In my last article, (My 10 Lessons Learned in the Downturn), one of those lessons was Find Reality and Deal with It Fast. After a summer of reading, observing, and thinking about where we are in the residential real estate business now and where we might be headed, I am convinced that we are in the middle of even more significant structural changes than I had projected last spring. The upheavals we are witnessing will challenge us to rethink the business models that have worked and evolved over the past six decades.
Since the end of World War II, the policy of the government has been to encourage home ownership over rental occupancy. During that period, the home ownership rate has climbed from well under 50% to nearly 70% at the peak of the housing boom. It now stands in the mid-60% range and continues to retract.
From a long-term view, the policies worked; perhaps too well, but the needle moved. Single family for-sale homes went from 53% of production in the 1970s to 74% in the 2000’s, while multifamily went from 29% to 18%. Manufactured housing went from 18% to 8% in the same time frame. Policy drivers and financial products that flourished under those policies enabled a shift from essentially less expensive housing forms (apartments, small single family and townhomes, and mobile homes) to more expensive forms (single family homes on larger lots and condominiums in urban areas).
A helping hand originally created for veterans and low income Americans morphed into assistance for all income and demographic classes.
Now, the true costs of the policy drivers (government guarantee of loans, a huge secondary mortgage market, extension of home ownership to income and credit categories that had not owned before, the mortgage interest and real estate tax deductions on income taxes, etc.) are being realized. These costs are being re-evaluated in a world of high unemployment, exploding deficits, and a battle for scarce federal budgetary dollars between housing, health care, education, defense, social security, and a host of other “entrenched interests”.
The unthinkable is beginning to happen. The core underpinnings of the policies that led to a vibrant housing industry over most of our lifetimes are beginning to crumble. A decimated industry that has no profits and is shrinking cannot generate the lobbying and political donation dollars that channel the industry’s influence in Washington. A broke constituency is not heard in these times and the policy debates veer away from housing support to other areas with louder voices and deeper pockets.
It is a wise executive who thinks about these possible changes and what the landscape of the industry will be going forward.
You can see the trial balloons already:
- “Renter Nation: The housing bust and tougher mortgage standards have made renting the best choice for millions of Americans. Population trends will fuel the shift from buying over the next five years.” (Cover Story, Barron’s, July 26, 2010).
- “Leviathan Inc: The state goes back into business”. (Cover Story, The Economist, August 7th, 2010).
- “Feds rethink subsidies for homeownership: with Fannie, Freddie shaky, a restructuring is in the works”. (Cover Story, Money Section, USA Today, August 11, 2010).
- “Banks Face War Over Loan Buybacks”. (Cover Story, Money and Investing Section, Wall Street Journal, August 18, 2010).
What seems to be most likely right now is that construction lending will be very hard to get from banks for the foreseeable future. Any construction will be financed with significant amounts of equity, if not total equity, unless you are a public builder. Permanent mortgage financing will be more difficult to attain, too. Tougher underwriting standards, higher down-payments, and more conservative appraisers will mean less people will be able to get a mortgage loan. Throw in damaged credit issues, a higher proclivity for saving, more temporary work, and a higher need to move to get employment and you have a recipe for less for- sale housing and more rental need and production.
Expect housing policy to focus on low income apartment rental subsidy programs and less on helping middle and upper class homeowners. In its basic form, it is another tax hike on the middle and upper income classes, hidden in the costume of trying to solve the root causes of the housing crisis.
Counterbalancing this are extremely low mortgage rates and overly discounted housing prices, which make affordability the best it has been in a couple of generations. I just think that the negative factors will overcome the positive ones for a while, until there is much more strength on the jobs front and much more good news on stability in the banks and an understanding of what the new rules of the game really are.
If the various newspapers and magazines were the first part of my summer reading, the second part was a recent Analysis of Selected Publicly Traded Homebuilding Companies table from Wells Fargo’s Housing Analysts. So, I’m a numbers guy. The analysts need somebody to read their stuff, right?
What struck me in the table was how uniform the twelve public companies are. The average sales price over the past 12 months ranged from $200,000 to $300,000, with the outliers being Standard Pacific ($325,000) and Toll Brothers ($568,000). StanPac is driven up primarily due to a strong California (i.e.: higher price) presence. Toll is the only one with a significantly different and consistent target market (luxury).
When it comes to inventory turns (essentially Sales Revenues divided by Assets), a measure of how efficiently capital is being used, eleven of the twelve range from .41 to 1.53, with NVR being the outlier at 4.47. NVR has a different business model (“asset light”, rolling options for lots, focus on production cycle time and operational excellence) than the others and has differentiated itself based on business model and process, rather than product. It has been the most profitable and consistent in the downturn.
This is an industry that really competes so well and insularly that most players have devolved into being indistinguishable from one another in the eyes of the customer. There is no Apple or Wal-Mart or IKEA, with globally honed business-model differentiation, to shake up the status quo. That similar business models produce remarkably similar (and poor) results should not be a surprise to anyone.
Which brings me to the final piece of summer reading, a book by Youngme Moon, a professor at Harvard Business School, entitled “Different: Escaping the Competitive Herd. Succeeding in a world where conformity reigns, but exceptions rule.” (Crown Business Group/Random House, New York 2010). Professor Moon makes a beautiful case that many companies in the United States have learned to compete with each other so well that they end up being indistinguishable and their profits dwindle because of the commoditization that ensues.
Sound like any industry you know?
She then uses examples to explain strategies for breaking away and differentiating and, if done well, earning profits where others do not.
As I noted in my articles earlier this spring, we are heading into a different demographic landscape than we have had over the past couple of decades. My reading and observations from the summer lead me to believe that the business (rent vs. own; financing availability and forms; government policy, etc.) will be moving in new directions, also.
The whole competitive landscape from the market to the rules to the financing is all in motion in a giant game of musical chairs.
The good news is that over the next decade, over 10 million dwelling units (some think 15 million or more) will be needed. How they split between rental, ownership, and product type is less certain. But at least there will be a demand. Whether it is fulfilled by new home or apartment construction, remodeling to make multiple units out of a current single unit, or manufactured/mobile homes is yet to be seen.
This will create a whole new environment that will need to be tested with new business models. It will be a cold and brutal environment for those who are trying to do things the old way. For them, it will seem like nuclear winter.
For those who understand and accept these sea changes and who figure out how to stand out from the crowd in a meaningful way, it will feel like a welcome summer.
So ask yourself this question: If the Wall Street Journal came out with a headline next week that said “Apple, IKEA, and General Electric Announce Joint Venture to Design, Build, Rent and Sell New Homes in the US Using a Radically Different Business Model: Adapting to New Market and Financial Realities”, what would the body of the story describe? How about if it was Google and Wal-Mart?
If you can answer those questions, you have probably unlocked the door to success for the next couple of decades.
About George Casey
With decades of deep hands-on experience in operations and processes, business consultant and keynote speaker George Casey brings unparalleled insight to a variety of businesses to streamline operations, increase profits and long-term sustainability, especially to the residential development and home building industries.
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