Housing Slowdown

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The Housing Slowdown: Let the Seller Beware

by Alexander Green, Chairman, Investment U; Investment Director, The Oxford Club
Monday, April 23, 2007: Issue #666

Two years ago I began warning readers that the housing market was looking more and more like the technology stock mania of the late 1990s.

Just as equity traders had justified eye-popping prices in tech stocks with empty statements like “the Internet is changing everything” and “this is the beginning of a New Era,” homebuyers were dragging out chestnuts like “buy as much house as you can possibly afford” and “real estate always goes up.”

Well, not always

I cited the housing slowdown in Dallas after the oil bust. I cited the slump in New York City real estate after the 1987 stock market crash. I cited the drop in Los Angeles following the 1991 recession. And so on. Of course, in each of these instances, the drop had a specific cause and, of course, prices eventually rebounded.

The current slowdown is different. Very different.

A Housing Slowdown Like No Other

Robert Toll is the chief executive of Toll Brothers, one of the nation’s most successful builders. In his 40 years as a builder, Mr. Toll says he has never seen a slump unfold like the current one.

“I’ve never seen a downturn in housing without a downturn in employment or some macroeconomic nasty condition that took housing down along with other elements of the economy. This time, you’ve got low unemployment, you’ve got job creation, you’ve got a rising stock market and low interest rates.”

In other words, the current slump is about the housing market and the housing market alone.

In Phoenix last month I had dinner with two residential real estate consultants that specialize in global markets. Their clients are primarily top executives and other high-net-worth individuals who want to compare, for instance, the advantages of buying a home in London with one in Dublin. Or are interested in the merits of ownership in Auckland versus Buenos Aires.

These consultants were quite knowledgeable and, as far as I could tell, understood every aspect of the market, from land prices to building codes to construction costs to potential rental income. But they couldn’t answer a simple question I put them.

“Why is it,” I asked, “that all over the world, home prices have soared relative to inflation, personal income, population growth and building costs? Other than low interest rates and easy credit, what has been driving this phenomenon?”

They looked at each other quietly for a moment or two. Then one finally said, “Look, if you want to know which major cities around the world have the strongest economic growth, the lowest property taxes, or the best rental potential, I’ll be happy to tell you. But if you ask me why it is that houses all over the world suddenly doubled or tripled in value over the past few years, I couldn’t begin to tell you.”

A “Insiders” Look at the Housing Boom Phenomenom

He isn’t the only one. I’ve been asking this question for two years now – trying to better understand this amazing phenomenon – and I still haven’t gotten a good answer.

Except perhaps from my brother, a Central Florida builder.

One afternoon a few years ago he told me he was raising prices on the half-million-dollar homes he builds by $15,000 a month, every month.

“Wow. Are your material costs rising that fast?” I asked him at the time.

“Heck, no,” he said.

“Labor?” I asked.

“No.”

“Land prices?”

“No, I locked those in a long time ago,” he said.

“So why are you raising your prices $15,000 a month?” I asked, half knowing the answer.

“Because,” he said with a shrug, “I haven’t found a limit to what people are willing to pay. None of my price hikes have slowed down sales one bit.”

Needless to say, that’s not the case today.

Is the Slump Coming to an End?

So when will the slump in residential real estate end? No one knows, of course. And every market is unique. But I wouldn’t count on a sudden spark from a rate cut, a burst of consumer confidence, less new construction, or the beginning of the “peak selling season.”

Inventory is piling up as too many sellers hold out for the prices they “could have gotten.” When they finally accept the reality of the current market, they’re going to start lowering prices. And not just a tad.

Many home sellers have simply never dealt with a down market before. Most, in my view, would be better off accepting a “reasonable” offer right now, rather than holding out for a good one.

This is just one man’s opinion, of course. But I genuinely believe there’s going to be a lot more pain and suffering before the housing slump comes to an end.

Unless you understand the recent doubling of home prices better than I do, my advice to home sellers is this: Caveat Venditor.

Good Investing,

Alex

Today’s Investment U Crib Sheet

Investment U’s Homebuilder Check-Up – The Inventory Jump Hits “Home”

According to The Wall Street Journal, the number of homes for sale in 18 of the largest cities climbed 6.5% from February to March. For the last 22 years, the typical inventory increase has been 1.7%. At the same time, sales of single-family homes fell to 7-year lows.

Here’s how the slowdown is impacting homebuilders:

D.R. Horton, the country’s biggest builder by number of units, reported orders for 9,983 homes in the first quarter. That’s down from 15,771 a year earlier. Net income fell from $352.8 million to $51.7 million. Profit tumbled 85%.

Lennar Corp. posted a 73% drop in profit for its fiscal first quarter.

Dominion Homes, Inc. sold 218 homes in the first quarter, compared to 475 in the same quarter last year. Revenues slid 52%.

KB Home posted an 84% slide in fiscal first-quarter earnings.

In other news, Bear Stearns announced this morning that it will be doubling its staff in Asia. The firm is planning to nearly double its head count in Continental Europe, too. Our recent report shows you why big banks are investing resource capital overseas and how to follow the money for substantial gains. Full story.