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July 9, 2023


By: John McManus  (Read original article)

Single-family homebuilding – next to generative artificial intelligence – is one of American business' truly feel-good stories in mid-2023.

Some might suggest it was dumb luck that led to a more-than-respectable first-half performance among operators large, medium, and small. A high interest rate regime triggered by the Fed last year – and likely to remain in place to battle the stubborn parts of the inflation challenge – didn't bust the market.

Rather, it cleared out competition. Potential resellers, locked into dirt-cheap mortgages, chose to stay put in droves. This allowed homebuilders – especially ones with finished or nearly-finished ready-to-occupy homes – a surreal, unprecedented competitive position as housing's virtual "only game in town."

A Wall Street Journal story by Nicole Friedman uses those very words to describe an almost eerily catalytic moment for new residential construction and development,

“For many would-be buyers—in Utah and in many other markets—new construction has become the only game in town. Newly built homes accounted for nearly one-third of single-family homes for sale nationwide in May, compared with a historical norm of 10% to 20%. Existing-home sales in May fell 20% year-over-year, while new single-family home sales that month rose 20% on an annual basis."

But it wasn't just dumb luck. It was more of a case of "you've got to be good to be lucky." While the rare absence of existing home inventory was a door-opener for would-be buyers, it's been homebuilders' product, price, location, delivery-time, and flexibility on mortgage finance options that convinced so many buyers to move off the sidelines and into such a tricky housing market and broader economy to buy now.

Nevertheless, the "not-so-bad" talk-track that carried the first half among a broad geographic, price, and product swath of operators, has begun to crease, flutter, and slacken, with spotty and choppy fissures and rumbling, depending on the locality and price-point.

In a recent forum of strategic homebuilding, development, and investment executives, a subplot to newly-constructed single-family housing's broadly positive narrative pitch pronounced itself.

That subplot reflects two roiling themes to watch, both of which impact credit availability in the high interest rate regime, and could unravel at least part of what housing has going for it if they go as poorly as they might over the next six months or more.

  • One is the exposure of the capital investment value chain to commercial real estate risk stemming from a future-of-workplaces accelerated transformation timeline.
  • Another, related one, is the hit on regional banks and their ongoing ability to serve as important sources of lending at a time higher-interest rates make depositors a more costly business.

Nested within that subplot, homebuilders and their partners on the land front continue to do what it takes to both ward off damage if conditions – for some unlikely reason – take a sudden turn downward, and to catapult forward should they continue to improve.

A c-suite strategist from one of residential real estate's large multi-faceted single-family-rental portfolio and build-to-rent construction and development enterprises raised a question in the recent forum.

We're looking to unwind exposure on some of our land exposure because now it's more expensive to finance ground-up houses relative to the cap rates calculated for that house when we pro formaed the land buy. We've found some builders – public builders – willing to buy some of those projects from us, at somewhat of a loss to us. Anyone else hearing about this type of transaction?"

The response – from a senior-level marketing executive of a well-capitalized multi-regional private homebuilding operator – turned the question inside out.

“We're seeing a sudden large fall-off in traffic and a dip in sales, so we're actually feeling like we may be a bit long on land, and have been talking with BTR developers about selling off some land parcels to them so that we're not oversupplied with land inventory if we have a back-half of 2023 like it was last year."

Two different perspectives and mirror-reflection tactics – one BTR developer looking to mitigate losses in a new higher-for-longer rate environment on a deal that no longer pencils by selling to a builder, and one builder looking for a BTR buyer to de-risk in the event for-sale demand falls off faster than expected.

“In general, what we're seeing is in many markets, builders are short on developable land," says Tony Avila, CEO of Builder Advisor Group, a sponsor partner of The Builder's Daily. I can tell you that in certain areas within Texas and Florida, certainly in the Carolinas, and even in California, they're short on land, where they can build. There may be situations where builders are a bit long, but generally right now, because builders shut down land acquisitions for the second half of '22, they're short in a lot of areas."

By and large, Avila's pulse check on investor, homebuilder, and developer behavior – based sheerly on the undeterred resolve of home seekers have continued to pursue a purchase and the likelihood that both interest rates and house prices may have plateaued – calls for an aggressive, acquisitive, growth-driven back half of 2023.

“Builders are bullish looking for land and new opportunities to lock-in positions," says Avila. "Many of them have been generating a lot of cash as they slowed or stopped acquiring land in '22. That means that they have recorded less of a land spend for 2023, and they have more capital to deploy for mergers and acquisitions. This gets them earnings faster. As we represent selling companies, we're having that dialogue with potential acquirers that they're looking to close. Sometimes, when you're doing mergers and acquisitions, you might have a buyer drag their feet a little bit. In the deals we're working on, it's quite the opposite. They're pushing to close as soon as possible so they can get access to earnings as fast as possible."