On the heels of the first interest rate hike since 2006, I share Federal Reserve Chief Janet Yellen’s perspective and remain “…confident about the fundamentals driving the U.S. economy, the health of U.S. households and domestic spending.” Not surprising, the decision to raise rates after some 9 ½ years actually had very little to do with economic conditions… as the stock market’s dramatic rout by that historic week’s end seemed to punctuate. The Fed hiked rates simply because they ran out of runway in an effort to project and frame expectations amid a clearly firming domestic marketplace. Yet the general concern remains that the interest rate rise here, albeit “dove-ish,” was designed to prevent overheating while economic growth overseas may be slowing. That, and the furthering strengthening dollar or even continued free-fall momentum in commodity prices, will have very little direct impact on the recovery path for home-grown construction.

Yes, real estate is more sensitive to interest rates than most other parts of the economy; nevertheless, the current state of the home and construction channel is well-positioned to digest the effects from this historically significant inflection point. Short rates, after all, are most at-risk for lift… while long term mortgages will remain at multi-generational lows for the foreseeable future. The average 30-year mortgage remains around 4%, still within ear-shot of the record setting low of 3.31 reached three years ago. Moreover, those homebuyers who remain on the fence — experiencing ever-surging rental rates and constricted inventory choices — will be much more likely to finally sign contracts. According to Fannie Mae in its Q4 Lender Sentiment Survey, mortgage lenders are reporting easing conditions and expectations for further reductions in credit standards for the future, which will help mitigate some of the past constrained housing affordability, particularly for the important millennials. As recently as June of last year, first-time homebuyers accounted for 32 percent of purchases, the highest numbers since September 2012. For more information see our blog on Millennials Here.

2016: Continued Housing Recovery and More Growth Opportunities

The long, slow recovery of the housing market will likely continue. The Commerce Department reported new home sales rose 10.7% in October. November building permits were 11% above October and +19.5% year-over-year. And single-family home construction rose 7.6 percent last month to its best reading since January 2008. On a macro level, the Leading Economic Indicators clocked yet another increase in November, with building permits, interest rate spread and stock prices responsible for the improvement. What’s more, the economic outlook for the last quarter and new year are all projected positive. Long-term, the growth rate of the U.S. economy has been about 2%. Despite escalating labor costs, this faster pace of growth is likely to prevail through the first half of 2016 — possibly beyond — and will contribute positively as confidence for continued investment in marketing as well as in product research and development. Consumer spending will remain solid due to the improved employment picture with increasing job opportunities, continued low interest rates and cheaper gas prices to boot.

Projections and Strategies

While China and oil remain the two biggest variables on the global stage, our nation’s jobless rate — led by construction — is at its lowest level since the housing crisis began, which continues to build a foundation towards stronger demand for homebuilding. In fact, single family building permit activity is at the highest levels since January 2008 and overall permit activity has clocked above 1 million unit seasonally adjusted annual rate for 24 consecutive months. Despite the stock market recording its worst January start ever, many builders and building products companies express optimism for continued economic recovery yet temper that confidence with strategies to minimize their risk, should a more significant downturn occur later due to debt, lack of incentives to expand fixed capital investment or growing geopolitical anxieties.

For example, on the heels of its recent acquisition of John Wieland homes, homebuilder Pulte Group is modestly increasing its spec construction to better attract labor. Achieving a more consistent stream of work can help drive backlog conversion rates closer to their historical norms. Another strategy Pulte Group is employing involves optioning more lots for better capital efficiency. These smaller, shorter duration purchases would be easier to exit should a slowdown occur.

Homebuilder Lennar leveraged strategic land purchases earlier in the recovery and is looking to future margin expansion. The company expects a longer recovery cycle with slow, steady growth but has implemented this land acquisition strategy to reduce risk before any possible economic slowdown.

CalAtlantic Homes varies its land strategy by market and the outlook of its management. CalAtlantic expects to carry longer lot positions in areas such as California. The company has increased its focus on capital allocation and shareholder returns.

Beazer Homes is deleveraging its balance sheet. For greater flexibility, the company is not providing a specific target or range; its pace will depend on market conditions and land banking opportunities. Beazer plans to reactivate legacy land positions it had on hold and wants to take on more land banking arrangements. The company has a number of land banking partners.

While orders rose and sales grew 24% in its most recent quarter, deliveries fell short of expectations and as such margins were pinched for KB Homes. The homebuilder continues to work on four key initiatives to improve profitability and returns: increase community count, improve revenue per community, gain more profit per unit, and achieve better return on investment. KB’s Design Studios enables buyers to make adjustments to their floorplans and finishes to make their optimal home more affordable. The options offered provide premiums for the company.

Housing demand in California remains robust, according to homebuilder Toll Brothers.  The outlook remains optimistic so the company continues to actively add to its land position. Toll Brothers’ City Living offers luxury condos and townhomes in New York, New Jersey, Philadelphia and the Greater Washington, D.C. metro area. New York City remains a top market for Toll Brothers and although it has modestly cooled, margins remain significantly ahead of the company’s single family business. This is expected to continue.

Homebuilder Meritage notes it has assembled new local operators and leadership to better assimilate a recent acquisition and it plans to proceed with more caution when considering future deals. The company will pay more attention to culture and overall fit. In Texas, Houston’s moderate job growth has impacted consumer confidence. Targeted incentives will be used to address this. Meritage has started to shift its land profile and plans to open more communities aimed at first time buyers in 2016. Its goal is to grow this segment of customers, which currently accounts for about 20% of its sales. The plan is to grow the first time buyer segment by 5% annually.

Confident that the housing recovery will continue, Installed Building Products is aggressively pursuing acquisitions. Its goal is to expand geographically as well as to add to the types of products it installs. Similarly, American Woodmark has widened its gross margins to 21.87% from 16.99% last year, based on increased sales to its dealer channel and direct-to-builders strategy who are continuing to make the choice to invest in higher-end homes.

Due to projected growth in the U.S. population for the next decade, demand for all types of housing should increase. The Mortgage Bankers Association anticipates 13.9 million to 15.9 million additional households will be formed by 2024.

Projected Household Growth by Race:

  • 5 million to 5.7 million more Hispanic households in 2024 than in 2014;
  • 4 million to 5 million more non-Hispanic white households;
  • 8 million to 1.9 million more Asian households;
  • 4 million more black/African-American households; and
  • 730,000 to 890,000 more households other than the four major categories listed above.

Two demographic segments – Baby Boomers and Millennials – may be the biggest contributors to household growth. More renter households will be headed by someone age 60 or older in 2024; and about an equal increase in renter households headed by someone age 18 to 44 is projected. Home values are also increasing, with growth at the fastest pace seen since November 2014. Low inventory has driven up home values, and hot markets such as Denver, Seattle, Dallas and the Bay Area, have spurred the housing recovery. Higher demand for move-up housing has increased median home prices. Buyers are seeking larger homes, even those people who might be viewed as candidates for downsizing. Highly competitive, the current market is seen as favoring the seller, with buyers submitting multiple offers.

 

Green Growth

More than half of home builders predict 60% or more of their new homes will be “green” by 2020, according to a study by Dodge Data & Analytics, the National Association of Home Builders and Ply Gem Industries. Consumers in the age group of 55 and older are driving the green market. Those homes are associated with healthier living.  More green elements and healthier living environments will likely boost home prices. KB Home has begun offering energy efficiency options for its homes. It has introduced a graywater system in a San Diego community that recycles water from dishwashers, showers and other fixtures to use for the home’s landscaping. The company said it is looking to expand this program to other markets. Demand for green housing may increase further in response to renewable energy and environmental concerns.


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