“If You’re Average In This Business” You Die – Grand Homes CEO
As I was getting my MBA from the University of Texas at Austin, everyone was speculating in real estate, and commercial property developers came to recruit, and yellow ties were in and denoted boundless future wealth in real estate, and people bought and flipped homes, and they all knew that you couldn’t lose money in real estate. The year? 1985. Two years later, with impeccable timing, Stephen Brooks founded Grand Homes in Dallas.
Oil had been tanking. Restaurant shuttered their doors. Housing spiraled down. Builders went under. Banks collapsed. The FDIC auctioned off foreclosed properties when no one wanted to buy. Dallas too got hit, and people in the industry who’d gone through it wouldn’t forget that you could lose money, a lot of money, and very quickly, in real estate.
So when the Fed blew the nationwide housing bubble, with home prices doubling in six years to peak in mid-2006 only give up much of that during the following three years, Texas mostly missed that psychedelic drama. The S&P/Case-Shiller home price index for Dallas stood at 100 in January 2000, meandered up to a high of 126 in August 2007, meandered back down to hit a low of 112 in February 2009, and revisited that low in February 2012. But suddenly things took off and the index has jumped 13.4% in 15 months to an all-time high of 127.58.
While Dallas hadn’t experienced the crazy run-up in prices – they’d lumbered up “only” 26% over those six years – it did experience a collapse in demand for new homes. And for home builders the story was bloody.
They’d been selling 50,000 homes annually just before the crisis, but in 2008, that plunged 70% to 15,000. Over half of the builders either collapsed or left the market. One of the survivors, Grand Homes, which had been selling over 1,000 units in the Dallas market, saw sales swoon to 328 units, all of which were done in the first seven months of the year; because from August through December, according to Builder Magazine, “it only sold two homes and both contracts were cancelled.”
To survive, the company did what other companies in the US did: reorganize its business model and cut staff – from 330 full-time employees before the crisis to 214 in 2010 and to 129 by the end of 2011.
“It’s a retail business in selling the house, it’s an investment business in the land, and it is a manufacturing business, as well as a service business,” Grand Homes CEO Stephen Brooks told Texas CEO Magazine in late 2011 after the crisis had hit bottom. His prescription for failure: “If you’re average in this business at buying your land, average at buying labor and materials, and average at running your overhead, marketing and finance, then your costs exceed your income.” And you’re finished.
But by September 2012, prices and demand for new homes had perked up to the point where builders were caught in a squeeze. “We lost over half of our production builder companies, and the subcontractors were enormously gutted as well,” Ted Wilson of Residential Strategies told CNBC after he’d surveyed Dallas/Ft. Worth builders. “It’s not like these guys are waiting by the phone. It’s been six years. These guys have moved on and found other jobs.”
This shortage of skilled labor – and the associated higher costs of labor – impacts builders financially. “You sell a house, and you typically could deliver it within 6 months,” said Mr. Brooks. “Now the cycle time, today, with the shortage of labor it takes 9 months. Instead of being 6 months of overhead, now it’s 9 months of overhead for the same house.” Hence pressure on the margin from two sides, he said: increased cycle time and higher labor costs.
But the party may already be over. On Friday, the Department of Commerce reported a real downer: new home sales in July plunged to an annual rate of 394,000 when pundits had expected 485,000; and June sales were revised down by 42,000 to 455,000. The median price dropped to $257,200. The low sales rate catapulted inventory supply to 5.2 months, highest since January 2012. In June, it was 4.3 months! An ugly report. The home-builder ETF ITB dropped 2.5% in sympathy; it’s down 19.2% since May. A shot before the bow.
Housing bulls called the report a statistical fluke and pointed out that these numbers were highly volatile and subject to big revisions. And besides, July sales were still 6.8% higher than a year ago. It would work itself out over the next few months, they said.
But real-estate site Trulia also saw slackening demand and an inflection in the home-price curve in some of the most sizzling markets. Higher mortgage rates – they’ve jumped over a full percentage point from 3.59% in early May to 4.68% in August – are colliding with home prices that have soared in some cities over 20% on an annual basis, a double-whammy for strung-out home buyers.
“Recovery of the housing market,” is what this phenomenon is called. Everyone has taken credit for it, particularly the Fed, whose handiwork this is. But there is a very ugly fly in this illusory ointment – and more challenges for builders like Grand Homes. Read…. How The “Wealth Effect” Mucks Up The Housing Market.