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


 
 

 
 

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:

  • 21st Century Shoe-Shine Boys
      Anecdotal Flags are Waved   "If a shoeshine boy can predict where this market is going to go, then it's no place for a man with a lot of money to lose." - Joseph Kennedy   It is actually a true story as far as we know – Joseph Kennedy, by all accounts an extremely shrewd businessman and investor (despite the fact that he had graduated in economics*), really did get his shoes shined on Wall Street one fine morning, and the shoe-shine boy, one Pat Bologna, asked him if...
  • India: The Genie of Lawlessness is out of the Bottle
      Recapitulation (Part XVI, the Last) Since the announcement of demonetization of Indian currency on 8th November 2016, I have written a large number of articles. The issue is not so much that the Indian Prime Minister, Narendra Modi, is a tyrant and extremely simplistic in his thinking (which he is), or that demonetization and the new sales tax system were horribly ill-conceived (which they were). Time erases all tyrants from the map, and eventually from people’s...
  • Christopher Columbus and the Falsification of History
      Crazed Decision The Los Angeles City Council’s recent, crazed decision* to replace Christopher Columbus Day with one celebrating “indigenous peoples” can be traced to the falsification of history and denigration of European man which began in earnest in the 1960s throughout the educational establishment (from grade school through the universities), book publishing, and the print and electronic media.   Christopher Columbus at the Court of the Catholic Monarchs (a...
  • The Government Debt Paradox: Pick Your Poison
      Lasting Debt “Rule one: Never allow a crisis to go to waste,” said President Obama’s Chief of Staff Rahm Emanuel in November of 2008.  “They are opportunities to do big things.”   Rahm Emanuel looks happy. He should be – he is the mayor of Chicago, which is best described as crisis incarnate. Or maybe the proper term is perma-crisis? Anyway, it undoubtedly looks like a giant opportunity from his perspective, a gift that keeps on giving, so to speak. [PT] Photo...
  • The Forking Paradise - Precious Metals Supply and Demand Report
      Forking Incentives A month ago, we wrote about the bitcoin fork. We described the fork:   Picture a bank, the old-fashioned kind. Call it Acme (sorry, we watched too much Coyote and Road Runner growing up). A group of disgruntled employees leave. They take a copy of the book of accounts. They set up a new bank across the street, Wile E Bank. To win customers, they say if you had an account at Acme Bank, you now have an account at Wile, with the same balance!   BCH, son...
  • The United States of Hubris
      Improving the World, One Death at a Time If anyone should have any questions about whether the United States of America is not the most aggressive, warlike, and terrorist nation on the face of the earth, its latest proposed action against the supposed rogue state of North Korea should allay any such doubts.   Throughout history, the problem with empires has always been the same: no matter how stable and invincible they appeared, eventually they ran into “imperial...
  • Long Term Statistics on AAPL
      Introductory Remarks by PT Below we present a recent article by the Mole discussing a number of technical statistics on the behavior of AAPL over time. Since the company has the largest market cap in the US stock market (~ USD 850 billion – a valuation that exceeds that of entire industries), it is the biggest component of capitalization-weighted big cap indexes and the ETFs based on them. It is also a component of the price-weighted DJIA. It is fair to say that the performance of...
  • Tragedy of the Speculations
      The Instability Problem Bitcoin is often promoted as the antidote to the madness of fiat irredeemable currencies. It is also promoted as their replacement. Bitcoin is promoted not only as money, but the future money, and our monetary future. In fact, it is not.   A tragedy... get the hankies out! :) [PT]   Why not? To answer, let us start with a look at the incentives offered by bitcoin. We saw a comment this week, which is apropos:   "Crypto is so...
  • Janet Yellen's 78-Month Plan for the National Monetary Policy of the United States
      Past the Point of No Return Adventures in depravity are nearly always confronted with the unpleasant reality that stopping the degeneracy is much more difficult than starting it.  This realization, and the unsettling feeling that comes with it, usually surfaces just after passing the point of no return.  That's when the cucumber has pickled over and the prospect of turning back is no longer an option.   Depravity and bedlam through the ages. The blue barge of perdition in the...
  • To Hell In A Bucket
      No-one Cares... “No one really cares about the U.S. federal debt,” remarked a colleague and Economic Prism reader earlier in the week.  “You keep writing about it as if anyone gives a lick.” We could tell he was just warming up.  So, we settled back into our chair and made ourselves comfortable.   The federal debtberg, which no-one cares about (yet). We have added the most recent bar manually, as the charts published by the Fed will only be updated at the end of the...
  • Despite 24/7 Trading: Bitcoin Investors are Taking off for the Weekend on Friday Already
      Crypto-Statistics In the last issue of Seasonal Insights I have discussed how the S&P 500 Index performs on individual days of the week. In this issue I will show an analysis of the average cumulative annual returns of bitcoin on individual days of the week.   Bitcoin, daily. While this is beside the point, we note the crypto-currency (and other “alt coins” as well) has minor performance issues lately. The white line indicates important lateral support, but this looks to...
  • Precious Metals Supply and Demand
      Fundamental Developments There were big moves in the metals markets this week. The price of gold was up an additional $21 and that of silver $0.30. Will the dollar fall further?As always, we are interested in the fundamentals of supply and demand as measured by the basis. But first, here are the charts of the prices of gold and silver, and the gold-silver ratio.   Gold and silver prices in USD terms (as of last week Friday) - click to enlarge.   Next, this is a...

Support Acting Man

j9TJzzN

Austrian Theory and Investment

Archive

350x200

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

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]

 

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com