Home Builders Face Inventory Downturn

This article first appeared in the Home Builders Face Inventory Downturn issue of Pro Builder.

Borrowing against the future has weakened the demand for homes over the next few years. Falling interest rates and creative financing allowed approximately 2 million more renters than usual to transition into homeownership. Rising home equity allowed millions more to move from their entry-level home to their dream home. Today, many renters are unable to buy a home and homeowners are content to stay in their existing home.

From 2001 to the present, we estimate there were 6.1 million new and existing home transactions in excess of what recent history suggests there should have been — nearly one year's worth of excess transactions. Over the long term, there has been an average of 4.9 transactions for every 100 households annually. Because people are more transient today, we believe the number should be closer to 5.6 transactions. Multiplied by the number of households in the U.S., this amounts to 6.5 million sales that should have occurred in 2006. In the last 12 months, there were actually 7.2 million sales.

The excess transactions stemmed from the following:

BORROWED HOMEOWNERSHIP FROM THE FUTURE: During the recent falling interest rate environment, we dipped deep into the rental pool for qualified home buyers and borrowed from the future, adding more homeowners than the long-term trend would indicate. This has brought the U.S. homeownership rate to a record-high level of 69 percent, which we think is about five years ahead of schedule. Demographics play a long-term role in rising homeownership, but falling interest rates and creative financing were the primary drivers behind the most recent surge.
INVESTOR PURCHASES: Speculative investor activity ramped up during the early part of the decade. A National Association of Realtors survey suggests that 28 percent of all resale home sales in 2005 went to investors, and another 12 percent were to second-home owners. Investors' purchases drove up price appreciation to record levels in many markets and gave them incentive to flip properties multiple times, also increasing the level of transactions.
MORE MOVE-UP ACTIVITY: Rising prices also increased the amount of equity that homeowners had in their current homes, giving them the economic means to "move up" quicker than they might have otherwise or to purchase a second home, borrowing from future demand in the process.
VACANT HOMES: The number of vacant homes — including unoccupied homes and seasonal/second homes — constructed has increased substantially. There are 2.3 million more vacant units today than there were four years ago, which is about 1 million more than we think should have been created. Not all of these count as transactions, but this category can't be ignored.

What Happens Next?

For the housing market to stabilize, these excess transactions need to burn off. The combination of strong job growth, slowing permit activity and adjusting prices that we are experiencing now will help bring the transaction levels back to equilibrium. We anticipate that sales volumes could correct another 30 percent, however, because of the excesses that were created recently.

Don't throw in the towel. This is all part of the cyclical business we live in. The harder the market falls, the sooner that conditions will improve. The best managed and best capitalized companies in the industry will survive and prosper.

Top 20 Metro Areas

			EMPLOYMENT			AFFORDABILITY			PERMITS
		1-Year Payroll Employment Growth	1-Year Growth Rate	Unemployment Rate	Median Resale Home Price	Resale Housing Costs as % of Income*	Housing Cycle Barometer**	12-Month Single-Family Permits	1-Year Single-Family Growth	12-Month Total Permits	Total Permits as % of Peak Permits***
1	Atlanta	48,700	2%	4.5%	$175,537	24%	3.8	57,672	-3%	71,440	95%
2	Houston	72,700	3%	4.5%	$144,600	25%	5.1	55,266	11%	68,245	91%
3	Phoenix	94,500	5%	3.4%	$256,000	39%	6.3	45,661	-24%	53,759	77%
4	Riverside-San Bernardino	28,000	2%	4.4%	$385,000	64%	8.9	36,086	-20%	40,836	71%
5	Dallas	50,800	3%	4.5%	$153,800	26%	4.0	30,476	-2%	38,860	53%
6	Chicago	43,600	1%	3.5%	$240,000	37%	5.3	25,123	-13%	43,141	98%
7	Orlando	37,200	4%	2.8%	$245,000	41%	7.0	24,827	-6%	32,404	90%
8	Las Vegas	42,700	5%	4.0%	$307,000	50%	7.3	23,970	-20%	36,441	93%
9	Tampa	27,200	2%	3.0%	$194,800	36%	6.3	20,860	-22%	25,316	67%
10	Charlotte	12,200	2%	4.5%	$158,500	25%	1.2	20,590	10%	24,505	100%
11	Austin	18,100	3%	3.7%	$173,800	31%	5.2	18,914	16%	26,780	100%
12	Washington D.C.	54,300	2%	2.9%	$396,101	47%	8.1	17,459	-25%	26,569	70%
13	Fort Worth	14,900	2%	4.5%	$113,800	20%	5.0	17,346	0%	21,411	56%
14	Fort Myers	9,000	4%	2.5%	$250,000	42%	6.4	16,182	-30%	21,500	72%
15	San Antonio	15,600	2%	4.4%	$136,900	28%	5.1	14,320	0%	20,233	91%
16	Denver	20,500	2%	4.2%	$240,000	37%	5.6	14,315	-20%	18,747	66%
17	Nashville	18,200	2%	3.5%	$158,800	28%	5.2	14,040	0%	15,538	85%
18	Raleigh-Cary	20,900	4%	3.3%	$185,000	28%	2.1	13,540	-3%	17,295	100%
19	Minneapolis	36,500	2%	3.3%	$250,000	35%	6.6	13,012	-26%	17,111	61%
20	Jacksonville	11,600	2%	3.1%	$188,000	30%	5.7	12,768	-32%	18,102	71%
Sources: Bureau of Labor Statistics; U.S. Census Bureau through the month ending October 2006; John Burns Real Estate Consulting. Data on all markets available at www.realestateconsulting.com Proprietary affordability scale with 0 meaning most affordable time since 1983, 5 meaning median affordability, and 10 meaning least affordable time. Annual Mortgage Costs +1/7th of the downpayment divided by income. ** Peak activity since 1985.

Author Information

John Burns helps many of the largest companies in the industry with strategy and monitoring market conditions. He can be reached at jburns@realestateconsulting.com.

PB Topical Ref