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Guest Post: Housing Market & Construction Costs: Builders Can’t Justify Investment
Submitted by Jeff Borack At Kerrisdale Capital
Housing Market & Construction Costs: Builders Can’t Justify Investment
At Kerrisdale Capital, we've written about the housing market before,
but estimating the fair value of the US housing market is difficult.
Two of the best ways to estimate fair housing prices are to compare
housing costs to household income or rental rates. Obviously people
can only spend so much on housing relative to their incomes, but
secular trends in spending, tax rates, and cyclical trends in income
make the data difficult to interpret. Likewise, comparable rental
rates do a good job of showing the relative cost of ownership, but in
an inflated market, rental rates are likely to be inflated as well.
A third way to estimate the fair value of the housing market is to
look at the replacement cost of existing homes. If the cost of building
a home is equal to the cost of buying a home, then the price to cost
multiple is 1x, implying a breakeven level of profitability for
homebuilders. If homebuilders can build a house for $300k and sell it
for $400k (a 30% return) they will continue to build homes until they
can only sell them for around $330k (a 10% return).
Unfortunately, construction costs aren’t easy to estimate. As
usual, the best data comes from Robert Shiller, presented in a chart with
home prices here:
The problem with this data is that the building costs are
represented by the price of a basket of goods including 66.38 hours of
skilled labor, lumber, steel, and cement. Not only might this fail to
reflect the actual building costs and technological improvements in
residential homebuilding, but it’s difficult to equate to home prices. A
better way to determine the price/cost ratio for residential homes
across the US is to look at the financial statements of the largest
homebuilders and to get a sense for what their margins are.
We looked at the financial statements of Pulte Homes and Lennar
Corp. In both cases, economic reality is distorted by impairments and
writedowns which have crammed a decade’s worth of losses into the
2006-2010 timeframe. So when we consider the cost of building
a house, we will look at the 2005 numbers, likely a conservative
estimate compared to 2010 now that raw material and labor costs have
come down. We can compare our cost estimates to the current price new
units are selling for to determine if homebuilders can justify
continued investment. The fact that all the main homebuilders (DR
Horton, Ryland Group, Pulte Group, KB Home, and Lennar Corp.) have been
operating cash-flow positive for the last three years is strong
evidence in support of the continued profitability of homebuilders and
reason to believe that continued construction will continue to add
housing inventory and push market prices down. However, part of the
reason for positive OCF is the contribution from inventory
liquidation. The relevant financials can be found below:
What we see here is that compared to unit costs in 2005 of around
$250k per unit, builders are just able to cover their costs. Lennar
looks to be a bit worse, but it includes selling costs in COGS, whereas
Pulte includes it in the SG&A line. When we factor in (S)G&A
expenses, homebuilders will need to have a 2004 cost per unit and
maintain 2009 prices and volume to approximately break even. The
highlighted numbers show how many units each company will need to sell
in 2010 just to break even (ie. to cover their SG&A expense)
assuming 2009 is a good indicator of revenue per unit and COGS, and 2004
is a good indicator of the per unit building costs. Needless to say,
breakeven doesn’t do much for shareholders, and it’s difficult to
justify investment in new construction.
So from this analysis, it looks as though homebuilders will have a
difficult time making ends meet unless we see some improvement in the
economy. We could have guessed this given the low
housing starts, but this data supports the position that building
is uneconomical, not just distasteful to builders that have grown
accustomed to fat margins. We shouldn’t see a recovery in housing
starts without a recovery in housing prices. The good news is that it’s
unlikely new construction will pressure the housing market anytime
soon, meaning the main source of inventory should
be foreclosures.
Kerrisdale Capital and its affiliates have no position in the
companies mentioned above.
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The housing industry is dead, forget the BS from the big builders. Companies like Pulte and Lennar never were good indicators, forced low bids , demanding high quality kept the subs barly in the money, while the brokers bank rolled the profits.
Housing wont come back until jobs that actually pay high wages come back.
Of course, they cant justify the investment.
People should thank the subprime bubble which enables to build homes in the US when they should have not been built.
Some people got burned in the process but the result is here: people in the US have access to built homes that were too expensive to build in the first.
Inventory/shadow inventory overhang plus the dim prospects for an economic recovery any time soon means homebuilders' outlook will be poor for a while. Does the analysis factor out land costs when calculating b/e levels? Land's the most volatile component - using 2005 as a proxy year likely means the BE is overstated right now and will be for a while. .
oh, this is original. "there's no market for homes but there is a market for the debt of said homes." and the holder of ALL said debt now is...Uncle Sam is it? In other words "you all don't follow your own logic." When listening to all of you I end up where i've been for years now. So, pleease...continue to "enlighten."
"66.38 hours of skilled labor" to build a house?
Maybe 99% of the real labor cost isn't on the books for some reason.
That and - how much (above tear down cost and land value) would you pay for a house that only had 66.38 skilled hours put into it?
"Yes, Mr. Jones, I'll have a crew of 10 guys here tomorrow and we'll be done in less than 7 hours.
Your wife will be cooking dinner in her brand new kitchen tomorrow. I swear."
Are these like moon bounces, just inflate and move in?
Builders are screwed for years to come. In April the WSJ said that there are 103 months of foreclosed home inventory on banks books. The numbers of homes range from 1.3MM to 1.7MM homes in shadow inventory on the banks books.
Since we have an unlimited checkbook to help the economy, we should be subsidizing the builders to NOT build just like we pay farmers not to plant crops. In fact they should be tearing down homes instead of adding more into inventory.
If there is a posiive $100 homes like we see in Detroit should become more common.
Just like the over supply of bankers, yet another misallocation of resources.
CRE is even worse as it is cheaper to buy a building/office at currency pricing than the build it. Future prices should be even more attractive as CRE gets hit with a gluttony of availability from private sellers and bank foreclosures.
... and even cheaper than that to rent one. Not to mention, nobody will lend you the money to buy one.
there is no way you can make a profit on a new construction with the market today. The real estate prices are too cheap now. I speak from experience as i just remodeled by house doing most of the work myself , with a little help from some chicos i picked up from Home depot paying them $100/day. What i did was tear down the interior of a 1500sq foot house all the way to the cinder block and rebuilding , including new a/c duct work, all new electrical wires/panel. I spent close to $50000 just for the interior of the house, again doing most of the work myself without any permits. Raw material prices are just outrageously prices and unless those come down significantly real estate prices now are a steal. A 5 pound box of screws costs $25 dollars at Home Depot. lol You can buy a house in south florida for 120000k with a pool. There is no way you can build a house with permits, architect fee, pay for labor, and make a profit.
True Dat
remodeling rarely paid even when market did well, sure you could spend 50k redoing kitchen and value of house might go up 75k, but many forgot house value would have gone up $25k without doing a thing.
You spent about $35/sf on materials to remodel...a middling price of new house in MN built by homebuilder would be $110/sf,,,that includes land and labor, so depends on sf price in your neighborhood if you did okay. Builder building multiple houses at once will can kill the price of a remodel because they have economies of scale, they have volume leverage on subs, they have volumes deals on materials you'll never get retail from Home Depot. Remodels require tearing out, hauling off waste before you even get started, and then everything is one-off, so not efficient.
When dotcom bubble burst, you could buy Cisco equipment cheaper on Ebay than they could make it...same phenomenon now with houses....
Tent City's are the new competition to single family homes. They are now visible from space.
As I see it, families are going to be living all together.
Friends and aquaitences will need to become roommates, say 8-10 per house.
I'm not sure aggregate national housing value data is that meaningful. It's all local and averaging a bunch of new tract housing in Nevada that should have never been built with houses in established and fairly affluent suburbs near major metropolitan areas doesn't make much sense. Mortgage rates are probably the closest common denomenator but replacement value? - if you replace one ghost town with another it's still a ghost town.
A lot of construction from the last seven years or so should just be bulldozed (cash for clunkers II?) although Obama probably would like to make some of that stock part of a comprehensive amnesty package.
How do you say Honk if I just bought you a home in spanish?
The Golden Rule of Value still applies here: a home is worth what someone is willing to pay for it. Traditional valuations are meaningless, as relevant comps - of like kind, in like area, of recent sale - do not exist.
It's payback time for buyers. Find a good deal, ask half, and be willing to walk.
"The Golden Rule of Value still applies here: a home is worth what someone is willing to pay for it."
Totally not true - Most people don't pay cash for their homes. Therefore, a home is worth what a bank is willing to lend to a borrower. The vast majority of buyer's, err... borrowers overbid due to the fact that they're using leverage (and will always go in over their heads). What prevents houses prices from going through the roof is the appraiser. This has always been the case with the exception of 2003-2007 period. Sooner or later, land, materials, and labor must come down to turn a profit. Otherwise household incomes must go up. In the long run, I think household incomes are a better indicator in determining home values. Short term, it's the appraisers. Everything else follows (labor, materials, land, etc).
Btw, new home prices could come down substantially to compete with REOs if the cities would reduce their ridiculous fees and requirements. In California, school fees were as high as $50K per home in some areas, regardless of size. Unfortunately, in 2011 the cost to build a home will increase by about $10K. All thanks to new regulations.
Housing market ??!? What's that ??
The good news for home builders is that deflation will deliver cheaper material costs.
yeah, i heard CVS is building stores again because they figured out the could be 5 or 6 for the price of 4 a few years ago, materials and labor cheaper, land cheaper....so even if new stores make a little less than when economy was better, they also cost less...so it works for them
the other folks getting over right now are the govt, school districts because they are getting bids 20-30-40 percent lower than their estimates from 2-3 years ago...So really, if our govt had acted in a counter cyclical way and slowed down construction to bar min needed doing construction bubble, and then spent the money when bubble burst, we would have gotten all our roads and schools at great discounts and even out general economy...but no...we, govt and businesses, get all exuberant and all bearish together...
Not to good of an article here. There are so many "other" factors that impact a National Home Builder such as project location and the health of its respective economy, land costs (which can have a dramatic impact on costs), overhead costs, developed lot availability and on and on and on.
To say that the homebuilders "can't justify the investment" is not accurate. The public companies, or should I say, the better public companies were granted the right to live on when they got their tax breaks. Which none of them should have been granted. This enabled them to justify the investment.
The builders will just modify the manner in which they allocate and carry land and inventory and their employee cost structure. Don't forget that these home building companies subcontract everything except their office and sales staffs (sales are even contracted in some states). They don't even own a hammer.
The development industry, on the other hand, will be the ones who may not be able to justify a project. But they will make it happen as well when the land owner realizes that his land is only worth x% of what it once was. This has actually already happened.
Now are they worthy of an investment? I had a high level executive at one of the nations largest home builders tell me one time that the worst thing a home builder could do was go public. Enough said.
CRE construction is dead, dead, dead - and housing is past dead, I know, been in the business 20+ years...now I'm sitting at the house, posting comments on ZH, and well on my way too becoming an alcoholic------CHEERS !!
Hiding at a friend's house, that way the wife still thinks I'm working.
Get a hold of yourself Rusty! I too have been in the business for more than 20 years. I closed on a spec just two weeks ago at one of the highest profit margins I have ever had. There is a rainbow in the sky if you just look for it. It's all about the land Rusty. Find the, "one in a hundred" really distressed sale and go capitalize on it, stay in A to A+ neighborhoods, stay at or below $700,000.00 and borrow very little.
The challenge we face is not what today brings, but rather what next week or 4 months from now will bring us through the Obama regime. I'm currently looking for another project and can't seem to pull the trigger because of this uncertainty. I tell myself, get some balls, life will go on.
By the way, stay with the expensive stuff, it's less burdening the next morning.
I had a guy out to replace my well pump. He has a side business actively flipping houses right now. He is buying lower-income foreclosures, putting in new paint, carpet and appliances and selling at a nice profit. He said some deals are sometimes dicey working with distressed sellers, but business is good. I believe him because it took him forever to get around to fixing my well; I think he was busy with his side business.
The basic cost of housing is completely fungible especially when cities like Los Angeles can "tack on" a $100,000.00 per unit "building & permits fees", they could cut that fee to $10,000 or even $2,500. and still make money on the transaction, in most of Tx that same fee would be far less, perhaps 90% less, on top of direct fee costs there's all the "soft costs" that also go into new housing costs & prices, soft costs would include bribing local officials to allow for the privelage of buying permits & zoning houses, then there's the labor fungibility, builders can hire Americans for $20-25 hour or illegals for $6-12 per hour, building materials are fungible too, you can buy sulpher laden chinese drywall for $2.50 sheet or USG for $6 a sheet.
What is the cost of housing? It depends.
We're also on the precipice of automated home fabrication, 90% of the human labor is still on the table, those "human costs" can be dramatically replaced and reduced by automated machines, my guess is most big builders will be automating fabrication over the next 10 years or replaced by builders that did automate.
cost of housing is exactly this, 30-50 percent of income applied to mortgage they can get, the range of 30-50 depends on region and feelings of the times (are we all bubbly or depressed? are banks loose lending or not?)
If interest rates go down, price of house goes up in proportion to the increase in monthly mortgage principle payment. If wages go down....
there have always been lots of automated , pre-fab house systems, transportation issues are always a big deal...I don't think they'll ever make that big of dent, although pieces of the construction will likely get more automated.. The thing that will make a difference will be building materials, practices. a plumber told me now the he can use pex to plumb a house, he went from jobs that took 2 guys to do in 2 full days to doing in 4-5 hours...same will happen with revolutions in wall materials, electrical systems etc...cooper wire, gypsum board will be replace by something cool in 10-15 years..would be sooner but building codes very slow to evolve as they have been seriously burned by approving new technologies that go bad 2-3 years after every house has it...
Three Words everyone needs to learn:
"I.F.O." ="It's Fucking Over!!!"
Laugh Laugh Laugh
Don't forget the government takes their cut before the builder in the form of local impact fees, permitting, application fees, etc.
...so many ways to kill the goose that lays the golden eggs.
Come to areas of Florida, land is worth less than zero. I have 200 town home building lots left over, the completed units started for $149,000 back in the day, now selling out for $79,000. It costs $85,000 to build them sticks and bricks, no soft costs, commission, etc. So, if I were to give you the lots you couldn't make money but you would have to pay the property taxes. Less than Zero.
This is the extreme Repo. My advise is to stay in the A to A+ locations and Florida is now an "F" location. Florida, Las Vegas, California & a few others will be in the can for sometime to come. No doubt about it.
You are definitely in a bind. I hope you find a way to survive. One would think you will eventually see your cost come down, but maybe not since your situation is not representative of the entire US. Which means we'll all eventually end up in the can or you'll be in the can with just a few friends for a long long time.
its just a question of how oversupplied an area is...some areas house prices fairly competitve to rent and not so oversupplied, so while tough, people can make money....sand states...nope....too many houses..
Unlike some places (such as Repo 105), builders are building homes not because they make money on them, but because its the only way to sell a lot. If a builder owns 1000 lots, there are no buyers, so he has to build a house to get rid of it. Assuming the house sells for more than the cost of straight construction, the place isn't sold at a profit, the "profit" is just what the builder was able to get for his previously unsellable lot.
Once the lot inventory fades, construction stops completely.
yeah, that explains the housing starts....land value=0, if land+house equals 1 more dollar than cost to build house, they are ahead...thing is, in florida, nevada, cost of building house is more than land+houseprice...
is their an ETF to short lumber
Developers get paid to develope.
The best road for new housing is shipping containers. Yes that's right from $8000 for your basic 20 Ft container to a veritable container mansion at $76,000 pictured in the link above. We aren't using the containers for anything so why not make them the new green portable houses for the great depression. Instead of section 8 housing for the old folks, buy them a container when they retire because it sure as hell will be cheaper than that Gold watch. These babies have everything. Central air, Plumbing electrical and far more comfortable than the great outdoors. Don't like your neighborhood. Call up Al's Midnight Move for the $399 cross state special and they'll have you in a new state overnight. Now if you have one of the expensive $75,000 multiple container homes, it may be tough to disconnect everything and have on the road in darkness, but think of those strategic walk-aways. No longer will you have to walk away from your home, just the mortgage . Take the home with you, repaint it, and live wherever you want.
Note. In early 2007, a pair of young guys came up with the $8,000 shipping container as home for Mexico. I wrote on the online comments "Why go all the way down here? We could use them up here? "
Imagine a 3 Year loan for -0- once the $8000 buyer's credit is reenacted. You know it will. No one will walk from these babies. Why you just sign some papers and get the keys and the deed and negotiate the electrical and gas hook-up and your ready to rock. No cleaning gutters. Plumbing and Electrical in a shell on the outside for easy access even by the most clueless home repair person. No new roofs to worry about unless another home is dropped on yours at the wrong angle and hey, that's what $77 a year home owner insurance covers. You get 400 Sq feet to 800 SQ feet less the internal add-ons like bed , kitchen, shower,kitchen, living area and bathroom. Call it 100 Sq feet on your $8000 home and 250 Sq feet on your single $16,000 40 foot container. Need more room?. Buy another container with the govt C203 home improvement loan. That's for when the kids come back after changing their names and faces to avoid the student loan police. Imagine that. One container for you and the spouse and one for the kids located right under a interstate exchange for easy on the road access. The hell with trailers. They can't take a tornado worth a shit. Put a 40 foot shipping container with rubberized ends and triple steel reinforced roofs and you can tumble to your hearts content no matter where your located.
See if Wall Street were taking companies like these public and would stop screwing with their prop trading accounts, the dream of home ownership will be back. Think of all those new low paying jobs. But hey, people can own a home or rent one on minimum wage now. Think of the ROI on a 10,000 unit rental complex at $250 a month per unit. Were talking zero maintenance and total ownership in 4 years with a massive amount of free cash flow for those of you who bought gold bitchez. Screw the stock market. Of course they'll have Container Default Swaps, but what the hell you gonna do with the mafia as government. Buy a fricking container and forget about it. Think about the ease of wiring a park full of containers for internet access. Hell go wireless with the new N wireless and you could have an access point for every 50 trailers and charge $5.00 a month. We'll never export anything again. So forget about those dead head trips back. Unload over at Wal-mart, put em through Wally's 2 Hour Container home and have a Wal-Mart House, made in China , assembled in America out in the back parking lot. Better hurry though, it won't be long before Wal-mart things about stuffing 10 employees in each one. Oh man, that would hurt. Well there is a downside to everything.
Just another investment idea brought to you by Face The Storm Investments LTD, LLC. It's coming. We all know it. Stand up straight and face reality and make money off the bitch. God if we only had these during the last depression. Hoovervilles were so tacky and damn hard to make money from too.
lol, true. I knew a VERY paranoid guy, back in 70's. He built a 3 story mansion UNDERGROUND with those containers. It was uber cool. He had filtered air vents (for chems) and booby trapped entries/exits. It was very nice, wish I had one. The IRS came looking for him in the 90's, he never paid taxes. Went to his property, all they saw was bare land and they gave up. He was the first gold bug I ever knew. He died in 2005. I always wondered what happened to all that gold he had hidden. He was an outcast from his family, don't know if anyone ever took it. I bet someone bought the land and has no idea about the house or the gold.
up for a road trip?, I'll drive......too bad the guy died in 2005, he would be feeling pretty smart right now.
NYC developers should read this article. There is so much shadow inventory in Manhattan and Brooklyn (especially Williamsburg) yet the prices are no more than 5-10% down from peak. Same with rentals, impossible to get a shoebox for less than $1500 a month. All the landlords and developers are hoping for one more good summer before the SHTF but it's not working. The 20 best properties get swept up in the first week, the thousands of others sit there all month. This shit sucks. After 10 years in the biz, I'm thinking of cashing out and buying a farm (no kidding).
BTW, great fuckin' site you guys have here, been keeping up with the parts I can translate into english for the last few months.
If you are free and clear on the house like we are, it costs less than renting to feed the home with the utilties each month. So we dont bother renting. What we might do is whistle up a Crew from time to time and make repairs or replace roof or whatever as our funds accumulate so that the house will be good 20 years from now.
People are buying homes off banks and such, they are going to make the repairs necessary to make it work. They WONT buy a brand new constructed house unless they are nailed down by a required job rule or other consideration.
Well, there's no we, just me, but I'm on the sidelines now like any other rational buyer. If you don't have a lot of silly habits, NYC can actually be affordable on the bills, especially not needing a car. Rent, Utils, Metrocard, ISP service, phone, and a cheap maid. The rest is cash in hand for food and fun.
Drove by a DR Horton site in San Marcos CA. Shitty site, overlooks big traffic interchange(not freeway though) up against a mountain w/ no breeze, looks like they're finishing it out after being mothballed. Looked like maybe 10 homes under const. My wife and I were SHOCKED at 2025 sq ft for $525,000! Are you fking kidding me? THAT'S $259/SQ FT!
Happy days really ARE here again!
here it is>
http://www.drhorton.com/Where-We-Build/California/San-Diego/Division-LA-...
You can get 2000 square feet here in Arkansas for about 200,000 or less depending on where it is.
Why drown in half a mil in debt when you get out of that state and go somewhere where life is a little slower and easier.
On May 4th I called the end of the March 2009 bear market rally.
The proprietary indicators I use in my technical analysis can identify trend changes before they occur.
http://stockmarket618.wordpress.com/about
Certainly a lot of details like that to take into consideration. Thanks windows vps | cheap vps | cheap hosting | forex vps