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!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add 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:

  • India: The World’s Fastest Growing Large Economy?
    Popular Narrative India has been the world’s favorite country for the last three years. It is believed to have superseded China as the world’s fastest growing large economy. India is expected to grow at 7.5%. Compare that to the mere 6.3% growth that China has “fallen” to.   India's quarterly annualized GDP growth rate since 2008, according to MOSPI (statistics ministry) - click to enlarge.   The IMF, the World Bank, and the international media have celebrated...
  • Don’t Blame Trump When the World Ends
    Alien Economics There was, indeed, a time when clear thinking and lucid communication via the written word were held in high regard. As far as we can tell, this wonderful epoch concluded in 1936. Everything since has been tortured with varying degrees of gobbledygook.   One should probably not be overly surprised that the abominable statist rag Time Magazine is fulsomely praising Keynes' nigh unreadable tome. We too suspect that this book has actually lowered the planet-wide IQ –...
  • Silver Speculators Gone Wild – Precious Metals Supply and Demand
    Silver Gets Frisky Last week, the prices of the metals had been up Sunday night but were slowly sliding all week — until Friday at 7:00am Arizona time (14:00 in London). Then the price of silver took off like a silver-speculator-fueled-rocket. It went from $16.68 to $17.25, or 3.4% in two hours.   March Silver, 30 min. candles. Someone certainly piled in last Friday... - click to enlarge.   What does it mean? We don’t know. We would bet an ounce of fine gold against a...
  • What is the Best Time to Buy Stocks?
      Chasing Entry Points Something similar to the following has probably happened to you at some point: you want to buy a stock on a certain day and in order to time your entry, you start watching how it trades. Alas, the price rises and rises, and your patience begins to wear thin. Shouldn't a correction set in soon and provide you with a more favorable buying opportunity?   Apple-Spotting – a five minute intraday chart showing the action in AAPL on February 1, 2017 - an...
  • Incrementum Advisory Board Meeting, Q1 2017 and Some Additional Reflections
      Looming Currency and Liquidity Problems The quarterly meeting of the Incrementum Advisory Board was held on January 11, approximately one month ago. A download link to a PDF document containing the full transcript including charts an be found at the end of this post. As always, a broad range of topics was discussed; although some time has passed since the meeting, all these issues remain relevant. Our comments below are taking developments that have taken place since then into...
  • Gold and Silver Divergence – Precious Metals Supply and Demand
      Gold and Silver Divergence – Precious Metals Supply and Demand Last week, the prices of the metals went up, with the gold price rising every day and the silver price stalling out after rising 42 cents on Tuesday. The gold-silver ratio went up a bit this week, an unusual occurrence when prices are rising. Everyone knows that the price of silver is supposed to outperform — the way Pavlov’s Dogs know that food comes after the bell. Speculators usually make it...
  • Trump and the Draining of the Swamp
      Swamp Critters BALTIMORE – The Dow is back above the 20,000-point mark. Federal debt, as officially tallied, is up to nearly $20 trillion. The two go together, egging each other on. The Dow is up 20 times since 1980. So is the U.S. national debt. Debt feeds the stock market and the swamp. What’s not up so much is real output, as measured by GDP. It’s up only 6.4 times over the same period. Debt and asset prices have been rising three times as fast as GDP for 36 years! Best...
  • Making America Great Again – How to Judge Policy
      A Simple Formula MIAMI – How do we know if new programs will make the economy better... or worse? Here’s a simple formula:   W = rv (w-w – w-l)   That is, wealth is equal to the real value of win-win exchanges minus the loss from win-lose exchanges. Yes, dear reader, it’s as simple as that. Like a whittler working on a piece of wood, we’ve shaved so much off, there is nothing left of it... except the essential heartwood.   When devising a win-win,...
  • When Trumponomics Meets Abenomics
      Thirty Year Retread What will President Trump and Japanese Prime Minister Shinzo Abe talk about when they meet later today? Will they gab about what fishing holes the big belly bass are biting at? Will they share insider secrets on what watering holes are serving up the stiffest drinks? [ed. note: when we edited this article for Acting Man, the meeting was already underway]   Japan's prime minister Shinzo Abe, a dyed-in-the-wool Keynesian and militarist, meets America's...
  • The Great Wailing
      Regret and Suffering BALTIMORE – Victoribus spolia... So far, the most satisfying thing about the Trump win has been the howls and whines coming from the establishment. Each appointment – some good, some bad from our perspective – has brought forth such heavy lamentations.   Oh no! Alaric the Visigoth is here! Hide the women and children! And don't forget the vestal virgins, if you can find any...   You’d think Washington had been invaded by Goths, now...
  • Gold Sector Update – What Stance is Appropriate?
      The Technical Picture - a Comparison of Antecedents We wanted to post an update to our late December post on the gold sector for some time now (see “Gold – Ready to Spring Another Surprise?” for the details). Perhaps it was a good thing that some time has passed, as the current juncture seems particularly interesting. We received quite a few mails from friends and readers recently, expressing concern about the inability of gold stocks to lead, or even confirm strength in gold of...
  • Receive a One Percent Gift When Buying or Selling a Home
      How to Save Money When Buying or Make More When Selling a Home In your professional capacity and perhaps also in your private life, you may be closely involved with financial and commodity markets. Trading in stocks, bonds or futures is part of your daily routine.  Occasionally you probably have to deal with real estate as well though – if you e.g. want to purchase an apartment or a house, or if own a home you wish to sell.   The people who took this photograph probably want to...

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