The Housing Bubble

Barron’s has an article on Toll Bros. today. “With Wall Street fearful about a bursting of the housing bubble, home-building stocks have been crunched, and none as hard as Toll Brothers, the country’s top producer of luxury homes. In just seven months, Toll has gone from being the Street’s favorite major builder to the least-liked. Toll shares, at around 30, are down nearly 50% from their peak of 58 last July.”

“The backdrop for builders has worsened in recent months as Toll has warned of weakening orders, rising cancellation rates and greater discounting. ‘Toll’s stock is discounting Armageddon,’ says Matthew Lindenbaum, co-chief of a New York investment firm that holds Toll shares. He values Toll at more than $50 a share and says downside risk probably is limited to the low 20s, providing a favorable risk/reward situation.”

“Toll’s rising book value should underpin the stock, Lindenbaum adds. Book stood at about $16.50 a share at the end of Toll’s fiscal 2005 in October. Home builders have rarely traded below book value if they are profitable. Book value, meanwhile, probably understates Toll’s asset value. Why? Toll holds land, carried for $1.7 billion, that mostly was purchased several years ago at below-market prices. Lindenbaum believes Toll probably is trading close to liquidation value now.”

At the end of the October 2005 quarter, Yahoo has Toll reporting inventory of over $5 billion. Hmmm.

“Robert Toll, the company’s outspoken co-founder and chief executive, doesn’t buy the bearish talk. ‘We don’t see any doomsday scenario,’ Toll told Barron’s last week. ‘Some of our markets are doing well, but none are as outstanding as during the summer of 2005. There’s definitely an overhang of supply in certain markets.’”

“Toll rattled the home-building group when it reported earlier this month that new orders had fallen 21% in the quarter ended January and that cancellations had risen to 8% from 5% a year earlier. The big questions for Toll are demand for new homes in the critical spring selling season and the profit outlook for its fiscal 2007. Toll has yet to give any guidance about its fiscal year ending Oct. 31 2007.”

“A hot topic on Wall Street is whether home builders should be buying land or their shares, given currently low P/Es. The buyback argument is that the stocks are cheap and land is expensive. Bob Toll is in the land camp. ‘Our business is not to shrink the company and buy back capital, but to expand,’ he says.”

Current assets reported by Yahoo strangely include the inventory. Excluding that line item, Tolls’ Current Assets are less than half the Current Liabilities.

What does the NAR see ahead? “Pending home sales continue to decline but are expected to recover in the months ahead. David Lereah, NAR’s chief economist, said ‘We’re going through a period of adjustment. As home sellers recognize a return to more normal rates of price growth, some that have been holding out for higher prices will be more willing to negotiate terms that are acceptable to buyers but still provide them a solid return on their investment.’”

“Regionally, the PHSI in the Northeast, the index was 11.1 percent below December 2004. The index in the West fell 8.1 percent in December and was 11.8 percent lower than a year ago. The index in the Midwest dropped 9.3 percent to a level of 105.8 and was 11.0 below December 2004.”

“Toll Brothers, Inc. engages in the development, construction, financing, and sale of residential homes in Arizona, California, Florida, Delaware, Florida, Maryland, Nevada, Pennsylvania, and South Carolina.”

News from the lending front. “Brascan Adjustable Rate Trust I today announced a change in the monthly distribution of the Fund. The reason for the change in the monthly distribution is the flattening of the U.S. yield curve which has narrowed the spread between BART’s cost of funds and the return on the Fund’s investment portfolio.”

“The Federal Reserve Bank has increased short term interest rates by 100 basis points which caused funding costs to rise at a rate greater than the rise in yield on the Fund’s investment portfolio. As a result, there is a reduction in BART’s income available for distribution to Unitholders.”

“The market is currently pricing in the expectation that the Federal Funds rate will increase to 4.75% in April, 2006 This has put further upward pressure on interest rates and the shape of the yield curve. Brascan is an investment trust with exposure to a portfolio primarily consisting of mortgage backed securities with an actual or implied AAA rating. Brascan Adjustable Rate Management Ltd., an indirect wholly-owned subsidiary of Brookfield Asset Management Inc.”

And Paul Muolo from NMN. “What is it with Southern California and nonprime mortgage bankers anyway? Take a look at the top five subprime firms. All five are based in SoCal. And 10 of the top 15 are in California, with the northern part of the state claiming a few HQs as well.”

“Now, for the bad news, it appears SoCal-based mortgage firms are shedding not only jobs but office space, big time. Grubb & Ellis executive Oliver Fleener has been witnessing lender after lender looking to unload their office space via a sublease arrangement. He said that mortgage firms suffering the most are young, net branch operations.”

“He also had this to say about the companies: ‘It seems all these executives know each other’…And in case you missed it; Washington Mutual slashed 2,500 mortgage jobs last week, mostly in operations.”

“Washington News: Office of Thrift Supervision director John Reich, says adjustable-rate mortgage products with negative amortization features are ‘not appropriate for unsophisticated borrowers or those with weaker credit capacities.’ Mr. Reich told the Exchequer Club that the regulators are worried about the sudden growth in option ARM originations by institutions with limited experience in managing the risks of these loans.”

About office space, “When billionaire commercial real estate developer Carl Berg of Silicon Valley speaks, his industry peers listen. But, while many today might still take a moment to hear his words, they’re clearly not heeding his message.”

“Amidst one of the most robust investment sales markets the valley has ever seen, Mr. Berg’s company, Mission West Properties, has been sidelined. Others are simply willing to pay far more than he is for the office and R&D buildings that are his specialty.”

“To justify their prices, Mr. Berg told Wall Street analysts recently, Silicon Valley buyers today will have to see ’substantial’ increases in rents in the next several years. If they don’t, ‘you have a whole bunch of idiots who are really going to lose a lot of money.’”

The Press Telegram has this report on Long Beach. “One million dollars for a home in Long Beach nowadays doesn’t sound far-fetched following a five-year market expansion with repeated double-digit percentage increases in housing prices. In fact, the run-up in home prices has forced a change in the definition of what constitutes a luxury home. The index tracks homes whose value in 1995 were $1 million.”

“But as the once red-hot housing market continues to cool the slowdown is affecting all homes, including luxury homes. (Banker) Katherine August-deWilde said luxury home prices may experience some price decreases in the year ahead, but she sees no signs of an inversion.”

“‘I would call it more of an adjustment,’ she said, adding that any deflation in the luxury market is better described as ‘a souffle as opposed to a bubble bursting.’”

“More and more sellers of luxury homes are already cutting prices, said Keller Williams Realty agent Richard Daskam, who has moved several million-dollar listings in the past few years. More and more sellers of luxury homes are already cutting prices, said agent Richard Daskam, who has moved several million-dollar listings in the past few years.”

“He recently took over a four-bedroom, three-bathroom listing in Signal Hill that was on the market for six months with no offers. He knocked $100,000 off the $1.5 million asking price and it sold in 45 days.”

“‘The slow down in the high-end million-dollar homes is definitely due to a slowdown in the middle-of-the-road median homes, because these are the buyers who have been moving up to these homes,’ he said. ‘What I’m getting from my buyers who are in the million-dollar range, is ‘If I have to come down on my home, then I expect the seller to come down in price also.’ It’s not necessarily dollar for dollar, but they are expecting some adjustments.’”

“Neighborhoods that will likely see home prices fall below the $1 million mark first are those areas where home prices are not traditionally high, Daskam said.”

A pair of reports provide an update on the Florida housing bubble. “T-Rex Capital is throwing a party Thursday at its new Eighty Points West luxury condominiums on Flagler Drive in West Palm Beach. It’s all to show brokers how much they’re appreciated. But T-Rex also has another motive. The company that once owned the former IBM complex in Boca Raton needs to generate buzz for its pricey condos, especially now that the housing market has softened.”

“Only about 10 percent of the 173 units have sold so far, although Cliff Preminger said sales are on schedule because T-Rex held back on marketing most of the $170 million project until now. Home sales have slipped across South Florida in recent months, and experts say West Palm’s condo market is overbuilt.”

“But Preminger remains undeterred. ‘Obviously, we don’t expect to sell out overnight, and people are not going to be sleeping in the parking lot, but we expect a good sales velocity,’ he said. Preminger, by the way, wouldn’t say exactly how much money T-Rex is pouring into the event. ‘Let’s just say it’s a six-figure party,’ he said.”

From the Orlando Business Journal. “Existing home sales set a record in January, with 1,831 homes changing hands, an 8 percent increase over January 2005, according to the Orlando Regional Realtor Association.”

” But that wasn’t the only record set for the month: The number of existing homes available for purchase, 12,015, is a whopping 262.22 percent increase above January 2005’s tally of 3,317 homes on the market. In January 2006 alone, ORRA members entered 6,172 newly available homes, compared with 2,970 in January 2005.”

The Union Tribune reports on the ‘paradise in progress.’ “This is life in downtown San Diego, where the official city tree might as well be the construction crane. Never before have so many buildings gone up at virtually the same time. Many people who live in the East Village, once a low-rent warehouse district, are excited about what things might look like at the end of the all the digging and hammering, whenever that day might mercifully arrive.”

“It’s just that living through the commotion, they say, can be a tremendous aggravation. A woman who lives in the Parkloft condominiums just north of Petco Park says the constant drone of jackhammers is so irritating that she hasn’t opened her windows in two years.”

“If peace and quiet are in short supply in the East Village these days, some residents are concerned about another vanishing commodity: their views. Kevin Albritton and his wife moved into the third floor of the Parkloft complex in 2002. They had nice view of the ballpark. Now, however, that view is being partially blocked as construction crews build an addition to the T.R. Produce building on the south side of the condo complex. Albritton calls the new addition, which will house condos and office space, ‘hideously ugly.’”

“Meanwhile, the Albrittons have taken to leaving on their air conditioning to drown out the noise of jackhammers and cement trucks. ‘Our electric bills have gone up considerably,’ he said.”

“Ian Wendlandt used to live in Chicago. But the rhythmic white noise of that city’s el train, he says, can’t compare to the discordant sounds that assault his East Village condo every day. ‘Here it’s completely chaotic in terms of frequency,’ said Wendlandt. ‘One day it’ll be jackhammers, the next day it’s the pounding of a cement truck.’ He hands out earplugs to some of his overnight guests.”

“Wendlandt lives in the Parkloft development, which at the moment is surrounded on all four sides by construction projects: a 33-story office and condo complex across Island Avenue; a 31-story office and condo complex across Eighth Avenue; a seven-story condo complex one block to the east on 10th Avenue; and the T.R. Produce project immediately to the south”

“A few people who moved into the Parkloft when it opened in 2002 say they weren’t quite prepared for the sheer amount of new construction. ‘I didn’t realize every corner was going to be developed so quickly, and all at once,’ said Barbara Edelson, who lives on the seventh floor. She said she’s kept her windows closed for the past two years to block out the noise. ‘I have beautiful patio furniture, but you can’t sit out there,’ she said.”

“Some folks wonder what the East Village will look like a decade from now. Will the finished neighborhood contain a mix of interesting people, good restaurants and eclectic businesses? Or will it be a forest of sterile, half-empty high-rises casting dark shadows on a collection of chain stores?”

“Gloria Poore thinks it will take ‘realistically, probably another five years’ before the area looks like a neighborhood as opposed to a men-at-work zone. In the meantime, she’s become quite adept at mimicking the noise of cement trucks backing up on her street. ‘Meep meep meep meep meep,’ she said.”

One more topic from readers over the weekend. “Will the condo crash be worse than the SFH crash? Can you really separate the two?”

Another asked, “What pressures do developers have to keep building in the face of a glutted market?”

To which one replied, “I had dinner a week ago with a 75 year old condo developer in Florida. This guy is a survivor and has seen it all. He put his latest hotel/retail/condo project on hold because of oversupply. But, what is interesting is the comment he made about the construction pipeline. Once you start getting airborne with the project you just can’t stop. You have to finish it to completion because if you do not you will have weather-related structural damage, angry pre-sale clients, an inability to get fixed rate financing and a host of other problems.”

And another said, “Mark Hulbert is confused about whether now is the time to buy housing stocks.” “Daniel Seiver recently wrote: ‘The end of the housing boom is now obvious to almost everyone..but we do not believe that the downtrend in housing stocks is over yet. The air will continue to come out of the housing bubble ever so slowly, and all through 2006. It will take years to unwind the overinvestment and overspeculation in housing.’”

“Seiver in his model portfolio currently is recommending two short sales from the housing industry: KB Home and Lennar.”

A reader posts, “We are seeing more days when the HB stock charts move consistently with what I term the administration of PPT methadone. What you see is a steep plunge at the open caught by a safety net which limits the loss for the day to less than 2%. This makes the crash gradual and unworthy of a news item in the WSJ.”

Speaking of the Wall Street Journal. “Home builders broke ground at the fastest pace in more than three decades last month, as unusually warm weather trumped signs of a weakening market. ‘The January number is an aberration that doesn’t mean anything,’ said (economist) Patrick Newport. ‘We’re going to see a big drop in February and then a gradual slowing for the rest of the year.’”

“Steve Gerber, vice president of production at a luxury-condominium builder in Bethesda, Md., said his firm is having a harder time selling units now. The company is into its third month of sales for a 14-unit condo complex in the Columbia Heights neighborhood of Washington, D.C. ‘A year and a half ago, we had a 12-unit condo building sell out in four hours,’ Mr. Gerber said. ‘Those days are over.’”

The Business Journal reports on the Greater Triad area in North Carolina. “With the growth of new home sales in the Triad starting to slow, national builders are unveiling large-scale promotions and deep discounts hoping to lure buyers to their developments. During a special 12-hour sale last month Centex Homes offered buyers more cash in their wallets, lowering the cost of homes scheduled to be completed in February and March by as much as $30,000.”

“K. Hovnanian Homes is wrapping up a promotion under which buyers at any of its 25 Triad neighborhoods receive a voucher for up to $16,000 in furniture from Rooms to Go. Hovnanian is the Triad’s second largest builder. ‘It is overwhelming what they are offering,’ said Elizabeth Ward Small, a Burlington-based broker. ‘They are doing anything they can to draw a buyer.’”

“Most local home builders and real estate agents say they don’t believe the incentives are a sign of a weakening housing market. Rather, they see it as an indicator of a strong market where builders are getting more competitive, especially in booming areas like eastern Guilford County where new subdivisions are filling up with home in similar price ranges.”

“There are signs that growth could be slowing. Last year, 5,100 new homes were sold in Guilford, Forsyth and Alamance counties. That was a 9 percent increase over 2004, but a long way from the 23 percent growth in new home sales seen between 2003 and 2004. ‘I think everyone is fighting for the customer because we don’t have as many customers,’ said Jan Cox, a Greensboro-based broker.”

“That sentiment is echoed by Scott Wallace, president of Greensboro-based Keystone Homes. who estimates his company is getting 50 percent fewer visitors to its neighborhoods than just a few months ago. A slowing housing market will likely put more pressure to increase sales on builders like Centex and K. Hovnanian, which are publicly traded companies and need to meet shareholder and analyst expectations. That could mean the Triad will see even bigger discounts and incentives from these companies in the future.”

“‘When I open the paper and see that $16,000 (K. Hovnanian furniture) ad, it makes me cringe,’ said Wallace with Keystone.”

“Such incentives do have an impact on how buyers perceive the market across the board. Many local builders said they have prospective buyers come in wanting to know what specials or promotions they are offering, and if they are as lavish as they ads they’ve been seeing. ‘Obviously it puts our sales people in a position to discuss things we would rather not to discuss,’ said Tom Hall, president of Greensboro-based Windsor Homes.”

“To counter such questions, local builders say they seek to change the subject, emphasizing the quality of their homes and the possible benefits of doing business with a local company, as opposed to a national corporation.”

“Sheri Bridges said that once an industry begins these kinds of promotions, it’s difficult to back away from them. Bridge compares the incentives home buyers are offering to those offered by auto makers. As the economy started to improve, the manufacturers announced they would no longer offer large incentives to buyers. Car sales quickly began to decline again. Bridge says if the large builders give away too much now, home buyers will expect the same incentives in the future and may not buy without them. ‘It conditions consumers to expect a deal,’ she said.”