Fewer New Homes - Looming Buying Storm

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By Michael Douville - Housing Industry

Builders across the nation have slowed construction to a pace not seen in 60 years, a time in which the US population was about half of what it is today. Although there still remains an existing unsold inventory comprising a surplus of between 11-11.5 months of new homes, the supply is finally shrinking. Although the residential real estate market is still very fragile, the supply-demand equation is balancing. Builders have been suffering for two years after all, lowering prices and giving huge incentives to current buyers to sell inventory.

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In the boom years of 2005-2007, builders acquired land for future development to replace the land that was being used at a furious pace. Most consumers are not aware of builders' "land banks"; however, this acreage represents economic liability even in good times. Generally the interest accumulates and is capitalized in individual lots, adding to sales price increases as developments are sold out. In uncertain times, the interest must be paid in installments, adding to cash flow concerns. Experienced building companies placed their land and lots on the sales market at huge discounts to remove the liabilities from their balance sheets; those that did not sell out immediately after the slowdown was evident have been forced to build their way out of their land. Over the past few years, there has been a consistent supply of new "spec" homes coming to market, replenishing the inventory. The available supply of homes has stubbornly remained at elevated levels. However, many signs point to much lower inventory levels in the coming months helping to stabilize the housing industry.

In my estimation, the absorption of excess housing inventory will take 6-9 months, placing the beginning of the recovery in the late second or early third quarter of 2009. Programs initiated by the Federal Reserve, the FDIC, and the Treasury have just begun implementation, and will have a cumulative effect. The rate cuts and loan balance reductions designed to lower mortgage payments and entice troubled and burdened homeowners to remain in their homes will result in fewer foreclosed properties coming to market, further reducing the glut. Foreclosed properties are selling much quicker due to a combination of lower prices and lower long-term mortgage rates, which are projected to continue declining to a possible 4-4.5% 30-year fixed rate. The "affordability threshold" has been breached and is reflected in stronger buyer activity. The dilemma for a buyer is timing the acquisition, deciding when is best to buy and lock-in a mortgage rate on a discounted home. There are many things to be considered in this decision.

In my opinion, the real estate market across the US was healing and starting to recover all throughout the spring and summer of 2008. When the rumors started about the possible failing and bankruptcy of several large financial institutions, and the sale of Bear Stearns and eventual loss of Lehman Brothers, asset managers responsible for the orderly dissolution of REO properties became extremely concerned and aggressively lowered prices. This jolted a fragile sales market and exacerbated lending conditions, resulting in further tightening of underwriting standards and a widening of the risk premium, which in turn caused higher rates, fewer approvals, and less qualified and more apprehensive buyers. Fear ruled the marketplace! As Bob Dylan sang ages ago…"the times they are a changing."

The U.S. is the only industrialized nation in the world with a considerably expanding population; there is a baby born in the U.S. every 8 seconds. October 17, 2006 is credited as the day our population first exceeded 300 million; 26 months later, the U.S. Census computes the population is over 305,492,000. There exists a need for over 1 million new homes a year to supply this level of population growth. Further, the problem areas of California, Nevada, Arizona, and Florida are the same regions consistently named as the highest growth areas of the nation. California remains the projected most populous state with a population increase from 33,800,000 in 2000 to over 46,000,000 by 2030. Nevada, Arizona, and Florida are ranked 1, 2, and 3 for population increase in the period 2000 to 2030; the projected increases are explosive at 114%, 108%, and 79% respectively.

These estimates may be conservative due to the disruption of the orderly demographic shift that will be have been initiated by the economic dislocations of this recession. The nation's most severe housing woes are centered in these four problem areas. In the Phoenix Metropolitan Statistical Area, where I am headquartered, new home permits are reported to have dropped to under 300 permits for the month of November in an area of 4 million residents. Absorption is underway here, and there is mounting evidence Nevada and California are experiencing the same conditions. The activity in my local market for December has been exceptional, with buyers purchasing foreclosed inventory and competing with sellers at opportunistic pricing and historically low mortgage rates.

"...liquidity is very slowly returning to our capitalistic society and the general economy, which is pointing to an overall housing recovery by 2010."

There are encouraging developments in real estate markets across the U.S. The balance between buyers and sellers is mending due in large part to the reduced builder activity and declining mortgage rates, which will support higher asset prices. Further, government programs to rescue troubled homeowners are starting to work; liquidity is very slowly returning to our capitalistic society and the general economy, which is pointing to an overall housing recovery by 2010.

There is at least one more wave of foreclosed properties entering the market in the next 90-120 days. These will have been priced on last years dismal statistics and should present extraordinary value. As last year saw the perfect storm in the securities and real estate markets, this round of foreclosures will have the bad news priced in to them. As a long-term investor, one should remember what Warren Buffet has been quoted as saying: "Be greedy when everyone is fearful and fearful when everyone is greedy." The growth dynamics of the United States have not been cancelled, only postponed for a short interval. Values are extremely compelling and there may now exist a new "Buying Storm" on the horizon, with extreme value and historically low mortgage rates feeding it.


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