{"id":3323,"date":"2022-07-19T19:21:48","date_gmt":"2022-07-19T19:21:48","guid":{"rendered":"https:\/\/preprod.realtrends.com\/blog\/2022\/07\/19\/are-homebuilders-too-pessimistic\/"},"modified":"2025-03-13T02:44:37","modified_gmt":"2025-03-13T02:44:37","slug":"are-homebuilders-too-pessimistic","status":"publish","type":"post","link":"https:\/\/preprod.realtrends.com\/blog\/2022\/07\/19\/are-homebuilders-too-pessimistic\/","title":{"rendered":"Are homebuilders too pessimistic?"},"content":{"rendered":"\n
\"1200x700_Homebuilder_Pt\"<\/figure><\/div>\n\n\n\n

On July 11, Rick Palacios had less a Twitter<\/strong> thread<\/a> and more a group therapy session.\u00a0<\/p>\n\n\n\n

Palacios posted messages about homebuilder sentiment \u2013 sentiments roughly equivalent to the feelings you have upon realizing your wallet is in the car, and the car just got towed. <\/p>\n\n\n\n

\u201cSomeone turned out the lights on our sales in June,\u201d an Atlanta homebuilder said to Palacios, director of research at John Burns Real Estate Consulting<\/strong>. <\/p>\n\n\n\n

\u201cThis recession is looking like \u2013 and feeling like \u2013 a big, long five year depression,\u201d observed a Charlotte builder.<\/p>\n\n\n\n

Even Austin \u2013 no homebuyer can resist Austin<\/a>, right? \u2013 has a homebuilder declaring, \u201cSales have fallen off a cliff. We\u2019re selling 1\/3 of what we sold in March and April.\u201d\u00a0<\/p>\n\n\n\n

So in the grim march to an increasingly likely economic recession combined with the inventory crisis that has long gripped housing, homebuilders are suffering with\u2026hey, wait, here\u2019s real estate consultant John Burns himself on the line. <\/p>\n\n\n\n

Burns shows us a map. It says that 61% of housing markets reviewed have \u201cstrong\u201d or \u201cvery strong\u201d new home market conditions. <\/p>\n\n\n\n

And who\u2019s that? Oh, it\u2019s Lennar<\/strong>, one of the biggest residential builders in the country. <\/p>\n\n\n\n

Here\u2019s Diane Bessette, chief financial officer for Lennar, saying that the company<\/a> had a gross margin of 29.5% in the quarter that spanned from March 1 to May 31. And Bessette forecasts that gross margin in the third quarter will hold steady at about 29%. <\/p>\n\n\n\n

What\u2019s really happening in U.S. homebuilding? <\/p>\n\n\n\n

Casting a shadow over that question is the possibility of a recession. If a recession does happen, not enough supply to meet demand \u2013 the<\/em> problem of homebuilders since, well, the past decade \u2013 may spawn other problems.<\/p>\n\n\n\n

“The new-home market is particularly sensitive to rising mortgage rates and builders want to ensure that if they build it, someone will buy it,\u201d stated Odeta Kushi, deputy chief economist at First American<\/strong>. \u201cBuilders are likely to respond to the decline in affordability and cooling demand by building fewer homes.\u201d<\/p>\n\n\n\n

The recession is what may<\/em> happen.<\/p>\n\n\n\n

What has<\/em> happened and is happening is a homebuilding economy at odds with homebuilder\u2019s pessimism. The homebuilding lobby and homebuilders themselves \u2013 many who spent<\/a> 2021 grousing<\/a> that supply snarls kept them from making even more of a killing \u2013 now fret over a mortgage rate rise and, like Palacios\u2019 Austin homebuilder, demand declines compared to recent months.\u00a0<\/p>\n\n\n\n

But saying the industry is not doing well compared to recent months, and saying homebuilding is doing poorly in absolute terms are two different things. <\/p>\n\n\n\n

\u201cThe industry,\u201d Burns said, \u201cis doing fine.\u201d <\/p>\n\n\n\n

A growing balance <\/strong><\/h3>\n\n\n\n

While the federal government plays a limited role in homebuilding \u2013 local government largely determines<\/a> zoning and land use policy \u2013 the Census Bureau<\/strong> and Housing and Urban Development<\/strong> do measure homebuilding. Each month they provide data from local government surveys about the number of new homes sold<\/a>.\u00a0<\/p>\n\n\n\n

Because construction is seasonal, the government provides raw numbers but highlights a seasonally adjusted annual rate.\u00a0<\/p>\n\n\n\n

This seasonally adjusted annual rate for May was 696,000 new home sales. The May new home sale rate is below the actual number of 2021 home sales, which were 771,000. It\u2019s also 5.9% below the May 2021 rate. <\/p>\n\n\n\n

But that says more about how terrific 2021 was than how bad 2022 is, said Tim Costello, chairman and CEO of BDX Inc.<\/strong>, which provides digital services to homebuilders and their suppliers. <\/p>\n\n\n\n

\u201cLast year\u2019s builders had the highest margins in modern history,\u201d Costello said. <\/p>\n\n\n\n

Also, the annual rate of new home sales in May was 10.7% higher than the rate in April, suggesting, again, new home sales are not in freefall, just not as good as last year. <\/p>\n\n\n\n

\u201cBuilders are dealing with the twin vipers of increasing mortgage interest rates and increasing prices,\u201d Costello said. \u201cBut they are still fulfilling a huge amount of demand.\u201d <\/p>\n\n\n\n

With builders more focused on fulfilling months-old backlogs instead of brand new orders, inventory is improving marginally.\u00a0<\/p>\n\n\n\n

There were 444,000 new homes available for sale nationally in May, which Census\/HUD deem as 7.0 months of inventory. There were 5.0 months of inventory in May 2021. As analysts like Bill McBride of Calculated Risk<\/strong> point out<\/a>, supply gains are improving and returning to pre-pandemic levels.\u00a0<\/p>\n\n\n\n

Each month Census\/HUD also report on the number of homes slated for construction, and how many have been completely built. Here, the news is mixed. <\/p>\n\n\n\n

The number of homes permitted for construction ticked up<\/a> 1.4% year-over-year to 1.685 million seasonally adjusted annual rate, but ticked down less than one percent compared to May.\u00a0<\/p>\n\n\n\n

Homes in which construction started fell 2% compared to May and 6% compared to June 2021, with an annual rate of 1.559 million. This suggests, as McBride and Kushi have theorized, that some homebuilders are beginning to wait to build<\/a>, apprehensive the demand might not be there.\u00a0<\/p>\n\n\n\n

Housing completions, though, are actually up year-over-year 4.6% to a 1.365 million annual rate. While the year-over-year number trends up, this completion rate trends down from the prior month, also by 4.6%. <\/p>\n\n\n\n

The numbers may reflect a modest balancing in a market where, as Kushi has put it<\/a>, \u201cDemand has outstripped supply every year since 2009.\u201d\u00a0<\/p>\n\n\n\n

Kushi recently stated<\/a> that, \u201cBuilders have a backlog of homes. Housing demand is softening but that means more balance is coming to the housing market.\u201d\u00a0<\/p>\n\n\n\n

Cause for concern?<\/strong><\/h3>\n\n\n\n

But homebuilders feel blue.<\/p>\n\n\n\n

The National Association of Homebuilders,<\/strong> the main trade group and government lobbying firm<\/a> for homebuilders, and Wells Fargo<\/strong>, release surveys on homebuilder confidence. And in July, builder confidence dropped<\/a> for the seventh consecutive month, marking the lowest confidence level since May 2020 and the largest single month drop in the history of the index, excluding the 42-point drop in April 2020. (Back then, uncertainty loomed about whether the housing market could recover from the COVID-19 pandemic. It did.)<\/p>\n\n\n\n

NAHB chairman Jerry Konter faults \u201crising building costs and high inflation\u201d for driving down sentiment and slowing growth. <\/p>\n\n\n\n

Another worrying sign is a sharp rise in mortgage rates<\/a>. As of July 15, the average 30-year fixed interest mortgage rate was about 6%. That compares to around 3.3% this time last year. Robert Dietz, NAHB\u2019s chief economist, points to the rising rate as exacerbating affordability.\u00a0<\/p>\n\n\n\n

Let\u2019s look at these concerns. <\/p>\n\n\n\n

*Slowing growth<\/strong><\/p>\n\n\n\n

Not only are home sales down year-over-year, according to Census\/HUD data, but also 51% of homebuilders surveyed are reporting a year-over-year decrease in sales, according to a survey put out by financial services firm BTIG<\/strong>, and homebuilder rebate management company HomeSphere<\/strong> that came out last week. <\/p>\n\n\n\n

But, again, 2021 was a record-setting year. Look into the statements of executives for publicly traded homebuilding companies, and the difference between \u201cnot as good\u201d and \u201cbad\u201d becomes clearer.<\/p>\n\n\n\n

On Toll Brothers\u2019<\/strong> most recent earnings call, which was conducted back on May 25, company CEO Douglas Yearley forecasted continually moderating demand. But that demand was moderating, \u201cfrom the unprecedented pace of the past two years,\u201d And it would remain, overall, \u201csolid,\u201d Yearley said. <\/p>\n\n\n\n

Meanwhile, Los Angeles-based homebuilder KB Home<\/strong> reported a sales decrease for quarter one 2022 of 9%, with net home orders totaling 3,914. But the first quarter of 2021 marked the company’s best Q1 for home orders in 14 years.\u00a0<\/p>\n\n\n\n

Meanwhile, the company is adjusting by cutting costs. KB Home predicts a full-year 2022 operating margin of 17% \u2013 a solid rise from 2021\u2019s 13%.\u00a0<\/p>\n\n\n\n

\u201cWe believe the strength of our company together with our built-to-order business model will enable us to navigate the changing market dynamics,\u201d said KB Home’s CEO Jeffrey Mezger on the company\u2019s June 23 earnings call<\/a>.\u00a0<\/p>\n\n\n\n

Like those who like their own representative but hate Congress<\/a>, perhaps homebuilders are nervous about their industry but fairly confident about their company. Or maybe they share in the understandable national nerves of a potential recession.\u00a0<\/p>\n\n\n\n

\u201cA housing deficit relative to demographic need will persist through this ongoing cyclical downturn,\u201d Dietz said. <\/p>\n\n\n\n

This could all change with one market run, or other cataclysmic economic event. Or just a slow burn recession. But, for now, the numbers do not support a homebuilding economy in significant decline. <\/p>\n\n\n\n

Rising Building Costs and High inflation<\/strong><\/p>\n\n\n\n

The U.S. consumer price index is recording its highest year-over-year price gains since 1981, and it\u2019s even worse in homebuilding. According to numbers NAHB took<\/a> from the U.S. Bureau of Labor Statistics\u2019<\/strong> producer price index, residential construction material costs were up almost 20% in June 2022 compared to last year.\u00a0<\/p>\n\n\n\n

High inflation, therefore, is understandably a concern for homebuilders. An exception to this is lumber. <\/p>\n\n\n\n

Lumber became a national cult fixation in early 2021. There were jokes about<\/a> needing armored vehicles to shepherd wood supply trucks through highways.\u00a0<\/p>\n\n\n\n

Today, the price of lumber has declined by more than 100% since the first six months of 2021. It is around $625 per 1,000 board feet, according to NAHB tracking<\/a> of the price. Some homebuilders have acknowledged their turn in fortunes.\u00a0<\/p>\n\n\n\n

\u201cThe current drop in lumber prices that we\u2019re experiencing,\u201d said Lennar co-CEO and co-president Rick Beckwitt, on the company\u2019s June 22 earnings call, \u201cWill lower the costs of our starts in the second half of this year and related deliveries in the first half of 2023.\u201d <\/p>\n\n\n\n

But lumber is just one piece of the material costs puzzle, asserted homebuilding analyst Carl Reichardt, managing director for BTIG.<\/p>\n\n\n\n

\u201cThe thing about material costs for builders is that it is a wide range of relatively small costs,\u201d Reichardt said. \u201cAs much as we talk about lumber being really important, lumber is probably somewhere around 10% the materials of the house.\u201d<\/p>\n\n\n\n

Other materials include gypsum \u2013 which is used to make drywall, ready mix concrete, iron and steel, and fiberglass and additional goods to make windows.<\/p>\n\n\n\n

Gypsum is a mineral in sedimentary rock, abundant in New Mexico\u2019s White Sands national park<\/a>. Gypsum prices have increased almost 20% from June 2021 to last month, according to the producer price index.<\/p>\n\n\n\n

Ready mix concrete, which is prepared in manufacturing plants and then shipped by truck to the homebuilding site, has increased in price 15% over the past year, per the producer price index. <\/p>\n\n\n\n

And iron and steel, whose prices the index combined, are up 16% year-over-year. <\/p>\n\n\n\n

But the producer price index is just that \u2013 an index representing change over time. It does not provide absolute numbers of how much it would cost to buy, for example, a cubic yard of ready-mix concrete. <\/p>\n\n\n\n

NAHB told RealTrends that they don\u2019t know the absolute numbers of these product costs. Other sources, including trade publications who cover these materials, also didn\u2019t know actual costs. <\/p>\n\n\n\n

The homebuilding industry \u201cdoesn\u2019t really have a handle\u201d on some material costs, said Dale Rogers, a professor of economic logistics at Arizona State University, adding that material prices are quite up and down and vary regionally. <\/p>\n\n\n\n

RealTrends did online shopping last week at Home Depot<\/strong>, which highlighted the variability. A 4-feet by 8-feet sheet of drywall<\/a> retailed between $12 and $20, depending on whether it was fire coded or waterproof.<\/p>\n\n\n\n

Don\u2019t even get started on windows<\/a>, which involved decisions like whether the frame material should be wood or vinyl, or whether they offer insulation (to say nothing of aesthetic selections of \u201cdecorative grid patterns\u201d).\u00a0<\/p>\n\n\n\n

None of this is to say that inflation is not a problem. Rather, the issue varies, depending on a homebuilder\u2019s specifications. <\/p>\n\n\n\n

One related problem is the cost of truck drivers and construction workers to deliver the materials. But these labor shortage issues may be changing.<\/p>\n\n\n\n

The American Trucking Association<\/strong> argued last October<\/a> that its industry is short about 80,000 trucking jobs, for a sector that claims around 2 million truckers.\u00a0<\/p>\n\n\n\n

But according to a June 23 article in Freight Waves, a trade publication regarding the global supply chain, new U.S. truck carriers have flooded the industry during the pandemic to the point where there may be an oncoming surplus.<\/p>\n\n\n\n

\u201cFrom July 2020 to now, almost 195,000 new carriers have entered the market,\u201d the publication reported, partly through analyzing Federal Motor Carrier Safety Administration<\/strong> data. <\/p>\n\n\n\n

Thomas Wasson, an enterprise trucking carrier expert at FreightWaves, noted that homebuilding activity is closely tied with tender rejection rates, meaning flatbed (meaning trucks that are open air) trucking reject the manufacturer\u2019s offer to carry a specific load, often due to a truck shortage.<\/p>\n\n\n\n

\u201cPart of the current challenge is flatbed companies are turning down around one out of every four loads, which can include materials, windows, doors, pipes, and other homebuilding materials,\u201d Wasson said. \u201cAdditionally, due to the extra labor required for flatbed carriers, it can be harder to find drivers who are willing to secure the load via heavy tarps, chains, binders, or even unload the product on site via driver assistance.\u201d<\/p>\n\n\n\n

Along with the trucking industry, concerns persist about skilled labor in construction. The Association of Building Contractors<\/strong> continues to sound the alarm<\/a> about the lack of trained talent to fill positions like electrician and carpenter.\u00a0<\/p>\n\n\n\n

Still, NAHB noted that the number of overall construction jobs were up in June, while the sector\u2019s unemployment rate was down.<\/p>\n\n\n\n

\u201cCrews and materials are starting to become more available,\u201d asserted Costello of BDX. \u201cIn general, there\u2019s more of a balance.<\/p>\n\n\n\n

Mortgage rate increase<\/strong><\/p>\n\n\n\n

The Federal Reserve<\/strong> raised the overnight lending rate<\/a> between banks last month, and there is a domino effect of raising various interest rates, including mortgage interest rates, to combat the aforementioned inflation. Homebuilders have had to adjust.<\/p>\n\n\n\n

\u201cThe housing market has cooled as expected in response to the Fed\u2019s aggressive and rapid reaction to inflation,\u201d said Stuart Miller, chairman of Lennar during the recent earnings call, adding that the Fed\u2019s move had \u201cthe desired effect of slowing price appreciation and moderating demand by increasing monthly payment costs and reducing affordability.\u201d<\/p>\n\n\n\n

Homebuilders\u2019 most acute fear from increased mortgage rates is cancellations. Already, supply line challenges and material and labor shortages made the homebuilding process months longer<\/a> than in previous years, said Reichardt of BTIG.<\/p>\n\n\n\n

That means someone perhaps agreed to buy a new home back in October \u2013 mortgage rate of 3.3%, but were not locked in their mortgage until June \u2013 rate of 6.0%, when the home reached completion. <\/p>\n\n\n\n

\u201cPeople getting delivery notifications and being stuck with rates that are way higher is certainly an issue,\u201d Costello said. <\/p>\n\n\n\n

For the publicly traded homebuilders, though, the issue to date has been a controllable one. Toll Brothers, which caters to a higher-end clientele, reported a cancellation rate so far in 2022 of 1%. <\/p>\n\n\n\n

KB Homes and Lennar have a greater cross-mix of clients, selling homes in the $300,000 to $500,000 range. They have experienced more cancellations, but apparently nothing alarming.<\/p>\n\n\n\n

\u201cOur cancellation rate during the quarter totaled 11.8%,\u201d Lennar\u2019s Beckwitt said on the earnings call. \u201cWe ended the quarter with only approximately 250 completed homes that were installed across our national footprint, putting us in a great position in a soft new sales environment.\u201d<\/p>\n\n\n\n

For KB Home, \u201cAbout one half of the cancellations occurred on unstarted homes,\u201d CEO Mezger said on the company’s most recent earnings call. \u201cWe ended the quarter with only 69 unsold homes in inventory.\u201d\u00a0<\/p>\n\n\n\n

Amid historically low mortgage rates exacerbating already high demand, the retail price of homes have shot up to new records<\/a> in 2021, even when adjusted for inflation over time. So, the rise in mortgage rates will inevitably continue to price out more people, already struggling to pay the home\u2019s sticker price.\u00a0<\/p>\n\n\n\n

Still, let\u2019s not get too carried away with 6% mortgage rates. The rate is higher than 2021. Much higher. But it is still lower<\/a> than the mortgage rate average the last 50 years of about 8%, and credit profiles in recent years are stronger than ever.<\/p>\n\n\n\n

\u201cI remember when the mortgage rate was 19%,\u201d Costello said, recalling the inflation combating measures of the early 1980s. \u201cA five to six percent mortgage rate is still historically low.\u201d <\/p>\n\n\n\n

More than a feeling?<\/strong><\/h3>\n\n\n\n

U.S homebuilding is not one-size-fits-all, but depends on the wealth, land availability, building laws, and nearness to supplies of specific places. Burns, the real estate consultant, provided a map showing where homebuilding is strong \u2013 indicating a company selling five homes a month or more at appreciating prices, normal, or slow. <\/p>\n\n\n\n

Strong areas include most of the Atlantic Coast, from Miami up to New York, and most of the south and southwest. West Coast cities are normal in sales and price appreciation. One city, Minneapolis, is singled out as slow.<\/p>\n\n\n\n

Lennar went through its markets on the earnings call and also singled out Minneapolis as softening, along with previously hot markets including Austin and Raleigh, North Carolina. <\/p>\n\n\n\n

Meanwhile, markets in the Midwest and South, especially Florida, perform well for the Miami-based company. <\/p>\n\n\n\n

Another nuance when assessing homebuilding is a gradually growing gap between larger and smaller builders. The top builders were sellers in 34% of single-family home closings in 2021, according to an NAHB study<\/a>, the largest share ever since the trade group began tracking this stat in 1989. <\/p>\n\n\n\n

And one final factor to keep tabs on. Sentiment itself. <\/p>\n\n\n\n

Not just homebuilders are pessimistic. In June, overall U.S. consumer sentiment hit an all-time low point<\/a>, according to a University of Michigan index tracking consumer\u2019s feelings since 1952<\/em>. And a Fannie Mae<\/strong> study<\/a> found that 81% of prospective homebuyers say the economy is on the \u201cwrong track.\u201d<\/p>\n\n\n\n

Economists are split<\/a> on whether sentiment can become a self-fulfilling prophecy. Paul Atwater, an economist at William & Mary, told Fortune magazine last month<\/a>, \u201cI am a believer that how we feel drives what we do. And so sentiment, to me, is an indicator of what we are likely to do ahead, economically.\u201d<\/p>\n\n\n\n

But, as the Fortune story pointed out, recessions are often prompted not by feelings of weakness or vulnerability, but overconfidence. Think of the 2006 housing bubble, or, more recently, the rise and fall of cryptocurrency investment and valuation. <\/p>\n\n\n\n

There are many concerns with homebuilding. Overconfidence is not one of them. <\/p>\n","protected":false},"excerpt":{"rendered":"

Builders might not feel great about the economy, but they\u2019re actually doing pretty well. 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