Cutting construction costs by “aggressively rebidding” projects, and “walking away” from land deals: executives in their own words.
By Wolf Richter for WOLF STREET.
Meritage Homes, which specializes in building entry-level houses, reported Q4 earnings on Thursday. In terms of revenues and income, they’ve been working through their backlog.
But sales order volume collapsed by 46% in Q4 year-over-year, to just 1,808 houses. Sales order volume in terms of dollars collapsed by 52%, to $704 million.
Orders got hammered by “weaker overall demand,” they said during the conference call, and because customers cancelled 39% of their contracts, up from a cancellation rate of 12% in Q4 2021.
And there was the dramatic plunge in the average sales price (ASP) of the houses that were ordered in Q4. The ASP for orders dropped by “20%” or “almost 20%” from the peak, as they phrased it (actually -19%), from $480,000 at in Q2 to $389,000 in Q4.
These sales orders aren’t included in the revenues yet – only closed sales are included. But those that don’t get canceled will show up in revenues when the houses are delivered and the sales close.
According to the executives on the conference call, this drop in the average sales price (ASP) for orders wasn’t due to a change in the mix of homes sold, such as more low-end homes in the sales order mix, but due to actual price cuts, mortgage rate locks, and mortgage-rate buydowns in order to revive sales order volume.
Cutting prices 20% revives sales order volume.
“Our position is that we’re an affordable builder,” CEO Phillippe Lord said during the earnings call (transcript via Seeking Alpha). “We have to get to a payment that makes sense for our customers.”
“We have taken additional actions to get back on our [sales] target, including lowering prices and utilizing a full range of incentives such as mortgage rate locks and rate buydowns, until we find the market clearing point to move our inventory and get back to our target sales pace,” Lord said.
CFO Hilla Sferruzza said: “We’re comfortable at our current pricing structure. We’re down almost 20% from the peak and we’re able to sell at an acceptable pace. So we don’t feel like we need to move it any further at this time, although we’re constantly adjusting with market conditions.”
January sales order volume increased from Q4 and showed that the 20% cut in ASP worked in perking up sales, they said. The company gave guidance for Q1 based on the sales in January, but withheld guidance for the rest of the year due to “limited visibility and market conditions.”
On general market conditions.
“We’re not sure the market, frankly, is any better, other than the fact that it’s the spring and not the winter, and interest rates have somewhat stabilized,” Lord said.
“Today’s higher mortgage interest rates continue to pressure housing prices as monthly payments still remain above 2020 and 2021 levels despite price cuts and rate locks,” Executive Chairman Steve Hilton said.
“We believe that until rates stabilize, home sales activity will remain choppy,” Hilton said.
“We see some potential buyers who could qualify but are waiting for further price declines as they anticipate additional builder incentives are coming,” he said.
“Other current buyers with rate locks in place or below current market mortgage rates were cancelling due to buyer hesitancy as they may have been nervous of the general economy or their own financial positions,” he said.
Reducing construction costs by “aggressively rebidding” and “simplification of the product.”
How can a builder cut their average sales price for orders by 20%, even as their sales orders plunged by 46%, and when their overall margin is just north of 20%?
“We expect that price concessions, elevated discounts, and a continuation of financing incentives for rate locks and [mortgage rate] buydowns will negatively impact gross margins in 2023,” explained CFO Sferruzza. So there’s that.
“Our purchasing team is actively rebidding our vertical costs to capture cost savings as incremental capacity is growing within our supply chain,” Lord explained. “We are pursuing cost savings across all cost categories in all of our markets this year.”
“We’re going through an entire rebidding effort right now,” Lord said. “We’re aggressively rebidding all of our communities for spring starts. We also have been holding off on opening some new communities to really rebid those to get our vertical costs as far as we can.”
In addition, some cost savings are due to “some increased efficiencies and simplification of the product,” he said.
“We’ve seen in some of the hardest hit markets that we’ve recovered over $15,000 per house [in construction costs] which, on a $200,000 construction budget, you can do the math,” Lord said.
“Where we’ve made the most meaningful [price cuts], in Phoenix and Denver, is where we also saw the most meaningful direct cost savings, which have softened what our margins have done,” he said.
“When we quoted earlier in our script that we got $15,000 per house, that’s in Colorado and Phoenix… where the market has adjusted the most, and also where prices ran up the most over the last three years,” Lord said.
“Walking away” from land deals.
“This quarter, we continue to right-size our land portfolio, walking away from underperforming land deals or recently sourced deals where we could not secure closing extensions,” Sferruzza said. In Q4, the builder walked away from about 3,700 lots and booked a write-off of $4.2 million, he said.
But the builder still ended up with 4.5-year supply of lots, within its target of 4 to 5 years. “So we’re comfortable that we have all the land we need right now,” she said.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
For every 1% increase in the 30 yr mortgage rate, there is a 10% drop in price.
Peak housing prices were set at around a 3.25% to 3.5% rate. So if the 30 year mortgage rate settles around 5.5%, then housing needs to at least drop 20% to 25% from peak pricing levels.
Also, the home price to household income ratio should be around 4 for a 30 year mortgage rate of 4.5% to 5.5%.
The ratio is 5 for a rate of 3%, based on my own experience securing a VA mortgage in late summer 2016 and what the regional bank mortgage broker stated, in addition to total monthly payments (principal+interest+insurance+taxes+HOA quarterly assessment) not being more than 37% of household income.
The mortgage broker reminded me I was foremost buying monthly payments as the bank owned the home until the loan was paid off.
A $400,000 mortgage would correspond to an annual household income of $100,000 to $133,000. Granted, a buyer may make a 20% down payment for a $400,000 home given they may have proceeds from a previous home sale, stock sale, etc.
Median household income was around $72,000 in 2022.
Median sales price is around $467,000 in last quarter of 2022. It was $329,000 during first quarter of 2020 :-/
Very Respectfully, AD
Nice summary, but I’ll be really surprised if mortgages settle at 5.5 anytime soon. I think people are going to be quite surprised when inflation doesn’t go down much, if at all, over the coming year.
Bond yields have been going down hard, despite Powell raising rates. Bonds are basically screaming at Powell that he is tightening right into the teeth of a recession. The isle curve remains heavily inverted, and the 10 year keeps going down. So it’s very possible mortgage rates can go lower than they are now.
Powell is going to be forced to pivot, by the bond market, specifically the 2 year yield. The Fed has always followed the 2 year yield, with its Fed funds rate.
How exactly is the bond market going to “force” Powell to do anything?
As wolf noted in past articles, rates are in an upward trend. These temporary dips are normal.
The Elliot Wave People believe the bond market sets the rates and the Fed follows in lockstep.
haven’t seen to many Trumps out there yet
It’s were big guy goes bankrupt and stiffs SMALLER contractors
Mike R.
Well the reversal in bond yields has…reversed. There have been large increases for the past two trading days. Surely the “hot” jobs number from Friday can’t be accounting for all of that.
I don’t think the Fed would pivot because of any slavish attachment to the 2 year rate – or even the onset of a recession which I do believe they are prepared to accommodate.
But I DO think they WOULD pivot in response to any of the following:
a) A major credit market event (think: Sept, 2019 repo market crisis)
b) A mandate from the national security establishment that they cannot front-run tightening ahead of other Western central banks (in effect exporting our inflation to those other countries)
c) A muni-bond crisis
I suspect we’ve already seen “b” at work since the fall – at least in a small capacity. “c” is not imminent – but there’s a growing probability of it the longer rates stay high. And I just cannot bring myself to believe that we can go on much longer without “a” happening.
Something has got to give.
Mike R,
“Bond yields have been going down hard, despite Powell raising rates.”
LOL. You should have said, “bond yields HAD gone down hard…” or “WENT down hard.”
Because now, the 10-year yield is spiking!!! It just blew past 3.64% Up 25 basis points from Thursday. The bond market bluffed, and the Fed is calling the bluff.
Best laugh all day so far. The Fed isn’t forced to do anything by the market. You are hilarious.
Good traders have known for decades not to fight the Fed, why are bond traders so full of hubris now to think they are different?
the really interesting thing is that the Federal Reserve essentially cant reduce the balance sheet with these higher interest rates unless they want to wrack up some very large losses, so they seem to want to kill off inflation with rate hikes and allowing the balances to roll off.
so let’s assume that works. once they start to lower interest rates, they will begin selling off the balance sheet, because with lower rates they dont take a loss on the sale of the bond. that allows them to reduce the bonds even faster by outright selling them. but by increasing supply of the bonds in the market it might actually push rates higher. this is probably like walking a tightrope, where every move must be carefully counterbalanced.
let’s assume that inflation remains sticky. what happens then? well we have stagflation, as the economy rolls over, but inflation does go away. it might be possible that with a balance sheet as high as it is, the inflation cant be reduced, as there is simply too much money chasing around. in that case, higher interest rates increase the unrealized losses of the Fed and so they cant liquidate the assets without a loss, yet that is precisely what they need to do to bring down the inflation.
i think that our economy is much more precarious than we really imagine. the central bankers have executed a crazy experiment in monetary policy, and now it has to be cleaned up by the markets. but the devastation that could happen is extremely high. massively high.
or maybe things hold together enough that we escape this carnage. i dont know for certain, but my guess is that the idea of a soft landing is going to be a joke in two years from now.
SocalJohn, I checked Ycharts and the 30 year mortgage fixed rate (average) bottomed 2.7% in January 2021, peaked at 7.1% in October 2022, and is now 6.1%.
It has steadily decreased since October 2022.
I am not saying it’s going to happen, but there is a theory that rates will come back down very quickly. The more debt, the higher the debt service and the less able the economy is to handle it because debt service inflates it away.
Just round off the total lag in Fed policy to about a year. So what things look like a year from today is what we should be pondering. Split government means no more helicopter drops of money and no big tax cuts to goose things.
@Old school,
Don’t expect the government to stay split for long. Stagflation has a strong “anti-incumbency” tendencies after all.
As to your last paragraph…don’t forget the House and Senate were split in 2020 but generous PPP loans and Household Stimulus payments were passed.
I looked up what Meritage was offering in Florida and I do not think we are near the bottom. The average person cannot afford the average house. The market does not care what it cost you to buy a lot and build a home. I believe we will see a significant further decline in single family home prices. I also think there will be a global recession and those humans that profited from (or at least sidestepped) the downdraft will be pleased with the bargains offered at the bottom.
+1
Yellen: “You don’t have a recession’ when U.S. unemployment at 53-year low.”
I agree with your assessment, but I think it’s more of a 2024 thing. The labor market remains WAY too strong for anything big to happen through the first 9-10 months of this year. And, inflation may actually make a small come back over the summer.
Location location location.
FL TX AZ ..still more buyers than sellers according to with whom I speak
AZ and TX were specifically pointed out buy the builder as the weak points. AZ got the biggest price cuts, but also the biggest cost declines because the contractors are now low on work and cut their bids when the projects were rebidded.
People’s opinions of what constitutes s good climate varies a lot.
I’ve lived in six states spread across US.
All had okay certainly not great climates in my opinion.
Quick opinion on Dallas climate…lived there 11 years.
From mid October thru April its either good weather (some beautiful days in February or March, late October), slightly chilly, or cold (December, January blue northern blow in).
May is good and bad ( starting to get hot and humid).
September is hot. June is hot and humid.
July and August are very difficult months.
Its usually 75 to 80 at 5 am and quickly in the mid 80s headed for 100. I’d ride my bike at 6 am to beat the heat but it wasn’t pleasant.
There is risk of large hail and tornados.
All the other places I live have their downsides: lots of cold, too much snow or rain, too.much humidity, etc.
Redwood City was very nice, one year.
Way too expensive for me today.
Near Seattle pretty good climate. A bit too chilly and dreary but I mostly liked it.
Also way too expensive today for my circumstances.
Spokane Valley looks pretty good on paper climate wise. Recent years too much hot weather and smoke in the late summer and fall.
Trade off: not much rain nice. But now drought concerns are starting to be a concern. Not like the southwest but it is a real concern. Wildfires definitely a concern throughout the state (and in Idaho and western central Oregon).
I probably bore people with these climate comments.
Mortgage Rate buydown is a SCAM that you should be aware of.
1. The buyer loses out on the opportunity to save for a future drop in mortgage rate through refinance and this benefit goes to builder. Remember, the sold price of house is constant. The mortgage rates vary.
2. The retail buyer cannot buy down mortgages, so reselling this house soon will result in big loss.
2. The buyer pays higher real property taxes and higher RE Agent fees due to artificially higher house price. Some idiot here will say that seller pays the RE agents, I would agree on that only if house sells at a loss, that is not normally the case.
3. The builder likes it because then it can keep the paper price of house higher that helps fool future buyers and help him cook the book.
Never accept “Mortgage rate buy down”. Do the Math and ask for equivalent discount on Sale price.
I think you’re wrong on “retail buyer cannot buy down a mortgage”. A seller / or buyer can pay “points” on the mortgage that is the equivalent, though for the entire term of the loan vs. a few years. A buy down is simply prepaid interest that is paid when the interest to amortization ratio is the highest. Most buy downs are only for a few years…. which then snaps the buyer in the a$$ with a wet towel a few years later when it expires.
Lowering the price to the equivalent of the buy down vs. the buy down doesn’t pencil as it doesn’t impact the interest to amortization ratio in the same fashion. The cost of a short term buy down is chicken feed.
On a new build, the best advice I could offer is strip out the gingerbread such as extra outlets, recessed lighting, granite countertops, buy your own appliances (take the allowance), take the flooring allowance, and spend the money on things that are difficult to upgrade at a later date.
I’ve purchased three new homes and while you can upgrade the appliance package, you will never receive an allowance in FL or NY. In FL, I wanted to upgrade beyond what was offered and could not because the builder must have appliances in place to get the certificate of occupancy from the state. So I got stuck with over priced GE appliances which I knew were crap.
If I wanted a discount I would ask for a credit against closing costs.
Petunia, credit is a bigger scam than mortgage rate buy down.
$480K starter home. ROTFLMAO
I looked this company. They’re basically building in the SE & CO.
Nice write up!
I was thinking the same thing. Already in Houston, you can buy a 2500+sf house for $325-350K.
yup> Principal, Interst, Taxes (PIT). Arithmatic, not complex calculus. See where it settles.
Good numbers but too broad. Prices are regional. Some areas will drop more in price than others. My flyover state.
Average household income is $82,103
Median Household Income $64,091
Median house value is $170k.
I suspect I see at most a 5% drop in price in my area. A 20% drop would make a house super affordable at barely 2x median income.
A lot of people invested in real estate think the same in my city as well
They think we are special and prices won’t go down a lot
Nice info AD!
What people might not be considering is that assuming prices continue to drop, there will come a time when homeowners start to go underwater and will walk away from homes or they go into foreclosure. that process will take a long time, but it puts even more downward pressure on home prices until it clears out of the market. we are seeing the reverse psychology of the previous time periods, where buyers thought that any home they bought would go up in price. now any home is going to drop in price, so buyers stand on the sidelines and wait.
home owners have still not capitulated one bit. inventories are still low and need to grow alot before the bottom is put in.
I agree. Nice summary AD, my gross income last year no overtime was somewhere around 80k. With overtime it was 153, netted maybe 93 after taxes (NY is horrible with that).
Between part time wife and I, we do about 225 gross, maybe 150k~ after taxes. Average home price in Long Island is somewhere in the 600-650 range, most in the 750-900 range for a decent south shore home in a good town and good school district. Average monthly payment is $4-4800, not including utilities.
We tried to budget on one income Incase she lost her career (pharmacist), I have pretty much guaranteed job security (lineman for the local utility, union etc), but it’s literally impossible at this point in my career. We both have to keep our current situation going to make ends meet and still save enough every month in case of an emergency.
Our 20% down would work on a 400k home…problem is there are none around, not even in the run down poor areas.
The significant price drops may be starting. Just saw an existing home in a Seattle suburb sell in January for asking price the day it was listed. Unfortunately the asking price was 33% less than what it sold for 10 months ago.
That seems like an outlier, but maybe sellers are starting to panic, or some have to sell. The neighbors won’t be happy with that comp.
Sadly by and large not in SoCal, at least not in certain areas like South OC or decent suburb, in fact saw couple of private sellers and home builders even listed on Redfin with price increase. The delusion is thick around here..
You got that right. I’m still seeing sky high prices in New England. A builder in Maine is trying to sell new homes from deals that people backed out of for $200k-$300k more than they were at the beginning of 2020 for the same model of home. The only incentive the builder is offering is to “buy down the interest rate”, which essentially means they will raise the price in order make it look like the buyer is getting a deal.
@Lucca,
The housing market in certain sectors of Greater Boston has gone from “white-hot” to…plasma.
We’ve seen a sizable influx of buyers from Western and Northern Europe since late-spring last year and it isn’t hard to guess why. They seem motivated to say the least.
Yes there are pockets of weakness (e.g. North Suburban Boston) – and I’d say it’s enough to have be lowering the YoY increases vs. 12 months ago – but overall it’s clearly a seller’s market.
I am in San Diego and seeing 18 percent down from peak .
I think OC would fall last but fall the hardest
Difficult to keep the charade going on with increased rates and increased lay offs in tech sector which pays quite handsomely
Have lot of friends in oc working for tech giants
Yup, hope you’re right. Here’s anecdote of the insane delusion still thick in SoCal. Look up Hotpad, just saw a 2400 sq ft house for rent in Signal Hill (near Long beach) for $12.5k a month..that’s right $12.5k a month. Had a good laugh there, immediate thought comes to mind, either someone is extremely greedy or want some other sucker to be the bagholder to cover the unaffordable mortgage. One look at the housing history, it’s likely the latter since the house was just sold not that long ago.
$12.5k a month, hate to think what that “RE investor” current carrying cost is right now…I think there are plenty of these examples all over SoCal. Next question would be, can’t find another sucker to cover this kind of insane rent, fire sale at some point?
Next problem property tax should be lowered on lower valuation,which will squeeze local governments income. Followed by lower insurance premiums,read snowball book about Warren Buffett,I believe this all about to work in reverse, What A Mess
Property taxes aren’t dependent on valuation. The taxing authority votes on a budget then divides it by the valuation to get your rate. Higher valuations = lower rate, lower valuations = higher rate, in either case the revenue is the same.
jr: It depends on your local laws. Our property taxes here in AZ have dropped with re-evaluations. Had similar experience in CA.
Those $200,000 – $350,000 / year suburban Chicago school district assistant superintendent and superintendent salaries and pensions with automatic COLA adjustments gotta be paid!
What or who is New Era?
era = period of time market by a distinctive character, events, etc. For example, “The era of steam power.”
In this case: the era of excess inventory, plunging orders, and big price cuts.
@Dave,
In my world “New Era” was a ski shop that opened up in Thousand Oaks, CA, back in the mid 70s when I was a kid. In the late 80s or early 90s, the owner sold the shop and moved up to Mammoth Mountain. Used to see him working in the ski shop at the Main Lodge.
Those were the days!
…in an older era it was considered the point where ” ‘the establishment’ subverted the dominant paradigm “… (or vice-versa).
may we all find a better day.
New Era was a brand of potato chip.
ElK – baseball caps these days, I’m told…
may we all find a better day
“In addition, some cost savings are due to “some increased efficiencies and simplification of the product,”
Slightly lower price, substantially lower quality?
Fewer customization options.
When it comes to cheapening the construction of homes, builders are geniuses. Meritage, a “low-end” home builder, must be getting very imaginative at this point if they’re cutting costs further.
HowNow I think you’re right. It’s one thing to let the market lower prices, but how are they cutting costs in this climate? All home builders pay about the same for materials — and they’re already very cheaply built — so other than paying their workers less, where are these savings coming from?
You’ll probably see these same homes blowing apart in the next big hurricane.
They push the cost cuts down to the contractor level. Many of these guys have been buying the $80k trucks. Cement layers, roofers, painters, carpet-layers, plumbers, electricians, landscapers, finishers, masons, etc.
In Omaha there advertising 2×4 for 2$ =disinflation hahaha
It means job security for the plumbers who pass on new construction.
The service work when the china made crap fails will always be there.
Yep. Dealing with a warranty department on some plumbing and workmanship issues with my 1yo build now. If corners could’ve been cut somehow (even at a cost of dramatically lower quality), rest assured, they absolutely WERE cut.
And this is just one home builder that targets the affordable home category! I imagine the higher end home builders are really getting clobbered, the segment where most builders have been competing because land prices have been so high. In Utah, this segment has been massively overbuilt (range of $1 MM to $1.5 MM) in Utah and Davis counties.
DTI >36. Some California areas running 60%. Denver Metro running 50% plus. No shortage of Range Rovers, BMWs, and higher end SUVs on the road. Yes the American dream is live and well. I wonder if subcontractors revisiting labor cost to help on savings. Quality and workmanship might start to suffer on new construction. Liquidity is at a premium, cheap borrowing cost evaporates. Markets no longer have supply and demand problem, only buyers looking over the edge of the cliff wondering how far down prices will go. FOMO fever has gone. Sitting on 2.65% wondering how the hell anyone affords 7.0% plunge.
Where is OC?
Orange County, CA
Thanks Wolf! This makes everything even more real. Plus we still don’t have real rates happening for the inflation we are experiencing. Wolf, rates climbed for about forty years till 1981 and dropped around forty years, do you think it is possible they could rise much higher? Like double digits? I’m waiting for it.
Today I learned that a $480,000 home is considered “entry level”.
Meanwhile, about 2/3 of individuals aged 18-65 and about 1/3 of households couldn’t afford a $1200/month housing payment, assuming a 3:1 gross-to-housing payment ratio. That comes out to a mortgage for $180,000, which if I’m not mistaken, is about the going rate for a broom closet in most cities.
Have broom closets gotten that expensive?
Broom closets with granite shelves and hardwood floors. /s
Ha, my thoughts exactly! Just shows how bubbly the market was and still is.
The sooner this building pattern goes under, the better. These companies need to die. They’re right about three $200k construction budget. In a sane world these homes would be priced below $300k. Suburbanization has taken away a lot of viable land where more density is needed. Speculation has turned home building into an extract maximum profit at all costs endeavor. We need to start building like we did before WW2 again. What ever happened to mixed use density, 1-4 unit homes, many with first floor businesses. There’s a reason that FNMA products consider a home anything up to 4 units – this had been how we used to build. As resources get more scarce and if our building pattern doesn’t start changing real soon our empire is going to get fooked.
Wherever today’s home buyers are, they must be under a roof somewhere because it’s estimated that less than 0.2% of Americans are actually homeless. So let the buyer’s strike begin!
The “housing shortage”, with lots of demographic mumbo-jumbo to define it, is artificial. Even if partially true, a general refusal of home buyers will drive down the exorbitant costs of both homes and the hardware that they’re built with. That is the only way this monstrosity of home pricing will return to something approaching normal. If buyers are going to remain horny, then price inflation will resume.
Anecdotally as someone in medicine that interacts semi frequently with the homeless via trauma call shifts, a majority of the truly homeless (ie living in the streets) are either grievously mentally ill and/or addicted to drugs. I’ve taken care of more than one person who had a 9-5 and a Roth IRA who for one reason or another got a taste of the good stuff and quickly threw their lives way to live in the streets because that’s where the dealers are. Any social support system they had they burned through quickly in ways you can probably imagine.
I have never met a “normal person” who is homeless. That doesn’t mean they don’t exist and it doesn’t mean the “not normal” homeless aren’t deserving of pity and help, but it does make me firmly believe that homelessness is NOT due primarily to the cost of housing
Bingo. Most normal people have friends or family that can help them out in terms of a place to stay for a short term problem. But of course, no one wants an insane person or a drug addict around their children. That’s why the mentally ill and drug addicts end up on the streets. Their friends and families, while they do usually care about them, prioritize their own safety and that of their families, understandably!
The “normal” ones live in state/national campgrounds, cars, vans and their friend’s couches. Or they squat. Rarely on the street, except on the west coast far away from city centers.
Just one anecdote.
Was leaving the library a few years back.
A woman was talking to some guy.
She claimed she was homeless. Had been a nurse, i guess lost her job (?).
She said she had to leave her home/husband because of domestic violence. Was living out of her car.
She sounded quite rational to me but heck I’m no doctor just have a masters in compsci.
I have no idea what became of her. Eastern Washington state.
Yes yes. Sample size all of one.
I happen to believe … w/o evidence to back it … that money … enough of it.. . would do more good for some, maybe most homeless than mental counseling.
The media heavily plays up the need for the homeless to get mental health counseling. Some in the health care industry benefit. How about that. Cynic me.
Again it depends on the homeless person… but I bet half of them would benefit much more from a check of $100,000 (no small amount) with some financial counseling… versus say 2 years mental health counseling.
Some might need both (perhaps not $100k or 2 full years counseling).
Both necessary… neither sufficient in and of themselves.
They have gigantic mortgages; they are ‘house poor’.
True Dave. Definitely part of the problem. Check the “Not Just Bikes” channel on YouTube. He has some good content on the “missing middle” – the part of housing that can’t be built in large parts of many American cities because so much of the land is zoned only for single family housing.
I’ve heard about it, but I don’t do much video watching. I have a low tolerance for watching something 20 minutes long that can be conveyed in a 2 minute paragraph.
In the city I grew up in there are not many big builders – New England’s suburban boom happened several decades ago. But there are many successful builders and you know what they do? Tear down dilapidated 3-4 family buildings that are 100+ years old and build what, single families in their place. In a city with a bus network and compact layout.
It makes no sense, until (like me) you end up in the trades and discover what builders are up against now. You cannot build a 3 family building anywhere in this country any more unless you have a doctorate in engineering. Trying to figure out the fire codes and egress requirements is ridiculous – so it’s just not done.
You can thank the NFPA and ICC and the relentless lobbying by various parties that have an interest in making single family homes (and duplexes fall under these codes) the only type of housing we build (the SUV/pickup trucks of houses!). You can also thank lazy states that blindly adopt national codes from these bodies (because thinking is hard – what fun is it to be a legislator if you actually have to make your own laws?).
Building materials are way safer than they used to be, but the modest 3-12 unit buildings that we used to build extensively in the 60s-80s can no longer be built without extensive planning and engineering costs. So if they get built at all, they are high end condominium buildings in high income areas.
So these builders are not jerks – they’re just doing what is profitable and easy. If we changed the codes and planning requirements that held 3 and 4 families to 1-2 family standards, you’d see more of this construction overnight.
@Digger Dave
Excellent post. Very accurate as far as I can tell.
Interesting post Dave and thanks for that. It begs one further question. Would the cities with high homeless populations benefit the homeless situation more by simplifying their housing code, planning and permit requirements than they do by trying to build city homeless shelters?
The Atlantic published an article in December which argued that lack of affordable housing is the #1 cause of homelessness. Not addictions or mental illness. You have to think that easing the red tape (and thereby increasing the incentive to build multi-unit housing instead of only single family homes) would be helpful.
They block minorities,
DD: Multi-unit residential is booming here in the major metros of No. Carolina. By multi- I mean 100-400+ units. These builders typically specialize so their understanding of code must be part of their cost of doing business, and they aren’t deterred.
Digger Dave,
“$200k construction budget. In a sane world these homes would be priced below $300k.”
Just to make sure: the $200k “construction budget” is just the construction cost of the house (materials, labor, etc.). It doesn’t include the land and any of the other costs.
They’re trying to keep their margin at about 20%, as they pointed out. So if the house sells for $390k now, and they make a 20% margin (which is now getting squeezed by the price cuts), it means their margin was about $78k, and their total cost in the house, including land, etc., was about $312K.
Out of this margin of $78k, they also have to pay their corporate expenses, marketing expenses, interest expenses (they have debt to fund land acquisition and construction), and other stuff, plus taxes. And what’s left over is net profit, if any.
Thank you for the explanation. This large scale development is very top-heavy, just like our medical system.
I have worked for some small local builders whose land acquisition costs, all administrative costs and construction costs are below $200k (even in the inflated market of the past few years), homes which they sell for below $300k (which in my rural area is barely affordable).
Loosen the regulations and we’ll see more of this “missing middle” building by smaller developers with very low administrative costs.
greetings from Canada … house price inflation in the world, a product of QE , where the availability and price of credit overwhelmed the fixed amount of assets required to absorb supply , now has a partner in consumer price inflation , where the covid subsidy of purchasing power met lockdowns and restriction of production…..both of these strategies , the first being intentional , the second a result of misjudging human behaviour , are a policy distortion of supply and demand ….markets do not clear until policy interference is removed and with the global central bank addiction of macro management as fundamental policy , do not expect a return to ” normal ” anytime soon in terms of consumer inflation or housing prices
Right now I see in southwestern Ontario a standoff between potential buyers who will bid this year’s much lower price and sellers who ask last year or peak bubble prices.
Affordable houses up to 400 k sell fast, even if they are old and in a bad area.
Cut your losses with 20% down. Great. The Fed will not cut rates. In 2025/26 the RE market might recover. Prices, down 33% – 40% in
nominal terms and 6% – 7% mortgages will be the new normal. The days of zero rates are long gone. After seeing blood in the streets and construction sites skeletons a combination of lower prices and normal mortgages might attract home buyers.
@Michael Engel,
I’ve no doubt that the fed will be willing to accommodate a recession to fight inflation – but…
a) No way housing (which has huge replacement costs) goes down 33-40% in an inflationary environment – which I believe is destined to continue
b) The US fed absolutely would pivot in the face of a major credit market event (or events) – and I just cannot see that/those being forestalled for very much longer.
As the homebuilder points out, construction costs are going down too.
It does not matter how much is the inflation.
Home prices would be dictated by affordability which is dictated by monthly mortgage payment which is dictated by 30 yr loan which is dictated by inflation and other factors.
This time the inflation and record high bubble home prices are coming together which didn’t happen during last inflationary time.
People do have short memories.
Well, no shit: if mortgage rates spike, you have to cut your prices, or watch your sales crash and burn.
Wonder how many meetings and “breakout groups” it took to figure that out?
The same amount of experts it took to realize that if you print trillions and hand it out for free, you get inflation. Crazy stuff.
A room full of consultants with flashy power point presentations.
Definition of consultant: Someone who borrows your watch, tells you what time it is, and keeps your watch.
Meritage homes for sale in Sacramento, Davis, woodland CA corn fields, from 600K to 900K, for retired CA firemen from SD, an old couple who escaped SF or LA ==> too expensive for most young Latino families.
I know it’s not a popular outlook here on Wolf Street but Powell will pivot. Politics will force his hand as always. The 10 year is also screaming at him . The real problem is the debt ceiling and what that will do to rates. Would love to hear some comments on this.
No he won’t. He well understands that inflation must be stopped, and the only way to stop it is to cut off easy money.
Everybody loved the party, now pay the piper and endure the hangover. Until it really bites hard.
The Fed blinked under Yellen, now she has zero desire to let inflation roar. Wait until the Trump tax cuts expire to really hear some rich folks howls. LoL.
Powell doesn’t want to be William Miller, so up go rates. The hot labor market means that he can do it. The really funny part is we have effectively outsourced the labor to huge numbers of illegal immigrants under fly by night contractors, so we get no big jump in unemployment until we lay off the sales girls and mortgage sales people in the office.
So much of our economy is now geared to these massive credit expansions that we will have quite the adjustment in how to do business. In short, rather than grab assets as fast as possible, now ROI will be king. What is your return, because the hurdle rate will matter, a lot.
You do realize that the Fed’s dual mandate is jobs and prices, right? The longer the job market stays stable, the more emboldened the Fed will be to raise rates to control prices. They could not care less about the 10 year yield. So glad that I gave up watching the markets long ago. It makes it too easy to miss the trees for the forest. Thanks to reported here, it’s clear that Fed rates are going to climb for the time being – rapidly at first and now slowly, perhaps with pauses, but still going up.
The bottom line is no one trusts Powell. Having him try to fix inflation is like asking the arsonist to help put out the fire. I don’t know if he’ll pivot. He probably won’t this year, but we shall see.
@Lucca,
Fool me once, shame on you. Fool me twice, shame on me.
No one knows what Powell will do. Even Powell.
breamrod,
“…but Powell will pivot. Politics will force his hand as always. The 10 year is also screaming at him.”
The 10-year yield is spiking!!! It just hit 3.64% Up 25 basis points from Thursday. The bond market bluffed, and the Fed is calling the bluff. LOL
Certain myth just needs to go away….like Musk is the next Tony Stark, going swimming after eating will give you appendicitis and Bond Market is the smartest money out there….you can’t say Bond market is the smartest without also saying stock market is the smart money as well. Both are dominated by traders, what make bond traders so much smarter than professional stock traders? Certainly not the recent results and their insistence of fighting the FED..
PI – with a big nod to an earlier post, ‘clever’ and ‘smart’ are not synonyms…
may we all have a better day.
I agree.
I always doubt when people say bond market never lies and other such things.
At the end of the day, people doing bond trading are like stock traders.
I don’t think the FED will pivot until the inflation rate recedes. Inflation is political. It hurts middle and lower-class people too much.
Have a friend building a home in FL facing the Atlantic. Yes, prices are being negotiated downward. But the action also entails reduction in features/materials quality unless buyer is willing to pay.
Real Estate Loans, All Commercial Banks (REALLN) are still strong.
We are fortunate to have had a builder that concentrated on building many apartment buildings in our town of about 40,000. I think he might have over did it.
Newish 2 bd rents are in the $850 range. House prices have ran up so fast that it’s probably the poorest buy vs rent I have seen here. About 3 years ago rent/buy was pretty competitive.
Powell will cut RRP interest when the RE market allow it. Home
builders might offer zero rates for 3Y, on top of a juicy discounts
Zero rates, teaser rates, always work. They target home owners to install new windows for free, new showers for free, new floor, new roof…because the ladies of the house love zero coupon and blue collar workers in the house…
If the lady of the house can’t pay her bills there will be a lawsuit and
the lady of the house might lose her house like Phoenix speculators
in 2011/2013.
There is no free interest it’s just added into the price of improvements be it windows floors or cars = another scam sales pitch
I received a surprise call from the owner of an AirBnB this week. I rented his place before, and he was calling to let me know the place was for sale. He is a practical street-smart guy who has a small business, in addition to two properties on AirBnB. He is able to sense when things are turning.
The property he is selling was purchased only about a year ago. He’s hasn’t listed it yet, but he said it will be listed in March. It makes me wonder how many AirBnb owners are in the same boat, sitting on a property that is not generating enough cash flow to justify investment, when you can easily get 5% return on a treasury bond with zero risk. In particular, owners who live an hour or more away from their rental might be viewing it as a hassle and potential time/money drain.
I predict housing inventory will be rising more than expected in March. Owners who watch markets and have inclination to lock profits must be viewing the Spring selling season as the last decent opportunity for many years.
“It makes me wonder how many AirBnb owners are in the same boat, sitting on a property that is not generating enough cash flow to justify investment, when you can easily get 5% return on a treasury bond with zero risk.”
Answer: A LOT. So many of the newbie Airbnb owners saw it as a get rich quick scheme 1-2 years ago. Now that the market is oversaturated with them and nights booked is collapsing, I imagine we’ll see a boatload of them come to market in the not too distant future. I, for one, with stick with Treasuries for the forseeable future.
Anecdotally and locally, I’ve seen more AirBnB units switching to long term rentals. The drop in demand due to cleaning fees, etc is causing the short term rental market to drop in volume. Owners can’t rent enough times to make their payments.
However, some of the long term rental asking prices are still well above the market (I hope) . The AirBnb owners can’t and won’t give it away and take a loss. At least yet….
These rental conversions are always listed as fully furnished (including silverware and Tupperware). I suppose that demands some premium.
Many touristy towns are now limiting short term rentals to 30 days or more, to get rid of the transient airbnbs. Travelers may like airbnb but the neighbors don’t like them at all. In FL, they have some that rent by the half day!
I read somewhere: Almost 58% of the Short Term rentals like ABnB are bought during Pandemic time when money was ultra cheap and people though real estate can never go down.
Translation. “We’re finding even crappier product that barely meets energy code, and we’re keeping our fingers crossed that the double-pane glass doesn’t fog up and the shingles don’t blow off until we drive away.”
Sconnie, you’re describing the entire real estate industry, right?
Here’s a comment from their earnings transcript:
“By not providing guidance for the whole year, we’re not confident that we understand all the dynamics yet for the rest of 2023. We do feel confident in the long-term operational structure that we have, the long term will be 22% or higher. As that clarifies over the coming quarters, we’ll give additional insight there.”
This is actually interesting, because this hesitation and uncertainty for 2023 is consistent with the growing polarized narrative of the economy on the cusp of unexpected growth and a global economy on the precipice of a severe recession. By not giving longer term guidance, that amplifies the notion that things may fall apart, with future impairments and instability. That implies they must be thinking ahead about future problems…
The conformation of what tips the scale for the Fed, home builders, bus manufacturers, day traders playing with 0dte, crypto lunatics and joe plumber is definitely in flux, and is tilted to the downside. The super slow motion train wreck, that might happen in two weeks or within two years.
I think this current period of economic uncertainty also lays provides the excuse for corporations to fine tune and aggressively begin pruning dead branches and weeding and planning ways to be leaner, meaner and proactive, preemptive, risk adverse, prepared, anxious. That cautious activity will be ubiquitous in the next several months and most likely weigh on consumer sentiment.
I read yesterday about a big New York developer planning for a tectonic shift in demographic lifestyle realities reshaping their future:
“But with the pandemic, offices in New York and other cities are posing a desperate challenge for RXR and other developers. Rechler has accepted that “the genie is out of the bottle” and that hybrid work is not going away. “We’re a real estate company and we still let people work hybrid on Friday,” he said. “So, it’s here to stay.”
In December, he asked his team to draw up a set of metrics that took account of the new reality and then ranked RXR’s office holdings accordingly. “I call it Project Kodak,” Rechler said, referring to the once-dominant film company that was upended by new technology. “Some buildings are film, and some buildings are digital. The ones that are film, you’ve got to be realistic about it.”
“Our position is that we’re an affordable builder,” CEO Phillippe Lord said during the earnings call (transcript via Seeking Alpha). “We have to get to a payment that makes sense for our customers.”
At $389k for entry level… I’m gonna have to disagree with you there, Bob.
“U.S. Treasury Secretary Janet Yellen on Monday said she saw a path for avoiding a U.S. recession, with inflation coming down significantly and the economy remaining strong, given the strength of the U.S. labor ”
How much ratio betwen salarys and spends.
Since 2000 , University bills get up ( very Up), Health bills Get up a lot, houses or apartment was Up , No looks like down but in wich time?
Now the couple work both. I don´t Know how much people can have savings for ?
It’s interesting the Treasury and Fed always say we could see a soft landing, but they never disclose the odds of that happening in their view. Why?
Read between the lines.
Per John L. Scott realty company last week:
“The Fed hiked the Fed Funds Rate by .25% and home loan rates improved to their best levels since September. The subsequent press conference also contained dovish tones where the Fed offered hope that inflation is headed lower and future hikes would be dependent on the upcoming data.”
It’s a propaganda machine.
Wolf,
Do you think it is possible that if inflation falls to 2 percent or less in the coming years we will see zero or negative interest rates again?
LOL. Do I think it’s “possible” that hell will freeze over? I mean, sure, it’s “possible” that hell will freeze over. Would I bet on it? Nah.
Powell was asked the same kind of nonsense questions — such as: “…the possibility of pausing…” and “Would it be possible to…”. He should have just tasered the reporters asking the questions.
https://wolfstreet.com/2023/02/01/what-powell-actually-said/
If Pow Pow start live tasering reporters, especially those braindead MSNBC or WSJ reporters, he will rocket up from one of my most loathe to like in a NY minute.
I remember the good old days when Greenspan would mumble and talk in circles.
Back then, people were reduced to watching whether Greenspan carried his little briefcase in the left hand or right hand or something. I remember some to-do about that.
I think so too, and I’m even convinced, so I’m going to bed and I’ll sleep very peacefully, haha
Sure, if a huge asteroid hits the Earth(or other major natural disaster) or there is a more deadly pandemic.
There’s always hope! /sarcasm
Otherwise, I agree with Wolf and most, that it is a long-shot gamble.
People that have seen a >20% decline in their 401k’s YoY will not accept a similar decline in the market value of their house gently.
The Wealth Effect is real. Plan accordingly.
And not “accept” it how? What are they going to do?
Change. In myriad ways. They will view themselves as less wealthy. The effect of that realization will not be the same for everyone but I think a likely outcome is a more financially conservative middle class.
YMMV
Even better is that those, who still have a pension, will find that the “lump sum” payout available as of March 1, 2023 will take a fairly big hickey. The reason is that the interest rate “forecast” is much higher than previously and this allows the amount for the lump sum (vs. the annuity at a higher interest rate) to be reduced. One company I am familiar with may see the lump sum drop by 20% for those who retire after the above date.
And the *hits* keep on coming!
There are many different types of annuities,be vary careful before moving your money in these . Some keep your money in account after your passing away .Is basically a insurance policy
A monthly pension payment is an annuity usually managed by a trustee. I’m not condoning buying an annuity on the open market.
It depends. If you’ve owned your home for decades and enjoy living in it (Like you should), you likely will yawn and ride it out like you did for the 40-50% drop from 2008-2012. Especially if you still have a loan and refi’d below 3% last year. If you purchased the house on speculation and planned to live off the yearly gains with cash-out refi’s and HELOCs until you die, then you may panic and have to get a job. If you purchased a house in the last 2 years with the goal of living off the gains, you are the problem. If you purchased 3 or more years ago to enjoy and live in the house AND refi’d at an incredibly low rate, you are doing well.
If you are about to retire, a 20% drop in your 401K may prevent retiring. (BwaHaHa, the Fed plan). You could sell everything in your 401K, cash it in, take the tax hit, and maybe pay the 10% penalty but that would be silly. Most people under 50 won’t care.
I find it interesting that people panic when their house drops in value. It is a place to live and your monthly payment is unchanged for that purpose no matter what the price.
Selling a house after a huge bubble run-up is not panicking. It’s common sense. Why sit back and lose hundreds of thousands as your home price drops because of the empty slogan “it’s a place to live”.
Don’t bring emotional baggage into a financial decision, if you want to be wealthy.
I agree with “Sell High and Buy Low”
To clarify my statement, timing the market has rarely worked for most people.
If you sell now at a high and buy again at the same high, that is not smart.
If you sell high and rent, your money is not going into the principal of the house and that may not be smart either unless you can time the market better than most.
If you sell high and move back home to live in the basement for free rent, that may be the smartest move.
In my mind, that is rational and not emotional.
I just view home ownership different than owning stocks.
For stocks, I can cash in at a bubble high and walk away with a huge profit and forget.
If I sell my house at a high, I have to then live somewhere. The decisions become more complex. Riding it out in my home, by my calculations from 2008-2012, was a better choice than renting and trying to time the market. Unless this time is different.
Seen it Bob,
Good points. You never know about the future. Selling may not be practical or worthwhile for people who can stomach watching RE gains dissipate.
I sold my rentals in so cal last year June
But I am keeping my primary.
Unless your house is rental/investment, no sense in selling your primary as this was neevr meant to be an investment.
My primary home has gone down a lot in value from peak, 20% or so per appraisals online.
jon,
You nailed the timing of your rental sales!!!
This is what FED wants to do if you think what they are trying to do.
They want to tame inflation. They don’t have any control over supply chain. But they have control over price of money.
The home prices go down, people feel less wealthy and thus spend less thus bringing inflation down.
I own a home btw.
My gf is a one of those ‘must stop at every open house’ people, and thus, I’ve actually been to a few places built by Meritage here in Colorado (I looked ’em up after reading the article).
I’m surprised they would call themselves an “affordable builder” – I frankly think the industry’s language hasn’t caught up to economic reality.
These were perfectly acceptable suburban homes for people who can manage a $100,000 down payment and a $2,500-$3,000 monthly payment; that includes taxes and insurance.
In my mind, this is mid-market. ‘Affordable’ in the Denver region is a fixer upper in a dubious neighborhood. Maybe a nice condo with a big cut on the sq ft. ‘Affordable’ isn’t a two average income earner household, or one fat paycheck household.
What constitutes affordability is relative…..
Hopefully your GF is just wanting to look out of curiosity and not intended to pressure you to buy now…because as RE agents put it, it’s a great time now cause you know FED will pivot soon…/s
If she does, time to find another girlfriend with more financial acumen, it will be healthy for your wallet in a long run.
“Dear Abby, my girlfriend wants to stop at every open house we pass. Is she trying to tell me something?”
“Dear Deer-in-the-headlights, ‘No, she’s just interested in learning more about the braking system of your car.'”
UNTIL mortgage rates hit 12% the fat lady hasn’t sung. 1981 inflation had rates at 12% for 30 years .
All rates and government stats today are LIES . imo
Mortgage rate popped, because tomorrow they might drop. Biden taxing buybacks and billionaires who pay less taxes than their secretaries. Tonight he will rip capitalism for free. High tech and wall
street billionaires, his supporters, have a target on their back.
Biden cannot tax buybacks. All he can do is ask Congress to tax them.
Shrinkflation, applied to the housing market, is a new wrinkle for me.
Less for more is not consistent with the American dream, which I think may still be active. As long as there are children, how can it not be.
I hope the concept is a fad.
I don’t really want to live in a world in which a programmed robot teaches me about “literal” authoritarianism.
Unless I have to live with it if I survive then that is a completely different point of view.
What would a safe behavior be, as interpreted by an armed, authoritarian machine
Wow for sure this a long thread.
Guy from Spain talking to folks in the other side of the ocean! hello all!
First,sorry for the English.
Then..
It is just funny to see how your situation, US, is repeating with lag even in Spain.
They said we were a good option to invest, even with other markets like Sweden falling. No risk.
And now december is the third consecutive month of annual declines in sales (17%) , mortgage(22%) and the first one with less than a 1% increment in price (0,5%) in many time.
Of course people it is not looking to the seasonally adjusted data ( they are looking INE’s data over “Notariado” data) and they still don’t know. The data they are looking into, contains transactions from months prior to December and still a positive output is being showed.
They don’t want to hear.
I will be glad to hear measures like this soon here.
Meaning, affordability= sales=win & win