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Articles By George!

October 24, 2017


Home building sage George Casey peers into the near-term future at a scenario every firm should recognize and manage for ... the unthinkable.

One of the core responsibilities of the leader of an organization is to think the unthinkable and then figure out how the organization should position itself in the event the unthinkable happens.

It is called trying to look around the corner.

I believe that we are at one of those juncture points where housing strategists have to think about some unthinkables and figure out what the “what-to-do-if-it-comes-true” plan might be.

It is pretty obvious that the housing recovery has been slower than many had anticipated 6 or 7 years ago. Although [it's] better now than it was at its nadir of a total of 553.9 total housing starts in 2009, current housing starts (which look like they will come in at around 1,185 mm for 2016) have pretty much flat-lined over the past couple of years at a level that can’t seem to punch through 1.2mm.

When compared with an annual average from the 1960s through 2009 of 1.514mm, even though we are at a pace over twice of where we were at the nadir, we are still at a pace that is only at 78% of the long-term average and don’t seem to be getting rapidly any better.

Although housing starts mix over the past two years has begun to improve on the single-family side (up from a low of 60.7% of production in 2013) to 64.5% this year, [single-family] is still way off of its normalized share of 74.3% of production, seen during the period from 1960 to 2009.

One can only conclude that structural changes in government policy, mortgage underwriting standards, construction and land development lending criteria, labor capacity, and local, state, and federal governmental rules and regulations has created a new environment that says that what we are seeing now might get better (albeit slowly), but also might be reflective of what new “peak production” for single and multifamily home building might continue to look like.

The manufactured housing side tells a similar story. Manufactured housing shipments have slowly improved from a low of about 50,000 units per year at the beginning of the decade to about 80,000 this year. However, this still pales in relation to the 245,000 per year average shipments from 1960 to 2009.

When taken together (single- and multifamily starts and manufactured shipments) housing “creation” so far this decade (2010 though 2016) looks like it will be about 5.5mm housing units short of what the long-term average had been, and does not appear to have a shot of making up the difference for a long while.

There is no wonder that we have affordability issues on the housing front.

And all of this despite record low interest rates for mortgages.

So, the first look around the corner seems to indicate that what you are now seeing either might be what you will get for a while, or might be the best of what it will be already.

If you want substantial growth, it is probably going to happen via mergers and acquisitions. It is probably not going to be happening organically.

So are you a hunter or prey? If you don’t know the answer to that question, you are probably prey. And if you are prey, are you going to be desirable prey (good pipeline, highly profitable operations, attractive niche that an acquirer may want) and can demand a premium in a transaction? Or will you be “commodity prey” (ultimately needing capital, be in quasi-distress, and seeing your assets go at book value or less). For those who want to remain independent, the trick will be in how you manage four key challenges:

  • Staying streamlined
  • Always improving operations
  • Focusing on a niche you are passionate about
  • Maintaining great banking and/or investor relationships.

On the macro side, there are some signals that, sector-wise, we may have entered that part of the cycle where the residential sectors are peaking (John Burns and RCLCO have recent charts on this). Whether we have one, two or three years left in this cycle is to be debated. But every month that goes by, the probability of down increases.

Similarly, macroeconomic leading indicators are beginning to flash red. Brian Westbury, the Chief Economist at First Trust Advisors, recently noted that medium and heavy truck production has dropped 31% since June of 2015. In the past 50 years, this measure has been one of the best early signals of a recession starting within 2 years of the peak, which would indicate mid-2017. He notes that there are some “special circumstances” that might apply, but this is a “sleep with one eye open” kind of signal.

Also, contacts with lenders indicate a beginning of “pulling the horns in” on new lending. Same for a significant slice of private equity when looking at real estate.

All of this creates somewhat of a self-fulfilling prophesy, where conservatism and risk-aversion create the situation that one worries about. It is the natural order.

With this kind of momentum in the capital side of real estate, and balanced against the other non-real estate macroeconomics, builders, particularly private ones, probably should be looking to deleverage to safer levels. At the same time, the public builders will still be trying to grow, so there may still be entity or asset sale opportunities for a while at least.

Of a deeper concern is the fact that all of this will be happening at a time when millennials will finally have jobs and will be starting those well-documented delayed households. Hell knoweth no wrath greater than a new mother and father without a nest of their own. Some may still have to settle for apartments, but my guess is that single-family homes will still be preference.

The demand will be working against a constrained supply, so absolute prices and rents for existing stock will most likely [continue to] rise. New stock will continue to bifurcate into the larger move-up product that makes sense for the smaller portion of the population that can afford this and much smaller, higher selling price per square foot for the middle market who still can buy, but will be price/qualification constrained.

The more affordable segment--where there is huge and growing demand--will most likely not be satisfied, except in some sunbelt markets that are relatively business and development friendly. For the rest of the country, it will be angst and increasing political pressures to include affordable elements in each approval or adopt rent controls. Both have the ultimate effect of further limiting supply, but that will most likely go on deaf ears and become a can kicked down the road.

I still strongly believe that rentals, both new single family and multifamily, will continue to grow in this mix due to qualification issues on the purchase side and, if some rocky economic times may hit us for a bit, risk aversion to owning compared to renting, particularly in the single family space. Memories of job losses and losing purchase equity will still be too raw to make the purchase jump for some.

A reasonable hedging strategy for builders is still to figure out financial counter-parties with whom they can develop single-family for-rent product. This may provide a mechanism for continuing to build and move land even if the for-sale market takes a breather for a while. Absolutely, the tidal wave of millennials will still need roofs over their heads and builders need to think innovatively about how to create those roofs and make money doing it.

All of this leads to a final thought. When looking around the corner, it is not the business that we had a decade or two decades ago. If you are not making money in what is now apparently the best of times, you probably have not innovated enough or adopted enough best practices and maybe this new business is not the right one for you and your team.

If you are innovating and making good money, now is the time to consider the strategic options ahead of you, because there is a reasonable shot that things are going to get dicey.

Staying still is not going to be a good option for anyone.


About George Casey

With decades of deep hands-on experience in operations and processes, business consultant and keynote speaker George Casey brings unparalleled insight to a variety of businesses to streamline operations, increase profits and long-term sustainability, especially to the residential development and home building industries.

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