Builder execs nervous about jobs and the economy .
Industry working off inventory glut, but 'wild card' for housing is recession
By John Spence, MarketWatch June 19, 2008 marketwatch.com
Home-builder executives said at an industry conference Thursday that they're making progress clearing out excess inventory, but warned that a recession and spiking unemployment could stop that advance in its tracks.
"No one who's unemployed ever bought a house," said Lawrence Angelilli, senior vice president of finance at Centex Corp. "That's the wild card that everybody is waiting to see is if we get a true economic recession." Job losses would only further pressure slumping housing prices, which are keeping jittery buyers on the sidelines.
"The other part about this is that everything that's happened so far has been in what was considered a relatively low interest-rate environment with historic low unemployment, so you've had this massive dislocation in the home-building space, totally independent of any economic fundamentals," Angelilli added, speaking at a home-building conference hosted by Bank of America Corp., which was Webcast from New York.
"If we introduce unemployment, that would be very significant."
'A lot of foreclosures are coming from nonowner-occupied borrowers who built new homes and were trying to flip them. Now you do have this first-time phenomenon of massive foreclosures that are coming through on new construction.' — Lawrence Angelilli, Centex
Home-builder stocks staged a rally in early 2008 that has since fizzled on lingering concerns about the housing market and tougher lending standards.
Inventory reductions
Despite worries about jobs and the economy, home-builder executives said they're reducing the backlog of new homes for sale on the market by scaling back construction, lowering prices and other measures.
"The standing inventory of new construction is declining rapidly, but it's being offset somewhat by existing homes and foreclosure," according to the Centex executive.
Earlier this week, the Commerce Department estimated housing starts fell to a 17-year low in May.
"Right now, we're seeing new homes that are being foreclosed on and that's a challenge, but ultimately the inventory reductions in the new-home space are significant and it's encouraging, and we expect it to continue through this year," Angelilli said.
Steven Hilton, chief executive at Meritage Homes Corp., said there is a "disconnect" between public home-builders' inventories vs. the numbers the government reports. He estimated public home builders have inventories of about three months, on average.
"We've reduced our inventory dramatically also," said Larry Nicholson, chief operating officer of Ryland Group Inc.
Cutting back construction
In particular, builders have been trying to limit the number of speculative or "spec" homes in the backlog. Spec homes are those without a buyer due to a cancellation, for instance.
"Every builder I know is working for cash these days and trying to add cash to the balance sheet, which means taking down your spec units," commented Ryland Chief Financial Officer Gordon Milne.
Home builders have been forced to lower prices, but they could stabilize once the companies are able to burn through enough inventory and raise cash, Meritage's Hilton said.
During the housing downturn, home builders have been trying to achieve a delicate balance between sales volume and profit margins. Some companies such as Centex have adopted the strategy of sacrificing pricing to move inventory and boost cash flows. Others such as luxury builder Toll Brothers Inc. have decided to hold the line more on pricing.
Home builders have been trying to get their balance sheets and debt in order so they're better positioned for the eventual recovery in housing.
Foreclosures and mortgages
Still, the housing market is still facing many headwinds, according to industry executives, who are particularly concerned about new homes going into foreclosure.
"Mortgage foreclosures were never viewed as being competition for new construction," said Angelilli at Centex. Listen to interview on new homes fighting for attention.
"The thing that makes today so much different ... is that a lot of foreclosures are coming from nonowner-occupied borrowers who built new homes and were trying to flip them," Angelilli added. "Now you do have this first-time phenomenon of massive foreclosures that are coming through on new construction."
One big question is how motivated the lenders will be to "take the haircut" and sell the properties at a loss, he elaborated. "Where we're a little bit in uncharted territory [is] how big is that and how does that compete with new construction."
Despite a contracted mortgage market, financing is still being offered to qualified home buyers, the executive said. "If you were to turn back the clock to the year 2000, probably somebody who qualified for a mortgage in 2000 would qualify for a mortgage today. There's a substantial emphasis now on down payments and being able to handle debt service within traditional ratios, and the market has had difficulty adjusting back to the old model in terms of mortgage qualifications, but liquidity is there for qualified buyers."
Meritage's Hilton said that "we're back in the 1990s" in terms of mortgage finance, with no more "exotic" loans being offered.
Several executives also commented that they expect smaller and private builders to be forced out of business. "We think there will be fewer builders at the end of the day," according to Ryland's Nicholson. "We expect some of the privates will disappear. Funding will be an issue to them."
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