Housing construction is a funny game.
More so, perhaps, than any other actors in the economy, homebuilders must remain eternally proactive, rather than reactive.
If the market demands more, say, cupcakes — cupcake manufacturers can manufacture more cupcakes relatively quickly to satisfy demand.
By the time the market needs more homes, though, it’s too late for the builders to get into the game.
One does not simply walk in with mortar.
With the rise of the American middle class after World War II and the resultant broadening of the availability of the American dream, the pattern has been fairly predictable — peaking regularly every five years or so, similar to the way the existing home sales market moved. And that makes sense — as existing home sales climb, available inventory drops and new homes have to be built to fill the gap.
But the regular five-year sine curve got funky in the early ’90s.
Home sales were up everywhere, and builders were more than happy to feed the beast. Rather than the expected easygoing up-and-down wave, home starts and home sales kept climbing, as did prices, with every indicator peaking between mid-2005 and early 2006.
Then, for six years, everything hit the skids. Existing home sales dropped off; builders stopped building because no one was buying. Housing starts hit historic lows.
Everyone just got out.
But things are picking up now — and they have to.
Harvard’s Joint Center for Housing Studies predicts 1.2 million housing starts in 2013, but that’s 400,000 fewer new homes than will be needed to meet expected demand.
In the Nashville area, housing supply — a calculation of the number of homes for sale divided by the number of homes sold — has fallen from a 10-month supply to a five-month supply in just one year.
“We have been forming households at almost the same rate prior to the recession. There is a lot of pent-up demand. Believe it or not, we could be looking at a housing shortage in Middle Tennessee soon,” said Jimmy Franks, a third-generation builder and the president of the Homebuilders Association of Middle Tennessee.
Housing starts have started to react — the St. Louis office of the Fed reports the Nashville metropolitan statistical area has shown a steady increase in starts since early 2010 and a big uptick twice in the past three quarters. But still, starts are only at 1995 levels.
“Middle Tennessee is projected to stay ahead of national trends in increased starts. That’s significant,” Franks said. “Our market never crashed as bad as others, so there was less room to recover for us, yet we are seeing robust increases. Not as much as in these severely depressed markets, but better than the nation as a whole.”
In the first two months of 2013, Davidson County issued 249 permits for single-family homes — an astounding 86 percent increase over the same period in 2012. Surrounding counties also had increases: up 36 percent in Williamson County, 30 percent in Rutherford, 34 percent in Sumner and 54 percent in Wilson.
Again, housing is delivered far more slowly than our hypothetical cupcakes, but builders and developers recognize that it’s time to get back into the game — and quickly — but they have challenges to face.
For one — a home is an end product, the final link in a supply chain that goes back to forests in South America and gypsum mines in Oklahoma. Building product suppliers got hurt in the great housing downturn just as builders themselves did.
And if you think it takes a long time to deliver a house — well, trees don’t just grow overnight, and science hasn’t developed a tree that grows in convenient 4-by-4-footblocks either. Nashville-based Louisiana-Pacific had first-quarter sales of $538 million — a 49 percent increase over the same quarter in 2012 — but noted an 82 percent increase in prices for particleboard on the futures market.
At the same time, the price of gypsum — a key component in drywall and concrete — went up 30 to 35 percent at the beginning of 2013. Like their brethren in lumber, gypsum producers responded to weak demand by cutting shifts and closing production facilities. Now production lags demand, and prices are responding.
Franks said Middle Tennessee homebuilders have been anticipating these increases in construction costs — he said those costs could be “significant” in the next 24 months — and have worked to keep costs down by buying and building on distressed lots. But land is the ultimate scarce commodity — they aren’t making any more of it, as the old saying goes.
When the broader home sales market started to thaw in 2011, one sector showed significant improvement. Between mid-2011 and mid-2012, “land and lots” — a term that encompasses everything from farmland to planned but undeveloped subdivisions — showed the strongest growth of any of the sectors tracked by GNAR. In hindsight, that was a strong hint that builders expected to be back in the game.
Land and lots have continued to show sales growth, but it has slowed; as Franks points out, available and empty distressed lots are disappearing.
In suburbanizing areas in Williamson County, for example, prices of buildable lots have seen 25 to 40 percent price increases in one year.
Franks noted, though, that despite taking hits — in their books and in the newspapers — during the housing collapse, banks are willing to extend credit to builders ready to re-enter the game.
Franks recently spoke to the National Mortgage Bankers Association and said lenders are “very eager” to extend vertical loans — a two-tiered lending instrument in which the primary loan is secured (in the case of home construction, by the projects themselves) and a secondary loan is unsecured. Cash flow created by the assets is used as collateral on the senior debt, with the subordinated debt used to actually fund the construction. It can be a risky play for a banker if the asset doesn’t perform as expected, but, Franks said, lenders are recognizing that home building is bouncing back, making them “more friendly” toward extending credit.
And of course someone has to actually do the dirty — and skilled — work of building a home. There are frames to frame, drywall to hang, pipes to plumb and so on. Since that 2006 peak, the home construction work force has lost 40 percent of its workers.
“The industry’s capacity has diminished since 2007 relative to the decrease in starts,” Franks said. “We saw a lot of [subcontractors] leave the industry or the area. Hopefully we will see subs come in from areas that aren’t recovering as quickly, but everybody is braced for sharp increases in labor costs.”
Economists have noted that while housing starts are on the up, relatively few construction jobs are being created. According to Bill McBride, chief economist for real estate website Trulia, it appears that many workers once employed in home construction moved into subcontracting work, which can weather the ups and downs of the broader economy better because it includes home remodeling jobs. Nashville is one of the better markets for home flippers, as well. Research from RealtyTrac put Music City as the eighth most active for flipping — with 1,230 single-family homes turned around in 2012, netting a gross profit of 35 percent.
The Bureau of Labor Statistics said many workers in new home construction repatriated to Mexico and Central America or moved into other labor-intensive jobs — the energy sector in Texas and the Great Plains, for example. Former residential construction workers, burned by the downturn, are hesitant to return to that job.
To meet the demand Harvard projects for 2013 (1.64 million homes nationwide), more than 2 million more housing-related jobs — in all sectors, including manufacturing of household items like appliances and furniture — will have to be created. They won’t get created overnight.
And that means the people still doing the actual work of building a home can name their price — adding even more to the final price tag of a completed home.
There is a trope in business that downturns shake the dead wood from an industry. It may be a cold reality, but weak, inefficient or poorly positioned actors will disappear when times get tough. The Darwinian process means only the strong survive.
To a degree, that was true with this recession, but it went on so long, it harmed even careful, competent operations.
“You could make a case for a thinning of the herd in 2008 and part of 2009, but this downturn was so deep and long it knocked out quality contractors who were good businesspeople,” Franks said. “Builders, by their nature, are optimists who look to the future, but this has been a profoundly bad time for many.”
For Franks, that means there’s one shortage that outside observers may not recognize right away: a shortage of homebuilders themselves.
Like many “mid-major” markets, Nashville’s market has historically been served by local or small regional builders, with not enough growth to justify the risk for national homebuilders.
With job growth outpacing the national trend and increasing population — and with many of those small local firms burned by the downturn — the larger national builders are starting to enter the market.
Fort Worth, Texas-based D.R. Horton, the nation’s largest homebuilder, bought 28 lots in Smyrna’s Woodmont Community from local developer Scott Sohr in early March. Horton had not been active in Nashville in nearly 25 years.
Miami’s Lennar Homes and Columbus, Ohio’s M/I Homes have rumored interest in Nashville, as well, eyeing unfinished and distressed subdivisions, especially in the ring counties, where several planned subdivisions were foreclosed upon and now sit empty.
Franks may see his prediction come true.
Hindsight is always 20/20.
It’s easy to look back at the extended boom and see it as silly: The rose-colored projections that said real estate would always increase in value, that there would be a perpetual market for new homes.
But hindsight has a benefit too. There’s an air of cautious optimism among homebuilders. In the short term, costs are going to be high — and buyers can expect those to be passed along, of course.
The price of a new single-family home may increase by $4 to $6 per square foot as cheap land evaporates and labor and supply costs increase.
That may put a natural brake on demand, allowing supply to catch up and, as builders and consumers alike hope, giving the material and labor markets time to ramp back to pre-recession levels.
But, in the end, that’s a good problem to have, and not just locally and not just for homebuilders.
Leading economists are starting to predict the pent-up demand for homes will drive the broader economy, with JPMorganChase foreseeing a 0.5 percent punch to the GDP, which could drive it above 3 percent — a sure sign of recovery.
And that’s good news for all of us — we’ll just have to suffer through some growing pains first.