If you didn’t have a chance to attend the Presidential Seminar in Aspen this year, you missed a lot. But here’s an opportunity to catch up with what some of the country's foremost housing industry analysts are saying about the industry's outlook:
Sales Should Stabilize Late This Year
The three speakers who dealt with the state of the home building industry and the economy—David Berson, John Burns, and Ivy Zelman—agreed that sales should stabilize later this year. Given the pain and hardship that we’ve endured for the last couple years, that certainly was good news.
While the economists and analysts agreed that existing home inventory is likely to continue to increase this year due to rising foreclosures and a general inability to move real estate, they all expect government actions to liberalize credit later in the year.
“We expect the market to stabilize in the second half of the year,” said Berson, chief economist of PMI Group, adding that it would be sooner, except unsold inventory is simply too high. “The next eight months should see more liquidity [in the mortgage market]. “That, combined with recovery in the economy, argues for stability in the second half of the year.”
Berson said the economy is in a recession right now, but it should be short, because the first federal stimulus package “will put money in people’s pocket.” Taxpayers will qualify for up to $600 for a single person or $1,200 for a married couple filing a joint return.
This week, Senate leaders announced that they had agreed on a package that would provide: $4 billion in grants for state and local governments to buy foreclosed homes, a temporary $7,000 tax credit for those who buy either new or foreclosed properties, more money for counseling for homeowners facing foreclosure, and the ability for homebuilders to recover taxes already paid on built properties.
The industry will be helped by reductions in short-term rates, thanks to Fed cutting. But Berson noted that while fixed-rate mortgages (at 5.78, according to the Freddie Mac index) may be historically low, they should be lower given that 10-year Treasuries are at 3.5 percent. That’s a spread of 2.3 percent, high by historical standards.
Because of illiquidity problems, the mortgage market also suffers from an abnormally large spread between conforming and jumbo loans, he said. The historic spread of 15 to 25 basis points, he said, has widened to 100 to 125 basis points. “Normally these jumbo loans are securitized and sold off,” he said. “Not today. Fewer people want to buy.”
Builders will be helped by the fact that Freddie Mac and Fannie Mae can now buy mortgages of up to $729,750 in high-cost areas for a year, a provision that Congress is likely to extend. But since the GSEs haven’t bought any of these yet, it’s not clear what interest rates on these will be. The agencies cannot combine these large mortgages with others in securities, Berson said.
The economist noted that we’re seeing a big increase in FHA-insured mortgages, especially since the agency can now insure them in high-cost areas. Ivy Zelman added that the biggest benefits are likely to be seen in Washington D.C., New York, Los Angeles, Orlando, Tampa, and Baltimore.
Berson said he expects oil prices to drop from $100 a barrel to $75 or $80 after the summer Olympics, when the Chinese economy drops into “recession,” which would be only 4 or 5 percent annual growth.
Contrary to public perception, Berson said that in most cases people can’t afford an ARM payment because they couldn’t afford their mortgage to begin with. Most ARM holders haven’t had an upward adjustment, he said. And with the Fed easing rates, the upward adjustment may not be that great.
Burns Wants To Help Builders Make Good Business Decisions
John Burns, president of John Burns Real Estate Consulting, who presented the group with an economic outlook that was similar to Berson’s, said his goal was to help builders make “good business decisions” this year. He identified several pockets of opportunity in today’s market.
First the bad news: Burns expects new home prices to drop this year, 10 percent on top of the 16 percent drop we’ve seen already. “We’re seeing big price declines everywhere, including Texas, where they’ve been discounting pretty hard.”
“We may see some stability in home sales very soon,” he said, explaining that he’s looked at actual county sales data in some hard-pressed markets that indicate the market is close to the bottom. This data is often better than “rounded” data on existing home sales from the National Association of Realtors.
Burns expects sales on a national basis to level out this year at about 4 million, which he believes is a long-term sustainable rate. In the meantime, we’ll see 4 million people who got into homeownership, and shouldn’t have, drop out of it.
Burns’ analysis of Las Vegas data indicated that in December one third of homes sold had been bought at the height of the market. And of those, nearly two-thirds were sold for less than the mortgage amount.
Burns predicted that the buyer’s market will continue for another three to four years. While builders will be competing for a shrinking pool of buyers, they have an opportunity to appeal to demographic segments such as active adults and single-person households that can’t find what they want in existing homes. He recommended that builders survey all buyers of new and existing homes in their markets—there are still millions of people buying homes each year.
“Monitor your market fundamentals,” he said. “We are getting close to a time when you could make the best land buys of the next 15 years…Look for distressed land below the cost of improvements near job centers. You could get filthy rich.” Builders probably won’t have much competition from vulture funds for this land, he said, “because they need quick returns.”
Impaired land in outlying areas is worth less than 30 percent of book value, Burns said, adding that it’s worth even less to a company that needs to produce cash flow now.
During the conference, Centex sold a bundle of land in outlying locations for 16 cents on the dollar. Centex had 12 bids on the land deal, which was spread over 11 states. The “real” price Centex received was increased by the tax losses the company could claim. Even so, the market for land seems to have reached a new low.
Builders need to determine the real value of the land on their books. “What would you pay for your land assets if you were to buy them today?” Burns asked. “That’s how you value your land.”
Burns predicted that more public builders will exit markets this year, not just because the fundamentals in those markets might be weak, but because they don’t have enough top management talent to go around.
Burns had plenty of advice for builders in their negotiations with banks. “You have to be able to tell the bank that you are a more efficient builder than anyone else in the market,” he said. Burns urged the builders to do realistic cash flow assessments, using information in their own backlog reports. “Assume discounts are permanent, assume market conditions will get worse—use the same assumptions that you’d use if you were buying from someone else.”
Builders who need lots to continue feeding their operation need to be patient, Burns said. Another alternative would be to do fee deals with banks that need to build out bankrupt communities. Privates who routinely pay off their loans have an advantage in getting these deals since they have better relationships with banks. In fact, public builders may not even have these relationships.
Ivy Differs with Her Colleagues on the Street
Ivy Zelman, CEO, Zelman & Associates said that Wall Street seems to think that the industry has reached bottom based on how investors are bidding up builder stocks. Investors seem to think that a federal stimulus package will bring back the market. Zelman believes the optimism is premature.
First, Zelman said that a “whole backlog” of homes in foreclosure is starting to come to market from the banks. They’ve already started hitting the market in the Inland Empire. Also, she said, banks are only now awakening to problems in their AD&C portfolios.
Zelman thinks that the tax rebates in the Senate bill should indeed help the market. And so should a recent statement by Fed Chief Ben Bernanke, who suggested that banks provide forbearance rather than foreclose on mortgages. He argued that in the long run this would be less expensive for them.
At the same time, Zelman noted that bank regulators had picked up their activity. Some recently asked banks to put aside more equity to cover potential loan losses. “This is going to result in a massive capital call,” she said. “Twenty-five percent of loans could fail if they were marked to market.”
As a result of massive losses from failed loans, Zelman said that banks are taking action to reduce headcount, exit markets, and in some cases are completely eliminating all AD&C lending programs.
Zelman presented some startling figures that illustrate the banking industry’s dependence on real estate. Large commercial banks have 49 percent of their assets in real estate (16 percent commercial and 33 percent residential). Small commercial banks are even more exposed; they have 67 percent of their assets in real estate (46 percent commercial and 21 percent residential). “We’re in a lot of trouble with the banks,” Zelman said.
Meanwhile, delinquencies on AD&C loans are on the rise. Delinquencies have nearly doubled since 2005 to 3 percent. The percentage hasn’t been this high since 1990, according to data from the Federal Reserve. “Delinquencies are skyrocketing,” she said.
Zelman believes that in the short run unsold inventory of existing homes will continue to rise, foreclosures will mount, and unemployment will increase due to weakness in the economy. She presented numbers, derived from five sources, forecasting a huge increase in first mortgage loan defaults (from 1.4 million to 1.9 million) and lost homes (from 870,000 to 1.3 million)
“The most positive thing we have going for us is that we aren’t building speculative inventory,” Zelman said. “We’ve put the brakes on the industry.”
Nevertheless, Zelman predicted another 20 percent decline in housing starts this year, from 736,000 to 565,000, with a pickup in 2009. She also said that existing home prices would probably fall another 8 percent this year and 3 percent next year. From 2007 to 2010, she expects home prices to fall 24 percent, after they increased 65 percent from 1996 to 2006.
Even with declines in existing home prices, she thinks new homes will be in a strong competitive position “because the costs have come out.”
Zelman believes it’s tough to say how much land prices have deflated because there were very few comps in 2007. Nevertheless, she thinks finished lots are off about 40 percent and raw land is off 60 percent. Lennar sold its lots to Morgan Stanley last year for 37 cents on the dollar, but after tax benefits were added back in, it was more like 60 cents, she said.
Public builders still have a ways to go before they finish taking impairments, she said. They have only taken 60 percent of impairments--$14 billion on owned land, $20 billion in options.