It’s time now. Register for #BuildersAreEssential, a new, live, exclusive crisis leadership, management, and training session on “How LBM Dealers Are Navigating Through the Coronavirus,” and what that means to builders.
Here’s why you should make time for this.
On a good day, the jobs residential real estate’s builders, developers, and an army of partners do comes down to a tricky, win-or-lose proposition.
Unavoidably–and often with a blend of discipline, practice, acuity, timing, persuasiveness, and alchemy–the job entails betting on dirt. That is, investing an intricate “supply chain” of expertise and resources on a piece of ground of some dimensional measure to give it more value in the selling than it had in its purchase. A
Introduce instability, unpredictability, and/or doubt into one side or the other in that equation–the dirt or the supply chain, writ large–and, Houston, we’ve got a problem. Frank response to the “what-keeps-you-up-at-night?” cliche for the home building ecosystem members, more often than not, can either speak the amount of pull–or demand–on the land, or the ability to push, via a reliably secured supply of human and non-human resources.
Disruption tore into both sides of this delicately balanced equation through the middle part of February of this year up to the present, in the form both a public health pandemic and a seismically thunderous shock to the economic complex.
Dirt, normally, with four neighboring units of property–or water or some other un-buildable border adjacent to it, costs X. It must hurdle to some X-plus value in its sale in order to pencil in a multi-phase trip to the real estate market. Direct, indirect, cost of sales, overheads, and money costs stack atop each piece of dirt. There are times–builders know well–you can get that piece of dirt for nothing and still lose money on it.
Make no mistake, nary a home builder, developer, or investor in the business is not busily calculating and recalculating those hurdle rates on every parcel of dirt he or she owns, as we speak. Each headline, each data release, each swing of the financial markets up or down or sideways, morning, noon, and in the dark of night thinks and re-thinks through pluses or minuses to the original the calculation.
This goes on normally. It’s why we hear, again and again and again, this is a local business. What could be more local than a chunk of ground made of square feet? Today, if you’ve missed something, not normal. A prognostication, in a time of unprecedented economic shock that house price trends–a fair proxy for what should happen directionally to lot valuations–will remain intact, or at worst suffer a few-point decline in a severe-case downturn scenario–is enough to add 30 or 60 minutes restful repose to a home builder’s Fitbit Sleep Score.
It’s if, or when–amid the continued stresses and convulsions of the global novel coronavirus outbreak and its concurrent economic disruption–the forecasts may start to sour that those Sleep Scores can also go South.
To date–in spite a collapse whose magnitude is incomparable to any in recent economic history and not anywhere nearly fully understood, four relatively stalwart force factors and one wild-card weigh toward optimism on the part of builders and developers regarding the dollar price value of their current land holdings–the single clearest benchmark of their financial viability through some rough-going ahead. If dirt, in other words, holds value anywhere close to how it penciled when it came on the books as an asset, all’s pretty good.
- One is the fact that standing speculative inventory and new homes in process are at low levels, and have been so, a presumed cause of deep pent-up demand of seriously motivated buyers.
- Two is that mortgage interest rates are–and will more than likely remain–at historically low levels, aided by our Federal Reserve central bank’s monetary and fiscal ventilator, pumping low-cost money steadily until the economy regains and sustains health on its own.
- Three, is that mortgage qualification criteria leading into the crisis created–by and large–a healthier, more resilient universe of borrowers in the past 10 years. Thanks to tougher lending standards, fewer got out ahead of themselves in terms of their ability to repay and their loan-to-value levels, so fewer (than in 2007 to 2009) might be expected to be unable to pay, or go under water on their home mortgages.
- Four, is that the most devastating blows–to both public health and economic activity–have been selective on the geographic front, and on the business sector front. This means that the immediate pulverizing effects, and even the first surge of fallout, have–up to now–spared particular markets and particular job classification of the brunt of Covid-19’s initial blasts.
- The 5th factor–one we’d call a wild-card–pertains to the mortgage loan forbearance programs that, if and when a borrower resorts to using them, allow them to go up to a year in good standing on their mortgage, without making payments. Those borrowers can catch back up with the missed payments either sooner–when their resources come back–or later, at the end of their mortgage term dates. Either way, no penalty.
- One might add a sixth positive while considering the near- and longer-term outlook and regarding it with relative confidence that residential real estate and construction may be vulnerable to a flesh-wound rather than a potentially debilitating blow to its health. That is, geography. Some markets, to date, have held up relatively well–both on the Covid-19 infection and death rate scale and the business of attracting a steady, if reduced, flow of buyers. Others, have collapsed.
The only problem with all of these plus factors may be the often invisible strings that attach to events that don’t seem to have to do with one another. In hindsight, we see perfectly clearly that they have everything to do with one another, which is when we’re apt to here “no one could have predicted this.”
Hidden in plain sight here are basic challenges that could either undo the effects of these favorable forces or dwarf their ultimate impact.
One essential problem with the assumptions that residential real estate will be somewhat buffered from the worst that the Covid-19 crisis and its related economic fracture has to do with people’s ability to make a living.
The jury is out on that matter. Households–who generate two-thirds of GDP–need incomes to do that essential work. That income is in question–at least for many, many, many who’ve already been Xed-out of their source of wage earning, and many, many, more, who’ve not been laid off, shut down, furloughed, offered a lower wage, etc.
Confidence that home prices will stay in a benign zone of risk while so many of the economy’s households are submerged in existential uncertainty about their next paycheck, or the one after that, or the one after that, seems to us misplaced.
The duration of the severest impacts, implications, and repercussions of what’s happening right now–and the tolerance levels we have to handle both the duration, intensity, and collateral effects are the two big areas of uncertainty of the moment. We don’t yet know what the floor beneath us really feels like, as much as we’d like to say we can account for it in our scenario planning.
Despite modeling and scenario-planning, we were wrong 12 or 14 years ago about how contained our industry was to speculative selling and the subprime market–or rather, un-contained. Do we need reminding of the error of our ways back then? We may not be at risk of those same two exposures, but that doesn’t mean we’re not at risk of exposures we haven’t become clear are there.
On the geography factor, are the markets that have held up through the current weeks going to be able to power through the convulsions and their aftershocks. Will the markets–especially susceptible to sector-specific effects or geographical health crisis hot spots or a combination–be proverbial canaries in the coal mine, or mere outliers?
It was just a weeks ago that the nation’s top expert on the novel caronavirus public health crisis expert, Dr. Anthony Fauci, head of the National Institute of Allergy and Infectious Diseases, opined on estimated scenario ranges of 200,000 to 1.7 million fatalities in the U.S. related to Covid-19 infections, said.
“The worst-case scenario is either you do nothing or your mitigation and containments don’t succeed,” he said “So although that’s possible, it is unlikely if we do the kinds of things that we’re essentially outlining right now.”
We’re going to go out on a limb here, and urge more business leaders in residential real estate and construction to appreciate a worst-case scenario for both the business environment and your individual firm’s capacity to withstand it. We think that ignoring, denying, or discounting possibilities–even one that could involve a material decline in home values, land prices, and a material increase in distressed residential real estate–is reckless at a level that one can hardly imagine, especially since memories of the last time people got it so wrong are so fresh in our memories.
Join me as one of those who’ll delight in acknowledging the error of my beliefs in six or 12 months, when and if much worse than currently reckoned with conditions define 2020, 2021 and possibly through the first have of the new decade. I’ll happily fess up to being wrong, and celebrate your successes and your more-correct call, given the opportunity.
Near term, the biggest business risks feel as if they apply to the current backlog of homes in process. We sorely need to meet expectations, both on the demand end of those “orders” for homes and the delivery of them for settlement.
If we can secure at least that part of the the business, then try to size our capital structure and financial exposures, we can then think about extending the horizon of planning to part of the business that need to be locked down for core future value creation.
That “supply chain” part of the business, at this moment as never before, depends first and foremost on a safe and healthy workplace, as it never meant before. The principles of “safe and healthy” and the real-time matter of Covid-19 testing, contact tracing, and safe operations–sanitized sites, socially-distanced associates, strictly disciplined scheduling, personal protective gear–are essential, non-negotiable baseline points of practice.
They’re not an option. Just as we’re all in a conversation where “lives” and “livelihoods” are not separable as one versus another, so too is the conversation where “safe and healthy” can not be separated in any manner from “operational.”
