Storm Front Approaching the Home Builders

There is only one problem with the home builders – expectations are way too high. The builders are not only priced for perfection by the market, the builders themselves have business strategies that are modeled for perfection. I believe the bar is set at an unattainable level.

Here is why.

In the beginning there is raw land. It takes years, if not decades, to develop this raw land into finished lots, lots that are ready for permitting and construction. When the final product is sold, the process of monetizing land is completed. Depending on their strategies, home builders buy land during various stages of this long development process. NVR, for example, is at one extreme. They only buy finished lots based on what they need at the moment. Even with NVR, it will still take them a few months to complete the finished design and put up a couple of models before they can officially market the communities. Most other builders take much longer from land purchases to final sales. They are exposed to market fluctuations during this holding period.

 


 

NVR, Inc.: buying only finished lots




With the time lag, there are three possible outcomes. First, when the houses are finally sold and closed, the sales price and costs are exactly what the builders projected when the land was purchased. Second, market conditions improve beyond their original estimates and margins come in much better than expectations. Finally, the third possibility is market conditions turn out to be far below expectations and all profits gone.

The lesson here is that it is not enough for the real estate market to be improving for the builders to be profitable, they need to have a low enough cost basis in order to have a decent margin. To really do well, they will also need volume.

 

Looking back a decade, starting with the bursting of the tech bubble, the builders were preparing for lean years and did not overpay for land. They did not know that Greenspan had different ideas. Consequently, with the Greenspan versions of quantitative easing, their margins increased way beyond their expectations. With the surprise windfall, builders went wild and paid higher prices to replenish their land inventory. This did not affect their profit margins. The subprime bubble was beyond their wildest dreams and offset all the higher costs, generating even more profits. At the peak of the bubble, the builders were totally fearless and kept buying land at even higher prices until one day it all came tumbling down.

Where are we today and why do I believe a storm front is fast approaching?

Easy Money, and Cheap too. With the help of the Bernanke QEs, every builder has since issued equity, convertibles, new debt and/or refinanced existing debt. The cost of these funds is unbelievably reasonable. This is however a double-edged sword. The cheap money lures the builders into buying more land and/or develop what they already have on hand. The cost basis is no longer cheap.

Land Cost. If we take a snap shot of the builders' land portfolios today, most builders have plenty of land but the finished lot inventory has been absorbed by the favorable conditions so far this year. To survive, they have been purchasing finished lots to meet demand. During the recent earnings conference calls, most builders still claimed that they have underwriting standards that do not rely on future home price appreciation. Anyone who has looked at any recent land deals knows that is not true. They can also spend money developing the raw land in their own inventory but that would add to costs and hurt earnings for the current and upcoming quarters.

No Competition, for now. The builders could not have planned for a more perfect set of circumstances. Whether it is intentional or unintentional, public policies have been the greatest friend the builders can dream of. They were given free money in the form of tax loss carry-back. There were tax credits. The greatest gift, of course, are low mortgage rates along with cumbersome underwriting documentation. Builders are uniquely positioned to coach buyers through the process, far better than their existing homes counterparts. Distressed properties are artificially held off the market. For the better deals that do reach the market, investors are gobbling them up, forcing the owner users to overpay for new homes.

Confused. The market is confusing a listing shortage with a housing shortage. The US population grew by only 2.3 million between 2010 to 2011. Housing starts for this year are around 900,000. Baby boomers are rapidly reaching retirement age, changing housing demand. Employment remains stagnant with no signs of wage appreciation. We are at best at equilibrium, while the market is still trying to absorb the excesses of the past decade.

In summary, the building model is flawed. They cannot avoid boom bust cycles. Right now, builders have to keep buying even if they believe that the market may slow. When every "A" location property is receiving multiple bids from builders, the price is not likely going to be cheap. Can the builders afford to buy, at prices that rely on future appreciation? Can the builders afford not to buy? How are they going to generate revenue if they are not buying land and therefore not building?  Shareholders would destroy them. They have no choice but to keep building, hoping favorable market conditions will continue indefinitely. Having used up most of the cheap land already, builders are now facing a "must appreciate" predicament. If the market slows, look out below.

 


 

The Home builder ETF, XHB – still in the market's good graces for now, but for how long?

 


 

 

Charts by: StockCharts.com


 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • factoryA Striking Chart
      The Economy and the Stock Market As long time readers know, we are always paying close attention to the manufacturing sector, which is far more important to the US economy than is generally believed. In terms of gross output it is the largest sector of the economy, and it should of course be obvious that saving, investment and production are the only ways to create wealth.   What's left of the Brooklyn Domino Sugar Refinery. Photo credit: Paul Raphaelson   Contrary...
  • trump-putin-1024Trump and Putin Narrowly Escape Assassination Attempt
      The Gloves are Coming Off First a little bit of recent history. Readers are probably aware that some questions about the occasionally malfunctioning Deep State android... no, wait, we'll start again. Questions have recently been raised about the health of presidential candidate Hillary Clinton by various “alt-right” tinfoil hat-wearing conspiracy theorists, such as this one.   The monsters are normally hiding under Hillary's bed, but lately they have come out into the open...
  • swing-voterWhy the Fed Destroyed the Market Economy
      What Have You Done for Me Lately? Swing voters are a fickle bunch.  One election they vote Democrat.  The next they vote Republican. For they have no particular ideology or political philosophy to base their judgment upon.   The primacy of the wallet.   They don’t give a rip about questions of small government or big government.  Nor do they have any druthers about the welfare or warfare state. In effect, they really don’t care.  What’s important to the...
  • wallet-367975_960_720Janet Yellen’s Shame
      Playing Politics In honest capitalism, you do what you can to get other people to voluntarily give you money. This usually involves providing goods or services they think are worth the price. You may get a little wild and crazy from time to time, but you are always called to order by your customers.   In the market economy, consumers reign supreme. There is no such thing as a “lost” vote in the marketplace; every penny spent affects production. Mises noted: “Consumers...
  • trump-mapDonald’s Electoral Struggle
      Wicked and Terrible After touting her pro-labor union record, the Wicked Witch of Chappaqua rhetorically asked, “why am I not 50 points ahead?”  Her chief rival bluntly responded: “because you’re terrible.”*  No truer words have been uttered by any of the candidates about one of their opponents since the start of this extraordinary presidential campaign!   Electoral map (note that the coloration may no longer be applicable...)   That Hillary Clinton is...
  • warren-buffett-gold-coinGet Ready for a New Crisis – in Corporate Debt
      Imposter Dollar OUZILLY, France – We’re going back to basics here at the Diary. We’re getting everyone on the same page... learning together... connecting the dots... trying to figure out what is going on.   The new three dollar bill issued by the Apprehensive States of America.   We made a breakthrough when we identified the source of so many of today’s bizarre and grotesque trends. It’s the money – the new post-1971 dollar. This new dollar is green. You...
  • 4-ip-and-non-def-capital-goods-ordersThe Economy, the Stock Market and the Fed
      John Hussman on Recent Developments We always look forward to John Hussman's weekly missive on the markets. Some people say that he is a “permabear”, but we don't think that is a fair characterization. He is rightly wary of the stock market's historically extremely high valuation and the loose monetary policy driving the surge in asset prices.   The S&P 500 Index and the NYSE advance-decline line. Most market internals weakened steadily until early February 2016, but...
  • silkroadHanjin Marooning in San Pedro Bay
      Global Trade Reversal Expansions and contractions in global trade have played out over long secular trends for thousands of years.  The Silk Road, for example, was established by the Han Dynasty of China in 130 BC, and allowed for continuous trade between East and West for nearly 1,600 years.  In addition to economic trade, the Silk Road was also a conduit for culture and knowledge among its network of civilizations.   A map of the main ancient Silk Road - click to...
  • voltaireGreat Causes, a Sea of Debt and the 2017 Recession
      Great Cause NORMANDY, FRANCE – We continue our work with the bomb squad. Myth disposal is dangerous work: People love their myths more than they love life itself. They may kill for money. But they die for their religions, their governments, their clans... and their ideas.   Famous French hippie and author Voltaire. He wears the same sardonic grin in every painting, whether he's depicted at a young or an old age, doesn't matter. His real name was François-Marie Arouet; he...
  • wilsonand-morganThe Donald Versus Killary: War or Peace?
      War: A Warning from the Past Although history does not exactly repeat itself, it does provide parallels and sometimes quite ominous ones.  Such is the case with the current U.S. Presidential election and the one which occurred one hundred years earlier.   The Donald probably has the better slogan...   The dominating question which hung over the 1916 campaign was whether the country would remain neutral in regard to the horrific slaughter which was taking place on the...
  • hittite-leftoversA Rift in the Space-Time Continuum
      Weird and Unnatural NORMANDY, France – First, a quick look at the markets. The Dow bounced on Monday, recovering 239 points of the nearly 400 it lost on Friday. Why the comeback?   FOMC member Lael Brainard: her comments on Monday were touted as the “reason” for the stock market recovering half of Friday's losses. We suspect the real reason is the triple witching on Friday... Photo via twitter.com   The financial press has a ready answer: “Stocks gain...
  • ukraine-mapCrimea: Digging For The Truth
      Renewed Escalation This summer witnessed a renewed escalation between Russia and Ukraine after Russian President Vladimir Putin accused Ukraine of sending saboteurs to attack Russian troops, targeting “critical infrastructure”. Kiev denied the allegations and claimed Russia’s “fantasy” was nothing but a false pretense to launch a “new invasion”.   August 10: Russian president Putin announces that there was an altercation involving a group of Ukrainian saboteurs at...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com