Senior executive at American Properties Realty Inc
- US homebuilding industry overview
- Industry trends, challenges and opportunities for large homebuilders
- Factors contributing to increased homebuilding demand
- 6-12-month demand outlook
SP: Obviously, it’s been an extraordinary 18 months. The challenges have been unlike any other 18 months that I can recall. Certainly very steady environment of sales, price appreciation, which is wonderful. Of course, the downside has been the inflation, as well as materials, manpower. Getting things done has been incredibly challenging, of course. The trends I would say, at this point I think we’ve levelled off a little bit in terms of sales. There’s some seasonality to that. There’s also, I think, some volatility developing on the materials side. Lumber prices have dropped off pretty tremendously. I think there’s some volatility to be expected there. Overall demand is still strong and the challenges still remain with manpower and materials but I think we’ve adapted to a new normal for the most part. See where it goes from here.
SP: Good questions. I think that the levelling off, as you put it, or maybe I put it that way, that’s only been for a short period here, but we definitely are seeing some inventory develop. We’re seeing a little bit less pricing power. I think that the initial feeling is summertime, usually we have strong springs and then we get midsummer, I think people are coming off of lockdowns and things are still really anxious to get out and spend time out and about. I think a lot of us feel that we’re going to let this play out a little bit before we make any judgment about a market top. I think before COVID everybody felt we were towards the end of a cycle but with the type of stimulus that’s been put into the marketplace, and the mortgage rates being as low as they are, I don’t think there’s too many calling this a top. I think it’s too early to make a judgment but feels like maybe some seasonality and just maybe some buyer fatigue. People getting used to the type of prices that we have for real estate now, we think, even with low mortgage rates. It’s going to take some getting used to. Hard to call it a top.
SP: I think we’re at the point now where people are less afraid. I think there’s less fear driving market trends and migratory patterns. I think there are some other macro trends out there, including the millennial generation growing up, that are going to continue to drive long-term trends. Here in New Jersey, I think we’re a place where, historically, people have been migrating from over the last few years and then we had this exodus from Manhattan, but I was just looking at rents in cities like Bayonne the other day and people migrated from Manhattan to Bayonne, which is still a city environment. All of the apartment complexes are at full rental.
I think that there’s going to be continued migration to more attractive markets for some, especially young people. The south, Texas, southeast, southwest, mid-west. However, the inventory in places like the northeast is so incredibly low and it’s just been driven lower that people are going to still have need here. When I look at things like interest rates, I don’t see the federal reserve doing anything to promote increase in interest rates. With that being said, and the drive towards full employment, we’re seeing actually now some wage growth. I think if we see wage growth catch up with some of the inflation costs, including real estate appreciation costs, we’re going to see this trend continue of growing millennials looking for secondary housing and the inventory is still short, so where’s it going to come from? I think that’s going to be an ongoing trend.
SP: No, I don’t think we are. I think there definitely has been some, I hate to use the word parabolic, move but there has been some price appreciation that looks parabolic in a number of markets. That’s got to correct to some extent. Deflation, I don’t see how that’s possible. The idea of a cycle coming to an end, I think the federal reserve has changed the dynamic there. Again, with the need and the supply still being short, there may be some short-term volatility in pricing but the trend is still up, that sort of thing.
SP: Not something I’ve been studying on the regular. I can comment broadly on that. My world has become more operational so I’m a little bit smaller-scale than I used to be. I think that some of the things I was looking at prior to the call certainly indicate that inventories have been cut substantially since pre-pandemic. I don’t see how that supply is being replaced at any great length or at any great speed. Again, I do think that there are some larger trends outside of the migratory short-term trends over the pandemic that are really starting to play out, and I think they were going to happen regardless of the pandemic. Maybe the multi-family housing cools off a little bit as we see some of this shift over in the growing millennial families. That said, in places like the northeast, you can’t find single-family homes, so the town homes are going to have to be the next best thing for that young family. They’re going to be looking for larger residences and more amenities close into town, those types of things. To answer your question, I can’t see how we’ve replaced all the housing stock that’s been eaten up in the last 18 months. I just don’t see that.
SP: I do think that there’s a lot less support in the business as a result of 2009, 2010. There were certain elements that went away and really were not replaced only until recently. We’re starting to see the attempt to grow but the problem is that the skilled labour is not there. As we saw all this post-pandemic growth, we saw quality control issues. A part of that was certainly related to, I think, manufacturing and just overall protocols for certain things being disrupted, but it’s also due to the lack of skilled labour. It’s a tremendous challenge. I think that many builders are struggling with that right now. Your job is to build a better mouse trap and run effective operations such that contractors can make money. I think that the companies that do that are going to attract talent in that regard. More stakeholder interaction, more communication. Some folks need more time to do things. That includes windows. We’re buying toilets now 10 months out and storing them on sites. We’re doing that with windows. I think that’s a tremendous challenge.
Now, hopefully what we’re seeing is some wage growth. Construction has historically been a business where wage growth is almost non-existent, which is why we have subcontractors, so many of whom are immigrants, who are attracted to the steady pay. Where those of us that are trying to support the cost of living locally need to earn more in order to call it a career. I think that’s been part of the problem, so I think now maybe we’re starting to see some of that wage growth. Some of the costs associated with labour have gone up tremendously. I think we’re still suffering as a result of the downsizing that took place after the financial crisis and of course this pandemic. People are being paid to stay home, so we have to see those short-term changes shake out as well, where people come back to work. I think the skilled aspect is still at a shortage right now, in this demand. It’s a struggle to find skilled people.
SP: I think certainly if we keep up the type of demand and price appreciation we’ve been seeing, it’s going to continue to be a struggle. I don’t think that there is a fast enough response in terms of people entering the trades and rising to a skill level such that we can add, I don’t want to say sufficient, but a significant number of skilled trades. Plumbers, electricians. I just don’t see that. Materials, I think there’s going to be some levelling off. Obviously the pandemic has caused a lot of the problems. I can’t imagine that those will continue if there’s no more lockdowns but on the skilled trade side, I think it’s going to take some time to catch up with this type of growth that we’ve been seeing. The next 12 months, I think it’s going to be a challenge. With that said, though, I don’t think it’s holding us back, to be honest. It’s holding up production, not stopping production. Homes are getting built. Some of them are taking longer but they’re getting built, so we’re finding a way, if that makes sense.
SP: I think that we’ve levelled off in many regards. Certain things have loosened up a little bit, in terms of their availability. Obviously the lumber prices have cratered and there’s some volatility there now. Pricing from vendor to vendor varies greatly, so that volatility is definitely showing up in the pricing. In some cases, it’s leading to some bargains on the lumber side right now. Most of the other materials and products, I would say, that we’re using, in terms of lead times and availability have stayed pretty much where they’ve been for the last 12 months. I think we’ll see more relief there over the next three or four months, but I wouldn’t say we’ve seen a lot of it just yet. Little more predictability but not necessarily more availability. Pricing increases have been ongoing on a weekly basis for almost everything, right up to this week. We have not seen too much pride reduction. We’ve seen some in lumber. From the July peaks, we’re down 30% in some cases, but most everything else is right about where it’s been for the last few months.
SP: Being willing to, first of all, extend cash flow and that includes spending money sooner for certain things like toilets. That’s one example. Stronger commitments. I don’t want to say that it’s been crippling. I think the price appreciation has offset a lot of that, fortunately. Certainly being proactive and communicating with stakeholders, understanding what’s going on. I’ve come from building cultures where builders can be very demanding and not necessarily be listening. I think there’s not a lot of listening that’s gone on. Flexibility around things that maybe normally we wouldn’t be flexible with. That includes scheduling, that includes pricing. Accepting price increases on a weekly basis is something I can’t imagine ever doing, yet here we are. We have to or we won’t get the material, so accepting the environment we’re in and communicating with stakeholders, thinking outside the box to create solutions. I think that’s been a pretty constant theme over the last 12 months for sure.
SP: I think that certainly for us in the markets we’re in, the price appreciation and the inflation on the house prices has offset that. The pace of the sales, which has huge impact on our bottom-line… We’re a cash flow business, so the sooner we can close, the sooner we can get the cash and we can improve our cost of carry. I think those two things have offset the price increases that we’ve seen, largely. Over the last four or five months, we have not increased prices dramatically in any location but, again, for us, the real estate that we have, the locations that we’re in, I would say that’s been a fair trade-off for us.
SP: I think that it’s a whole lot more difficult to lower prices than it is to raise them. There’s going to have to be some vigilance on the part of builders. We have a number of pricing indicators that we’re looking at on different materials and things to see. People are asking for price increases, we’re looking at what metrics are out there on commodities that tell us, relatively, are the price increases valid? It’s difficult to spend double or triple your back office time in proofing prices in the middle of a project, so we don’t want to have to do that. We have to have some vigilance to be aware of what the market is doing. Lumber is one place where we’ve done a lot of that. We have seen volatility where, 12 months ago, all vendors were level in terms of their materials pricing and now we’re seeing a lot of fluctuation. I think the vigilance in attacking that aspect as we get through this next period is going to be important. I don’t see that the same WoW price increases on our home sales in the near-term. We really have to be paying attention to materials costs, labour costs, and that’s going to require some work.
SP: I think when you look at lumber and you see USD 1,600 for a thousand board feet and it goes down to USD 480 in 30 days, that gives you some indication of what you should be expecting in terms of price volatility. I think that we’re in a really strange time economically in terms of I don’t think we’re going to see direct across-the-board inflation. I think there are going to be some things that are going to deflate in price and some things that are going to inflate in price. There are so many macro and micro economic factors that are going to lend to that. Hard to predict, really hard to predict, but I don’t think you can expect to continue to see parabolic pricing with no correction and no volatility. That said, my impression in the overall market and the commodities market is inflation. Over the long-term, I think the trend is up in commodities pricing. I think that’s going to affect a lot of our materials.
SP: I learned a little bit about the lumber market over the last 12 months, and one of the things I came to understand is there are less lumber producers than there used to be. We do have a bit of a oligopoly in lumber production, there’s plenty of lumber but the production facilities are controlled by a small group. We’ve heard from the new administration that there are going to be efforts made to try and diversify some of that and promote some growth and availability of materials through incentives, not sure what they are. That said, lumber is out there and the manufacturers are overcoming their pandemic constraints. I don’t see any reason why we shouldn’t be able to continue to get lumber.
Of course, the tariff discussion with Canada is important. Canada supplies a lot of materials to us, but the demand is going to continue to be there. I don’t know that I’m educated enough to speak too tremendously on the supply chain for lumber, but it seems to me that the material is there, it’s just a matter of the commitment, that those who are harvesting it and producing it continue to do so. There are no alternatives for this market, this residential two and three storey building market. Steel is not the answer at this point. It’s had a bit of a run-up as well, so not sure there is an answer. Hopefully, the demand will help to reconstitute the production side, along with some support from the administration and we’ll see a little bit of a levelling off. It’s unprecedented this, what’s happening in the lumber market.
SP: Yes, I think there’s been an expansion, and when I was with Toll Brothers I spent a lot of time in new markets. I think that effort is growing on behalf of the big builders and small builders. There’s a lot of migration going on, and people are looking for lower-cost housing opportunities. I do think it’s a once in a lifetime-type of opportunity because once those areas grow some of those opportunities will be limited, places like Jacksonville Florida, suburbs of Texas, Arizona, big, big growth potential in these markets. Just the willingness of local governments to support housing in some of these places where they have not seen this type of interest in the past and really desire that type of growth, where here in New Jersey, the opposite political bent. Yes, I think growth and looking into other regions, so and so forth are really a fantastic opportunity.
As far as the difference between primary and secondary markets, I’m not sure I fully understand the dynamic there, but from my perspective, there is definitely a shift from, to me, when we came out of 2010 we were doing it on the backs of apartments and starter homes, multi-family homes. That group has continued unabated, what you see now is the shift, where the millennials who were buying those homes 10 years ago are starting families, and where we had this migration into the cities, now we’re starting to see the reverse in some areas. Does that mean that the primary markets are going to suffer? I’m not sure I think that’s the case right now. I think apartments are fully rented in the markets that I’m serving. I’m talking about vacancy rates that are historically extremely low, so I think you’re adding in that other element now, where you have that tremendous need on the starter home and move-up home side coming into play with the growth in millennials.
SP: No, I think maybe my definition was varied a little bit, but my comments touched on it. Yes, I think there are builders, and I’ll use Toll Brothers as an example, that are less comfortable, we used to say, pioneering. We needed somebody to set a track record so that we could comp and justify some of the opportunities outside of traditional markets. Yes, I think my answer is still valid in that there is a trend to those secondary markets that are now becoming primary markets. The Ozarks, Oklahoma, Tennessee, these are places that big builders have not been typically attracted to, but they’ve seen enough growth now where they’re willing to jump in, so they’re acquiring builders and they are acquiring land, looking for those opportunities for all the reasons you just mentioned.
The bias towards development drives home prices up in the big markets, but in those secondary markets there’s a lot more willingness and support, which keeps prices low and attracts the buyer profile that we’re talking about here. We see the job growth coming back and now we’re starting to see the wage growth. Those two things, along with mortgage rates, are going to continue to drive opportunity for young families. If they want to have the house with the four bedrooms and the two-and-a-half baths, they’re going to be considering relocating. Yes, I think it’s a big opportunity and I think a lot of builders are capitalising on it.
SP: I think that if any segment has softened, it’s been the luxury market. I think that all of the stimulus and efforts to create jobs and now the wage inflation that’s starting to occur are giving folks… We see a year ago, savings rates, people have money in the bank. Young people, I think the younger segments, the starter and the move-up homes have pushed forward at a really frenetic pace. Not that the luxury market has evaporated, but if you had to compare them all, I would think that that one has softened a little bit. I’ve seen that, we’ve seen that in the marketing we’re looking at. Home prices in this area over USD 1m are much softer than they are at… Between USD 400,000 and USD 700,000 has been just knocking it out of the park, so we could certainly testify to that.
SP: I think to some extent it depends on the market. If you’re in a place where there’s developable land with low regulatory cost, detached single-families are the American dream. In other markets, many areas of the northeast, for example, you have highly constrained land where constraints are getting more constraining. Certainly in New Jersey, that’s the case. You’re going to need to think outside the box to meet some of this demand. I think that if you were to talk to senior people in the business who’ve been around a long time, they will tell you, “The apartments and the attached condos, there’s going to be a levelling off, there’s going to be a correction,” but in the same breath, they can’t identify the drivers for the correction.
When you look at the retail market that is absolutely decimated by this pandemic and the online business, I think in places like the northeast, you’re going to start to see a lot more creativity with some of these sites for redevelopment, and these jurisdictions are going to ask for mixed-use. We’ll take very single-family detached we can possibly get, but we’re going to get a third of the project or a quarter of the project. There are two things at play. The significant demand is going to continue to outstrip the available supply where there are no new homes coming online and the regulatory demand is going to continue to constrain projects to denser, closer and cluster-type developments. It’s going to have to be a look in the mirror to determine what we’re going to be, certainly in these constrained markets, for the next 5-10 years.
SP: I think one of the biggest question marks is regulation. We had Hurricane Ida blow through here last night, and every radio station and television station is talking about climate change, and what we’re going to do and how we’re going to stop this. In New Jersey we’ve just had implemented new storm order requirements and regulations, these are things that only add cost to new homes and it takes time for that price and that expense to be realised by the marketplace. I think to your point about secondary markets, there’s a lot less risk, regulatory risk in those markets than there is in a place like New Jersey or anywhere in the northeast where there’s a liberal Democratic government that is looking towards more regulations on land. I think really understanding the way the winds are blowing, and our real estate projects are long-term, four, five, six, 10 years. I think a lot is going to happen to constrain land over the next five years that is going to play a big role in profitability for homebuilders.
SP: I can’t say that I’ve seen or heard anything to the extent, let’s face it, it’s a bad time politically to be putting new regulatory requirements on any businesses, so the political winds are not blowing to support, I think, what may be coming. Certainly, the capital gains tax changes that are being proposed are a big deal to anybody who is buying or selling a large tract of land, or involved with turning a profit from developing it. Those are definitely, there’s a lot of planning going on to deal with an increased capital gains tax. The local government here in New Jersey, as an example, is certainly not holding back on any of those types of things. The Biden administration, from my perspective, I have not heard the regulatory constraints on the homebuilders or anything that we do, at this time. That’s just my perspective.
SP: I think that all of the indicators are that yes, there would be more M&A taking place, and certainly the barriers to entry for homebuilding continue to grow. I think some of the metrics that have been out there do show an increase in big public builder share however, it’s 25%, maybe 30%, I forget what the number is but I know it’s been growing. I think it’s definitely an environment for more M&A. I think there’s a limit to it because there are a lot of people, I won’t say a lot of people, but finding land and getting land approved is done at the local level. People with local on-the-ground knowledge, there’ll always be that entrepreneur element that’s out there buying up land and getting it approved, so yes, I think more M&A, but there’s a limit.
SP: I think that they all reacted similarly last April, and some responded faster to the idea that we were in an inflationary environment and not a deflationary environment. I was an employee of K Hovnanian for a number of years plus Toll Brothers, and I’ve been doing work with both of them in recent months. I think Hovnanian has gotten themselves a pretty good programme and has reacted well. I think the biggest challenge for them and for Toll Brothers now is maintaining the growth. In January of last year, I think everybody was struggling to find growth, like I said, maybe the end of a cycle, and then COVID happened and flipped the whole thing on its ear. All these guys have seen, I think, improvements to their balance sheet for the last year and-a-half, for sure.
Going forward, I think the challenge is to not be afraid of the continued market-growth vs being too conservative. It’s going to be interesting to see who chooses what path. I think Toll Brothers is a company, I know this based on my experience there, that they were looking to grow the starter and move-up segments of their market as well as other market segments including apartments and the commercial, but they were doing it because they were too heavily invested in the luxury market. I think they’re doing things to move towards the middle a little bit, which is going to help them. K Hov has, I think, mastered that middle market. Chris Ryan always does a great job because they’re never exposed. They give up some of the land margin to limit their exposure so they’re always going to be a good conservative bet and they make great margins. They’re all good at what they do individually. Beyond that, I don’t know how much more I could offer.
SP: I think you have to have contingencies. At American Properties, we have projects that we could do rentals, we could convert to rentals, that’s always a contingency for us on the multi-family projects that we’re doing. As a smaller builder with private banks and individual investors, there’s going to be less willingness to hold property if a market downturn happens. From a big builder perspective, guys with strong balance sheets and lots of cash who can hold, I think one thing we’ve seen is these market cycle turns are really not tremendously long in terms of the ability to get back to an inflationary environment. A company like Toll Brothers is going to be able to weather that storm. Of course, they manage their risk by being vigilant about their competitive analysis and we do too. That’s the best way to manage risk, is to really understand what buyers are paying for, and then if there’s a correction you’re not suffering from double-digits in terms of your miss. You’re following more specifically the actual deflationary environment that’s going on. You want to be in A locations, you want to have really good comps, and you want to have optionality. Optionality is important. Those are some of the ways we deal with it.