June 14, 2015

The Last 20 Years Were An Aberration

A weekend topic on construction, Builder Online. “I have been sitting on the sidelines and patiently watching the spring selling season play itself out and testing a couple of hypotheses in my head regarding where we are, where we are going, and what strategies might be appropriate to consider. One of those hypotheses is that, from a long-term perspective, the last 20 years were an aberration for the home building industry, at least in terms of the composition of product mix.”

“Those making strategic asset acquisition and financial decisions using this frame of reference might be making bad decisions if the ‘cheese’ has actually reverted to patterns indicative of the period prior to the aberration (notice I did not use the word ‘bubble’). This fact gets ignored because the data set most analysts and commentators use runs the 25 years from 1990 to the present. It is as if the period prior to that timeframe did not exist and bears no relevance.”

“Yes, there were up and down years, but when taken in 10-year batches, the only decade that jumps out is the 70s, when the baby boomers were full-bore coming into the housing market, and the recent time period coming out of the Great Recession. The mix of housing stayed remarkable similar, also, up until the early 1990s with about 55% of production in single family, 30% in multifamily, and 15% in manufactured housing.”

“However, as the housing recession of the late 1980s and early 1990s began its recovery, this pattern began to change in marked ways. As the recovery took hold in the early 1990s, the mix changed to 65% single family, 16% multifamily, and nearly 19% manufactured. Yet the total number of homes produced was not markedly different on an annualized basis than prior decades; just the mix changed.”

“The cratering of the manufactured housing end-loan financing structure in the late 1990s took nearly 200,000 units of mostly-affordable housing per year from the production mix. This supply went to the lower end of the single-family sector (aided by ever-more aggressive financing) and back to the multifamily sector. Yet the number of homes created for the 2000s decade was not materially different from the prior decades, even though the housing crash occupied the latter third of the decade.”

“However, as the residential real estate market bottomed out around 2009-2010 and began to recover, the composition of production began to change (and continues to change) with a multifamily sector mirroring what is was from 1960-1990. The single-family production is proportionately higher than during that earlier period, primarily because the manufactured housing segment is still hobbled, taking out the most affordable sector of detached housing.”

“What is more surprising is that during the period (1960-2010) the population of the country increased from 179 million people to 308 million, about a 72% increase, while the US housing stock increased from 58 million to 130 million, about a 124% increase. Yet, the average annual production of shelter did not increase in any meaningful way, except at the height of the sub-prime boom. Essentially, we became less intensive in our use of shelter, going from about 3.1 persons per housing unit in 1960 to about 2.4 in 2010.”

“Considering that the weighted average new house size went from 1093 sf to 1899 sf in the same 1960-2010 period, an increase of 74%, we essentially enjoyed a luxury of both fewer persons occupying each house and those persons enjoying more square footage than before. We essentially lived in a period when we created the ability to have more space to store more stuff that we were buying with more credit card and mortgage debt.”

“What does all of this imply? First, it looks like that the period 1990 to 2006 was an anomaly, not the ‘normal’ that many think we should be returning to, at least in terms of the distribution of production. When we look at the changes to the dynamics of the housing market that occurred from the mid-90s until the late 2000s, particularly in public policy favoring home ownership and laissez-fair lending, it is no surprise that production shifted to single-family homes disproportionately.”

“Similarly, the huge defaults in the manufactured housing segment in the mid-90s meant that lending stopped in that segment and manufactured housing shipments declined with the change. The fallout of all of this has been a change of rules that is driving different results. Dodd-Frank has made lending into the real estate sector less attractive, as have the plethora of fines and penalties. Freddie and Fannie now are the major players in individual residential mortgage finance and their political exposure and legal situation pretty well drives them to a level of conservative underwriting not unlike bankers did 30 or 40 years ago.”

“The explosion of student debt has put a prior lien on the vessel of personal credit capability of many in GenX and GenY that was not there in the past. The dollars that went to a mortgage and a car in the past now go to the student loans first and then cell phone bills and cable TV and Internet subscriptions. Connectivity, entertainment, and paying for the great party that college has become is now the primary tap on income, not leaving much for housing, particularly owning a house.”

“The rules of employment have changed also. Starting with the downturn of the early 1990s and then into the 2000s, employment security began to evaporate. You could be doing a great job and be let go on a whim in order to make the financials work. Loyalty and security were replaced by temp and contract status with little certainty of whether your job would be around next week or next month. Throw in a slow economic recovery here and abroad, that creates uncertainty, too. This is not a good environment to take on long-term economic obligations.”

“Sure, this situation does not impact everyone in the workforce, but few would contest that it is more prevalent today than 10 or 20 years ago. It is no surprise that these core changes have resulted in a different composition of residential living demand than in the recent past. The data from the past several years that have now been influenced by these changes seem to indicate that the composition of housing production is reverting to something that looks more like it did 30 years ago, with a higher proportion of multifamily production. The still moribund manufactured housing sector is giving up some of its share to multifamily, but a good portion of that demand just seems to have disappeared.”

“We see it in overall starts not coming back to norms as people had thought. The other apparent outcome from this new reality is that the volumes of production are significantly less than they have been overall and in single-family for-sale in particular. In fact, the situation may be worse than people think. The recent public builder report cards show increases in incentives in some markets and gross margins declining from already somewhat weak levels. These are indicators of a supply-demand imbalance, with there being too much supply and production being forced through.”

“The good news is that people still need roofs over their heads and the population is growing. The bad news is that to create the new shelter for that population, many of the business models, assumptions, and management practices from the past won’t work anymore and, in fact; the old practices will probably take a bunch of existing builders to the ash-heap of history.”

Bits Bucket for June 14, 2015

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