. He believes material and labor shortages are having some positive effects on builders, giving them the impetus to test the waters with price increases.
PRICE FLUCTUATIONS
Part of the rise in home prices is related to the type of home being purchased. They are larger and more elaborate because those currently qualifying for new-home mortgages tend to be people who have strong credit scores, NAHB’s Crowe said. Home price indices such as the S&P/Case-Shiller are rising at a softer rate than new home indices, about 5% to 6% a year. Such price increases are expected to continue.
In fact, prices could potentially rise a whole lot in some markets, giving rise to some concerns of isolated housing bubbles in places like Phoenix or Las Vegas. The possibility exists that prices could rise 20% to 30% in some markets over the next couple years reaching unsustainable affordability levels if mortgage rates rise, Burns said.
But as the credit market loosens, housing experts predict more construction of entry-level homes, which will in turn moderate new-home price increases. Home prices this year are just reaching prices seen in the early 2000s. When looking at current prices and their relationship to income, they now are where they are generally located on a historical basis with home prices 3.2 times median income, using the national median income estimate, Crowe said.
“That is where they were throughout the 1990s, and that is where they are right now,” he said. “Interest rates will go up and that will be a drag, slightly, on the ability to purchase, but the interest rate right now isn’t the key to home buying. It is the availability of mortgage money.”
Lenders remain reluctant to lend due to fear of putbacks — returning the mortgage to the lender because of some problem with the loan. Still, underwriting standards are expected to loosen somewhat with recent Fannie Mae and Freddie Mac clarifications on repurchases and Dodd-Frank Act rules such as the Qualified Mortgage and the Qualified Residential Mortgage rule, which will provide clarity to the lending space. The Qualified Mortgage rule was released earlier this year and will take effect in 2014. The QRM rule is expected out later this year.
THE HOMEBUILDERS
Toll Brothers returned to a profit in the first quarter ended Jan. 31, reporting net income of $4.4 million, or 3 cents a share, up from a loss of $2.8 million, or a loss of 2 cents a share, in 1Q2012.
Demand rose as the luxury homebuilder gained market share with little competition from local private builders, CEO Douglas Yearley said during the company’s recent earnings report and conference call.
“As the spring selling season kicks off, we are also enjoying increasing pricing power due to the release of pent-up demand colliding with limited supply in the affluent markets where we operate.”
Toll said its backlog of housing units rose by 57% compared to the year-ago period. The number of signed contracts also rose by 49%.
The builder expects to deliver between 3,750 and 4,300 homes in FY 2013 at an average price of between $595,000 and $630,000. As demand began to rise in the second half of 2012, Toll raised its prices, which should positively affect its gross margins this year.
Yearley notes the homebuilder is selling homes in multiple markets, including in hard-hit Michigan. Contracts and prices continued to rise in the first few weeks of the second quarter, he said.
All homebuilders are stocking up on land now, but they face some challenges they didn’t have during the height of the market, said Robert Rulla, a building materials analyst at Fitch Ratings.
Options, which were readily available during the boom times, just aren’t there anymore. That means builders trying to rebuild their land positions are having to take the land onto their balance sheets with outright purchases.
Lennar Corp., for example, shed a lot of options when the market turned south, taking impairments. But as it and other builders try to stock up again on land, they are finding options are hard to come by.
Fitch’s Curran said private builders, more so than the publics, remain constrained by a lack of credit availability. The publics have access to credit markets to fuel their land buying, but private builders go to banks for credit, and banks remain pretty risk adverse. So a private builder who wants credit for five speculative homes, for example, might only get enough to build three, Curran said.
As home prices rise along with the stock market, some underwater borrowers have risen above water and with that, confidence has returned to the market. Some consumers, who perhaps couldn’t qualify to buy a house two to three years ago, can now qualify to do so, notes Bank of the West’s Anderson.
But uncertainty will hang around during this fledgling recovery, at least through 2013.
“If affordability becomes more constrained, there is a percentage of the public that gets squeezed out,” Curran said. “If home prices rise, and we think they will, and if mortgage rates rise, and we think they will, it probably means housing over the course of the year is somewhat less affordable than in 2012.”
Still, all is not lost. In fact, much of the new-home market remains pretty positive, said Curran. “It should be a good year for housing.”
