A friend of mine moved to Orange County, Calif., just before the housing market collapsed. He paid more than $1 million for a high-rise condominium that in lightning speed dropped about 40 percent in value. He’s been consulting the economic soothsayers ever since, sending me clippings from local publications about improvements in the Orange County housing market.
As I sorted through the latest stack of articles about Orange County that arrived in my mailbox, I noticed a number of the clippings reported on new residential developments, condominiums, apartments and single-family.
Now, I thought, that is a tangible sign that the Orange County market is actually turning around. (I lean more on sales of new builds rather than existing-home sales as an indicator of the health of a housing market.)
In regard to Orange County, one clipped article noted that Toll Brothers Inc. has bought half of the 2,379-home community for the Baker Ranch in Lake Forest. Soon afterward, I picked up the Wall Street Journal where I read Toll Brothers experienced a 46 percent increase in third-quarter (ending July 31) earnings. Other big homebuilders such as PulteGroup and D.R. Horton also notched higher earnings.
To me, all this indicates if not a turnaround for homebuilders, at last the bottom of the market has been reached and it’s time to climb back out. I should temper such excitement by adding that the market still has a huge way to go before the industry looks anything like it did before the fall, but progress is progress.
According to the Eye On Housing blog, from peak to trough, new-home sales fell 80 percent from July 2005 to February 2011, but starting in fall 2011, new-home sales increased 22 percent. Eye On Housing expects new-home sales to reach 372,000 this year.
Another housing blogger, Calculated Risk, reports 2012 will be the first year since 2005 that new-home sales will climb above year-prior numbers. It expects 360,000 new-home sales in 2012 versus 306,000 in 2011 and 1.2 million in 2005.
Calculated Risk also said the ratio of existing homes sold to new-home sales is normally 6-to-1. Today, it’s about 12-to-1, which is an improvement from the abyss when it was 18-to-1.
Outside the industry itself, others are beginning to take notice that things are looking better for homebuilders. In August, Wells Fargo, as an example, announced it was unveiling a new division that will solely focus on lending to regional and midsize homebuilders, a group that uses debt to purchase development land.
The last note is interesting because Steve Friedman, Ernst & Young’s U.S. homebuilding co-leader, tells me one of the biggest concerns of homebuilders today is accessing entitled lots on which to build close-in communities. Wells Fargo is looking to make sure at least some builders will have the capital to purchase those desired lots.
For the past three years, Ernst & Young has been surveying the chief financial officers at more than two dozen major U.S. homebuilders to gauge market sentiment for new homes.
Lately, CFOs have been a gloomy lot, and you can’t blame them. Since 2005, it’s really just been about survival for homebuilders, and slicing and dicing numbers wasn’t a happy experience. Granted, almost all the major homebuilders did make it through the recession, but homebuilding is mostly an entrepreneurial enterprise with 10 times more small builders than large. Friedman guesses that about 50 percent of all homebuilders evaporated during the Great Recession years.
When a homebuilder is developing a new community, it does an accounting test to see whether or not the sellout of the community will get the builder back at least some of its money, because if the builder makes money, it won’t have to "impair" the carrying value.
"The recession was so horrific that builders took impairment charges of more than $40 billion," Friedman said.
While homebuilding, per se, evaporated, banks were supportive of the industry in general and large builders had no trouble restructuring balance sheets.
"Builders have refinanced debt at lower rates with longer terms," Friedman said. "And now they are starting to generate profits. Most builders are healthier now than 24 months ago."
When Ernst & Young first did its survey three years ago, 52 percent of CFOs polled expected their companies to see a net loss for the year. In the current survey, 85 percent of CFOs predict their companies will either break even for the year or realize net income in 2012.
A host of factors influenced the CFOs to predict positive outlooks for the near term: Builders have become more efficient and can generate gross margin off of lower prices; redesigned and more energy-efficient homes are more attractive to consumers versus existing product; the economy is slowly improving; household formations are increasing; and homes are more affordable than they have been in decades.
In addition, a lot of competitive existing-home product has been removed from the market; 37 states now have more demand than supply of resale homes.
"With interest rates for mortgages incredibly low and home prices at a point people haven’t seen in their lifetime, based on nothing but economics, this is a really good time to buy a house," Friedman said.
My buddy in Orange County isn’t moving anytime soon, but when he reads that new luxury condos are going to be built in nearby Newport Beach, which will carry price tags of $1.4 million to $3 million, he guesses that bodes will for his condo.
He figures, since the bottom of the market, his condo has regained abut 40 percent of its lost value, which isn’t too bad considering Orange County was one of the California markets hit extremely hard by the recession. After all, Orange County was home to the subprime mortgage industry, and that was thousands and thousands of jobs that disappeared. I guess you reap what you sow.