Tuesday, August 29, 2006

top of the flagpole stuck into an iceberg

mal ne andere sichtweise die sich in erster linie mit dem innenleben und der organisation eines homebuilders auseinandersetzt. wie vorher schon bemerkt http://immobilienblasen.blogspot.com/2006/08/aus-dem-innenleben-eines-homebuilders.html kennt das management/divisionsleiter bisher oft nur einen bullamarkt und ist in der jetzigen phase vollkommen orientierungslos. das mag evtl. auch eine erklärung für die im monatstakt getutzten prognosen und warnungen sein.

dank geht an txchick57 und ben sowie thestreet.com

Housing Industry’s Hidden Cracks
By Dan FitzpatrickRealMoney.com Contributor

Last week I wrote about the homebuilding sector, an industry that has been getting a lot of attention lately. But after spending much of the weekend looking at what various homebuilding analysts have been saying, I am convinced that some critical issues are being overlooked. The homebuilding industry is unique in many ways, with essential intricacies that matter only during significant downturns in real estate — like the one we’re in now.

The “lead down, lag up” nature of housing is just one factor that pundits and the public alike are ignoring. I’m also concerned about the lack of downturn experience among the bull-market babies who currently make up the executive ranks among homebuilders. And because they haven’t seen these issues before, they’re creating housing-price problems that will have nasty fallout. Worst of all, most Wall Street analysts just aren’t picking up on any of these issues.

First Down, Last Up

I’ve seen this before. I began my career in the homebuilding business back in 1984. By 1989, I was managing the Las Vegas division of a private homebuilder. One summer day, people just stopped buying houses. While the economy was just starting to weaken, somebody turned off the spigot on real estate. During the worst of it, many owners were simply giving their homes back to the bank because the house was worth less than the principal balance of the loan.

People didn’t start buying homes again for another few years, not until the economy had already turned around. This is an important point for anyone looking at this sector to understand: The homebuilding industry has always been the first sector to crack in an economic downturn, and the last to repair itself. This should be intuitive. People make big purchases — and a home is the biggest — when they feel secure, not when they’re nervous. As a result, the homebuilding industry leads on the way down and lags on the way up. It’s a fact of the business.

Since the early 1990s, we haven’t seen a deep pullback in real estate. Yes, we experienced some stagnant real estate values from 1998 to 2000, but the FOMC quickly came to the rescue with cheap money. The 9/11 attacks also put homebuyers on the sidelines and converted many homeowners into sellers. Over the next 16 months, the Fed again dropped rates to historic lows, and the homebuilding bull market continued — until about a year ago.

Staffing Issues

Now that the industry is struggling, a lot of deficiencies inherent in the business are once again relevant. Over the past several months I have outlined my current take on the industry, noting the high cancellation rates, the rising cost of raw materials and the futility of valuing these companies using current projections. I believe that the analyst community is overlooking some critical problems that will become more apparent over the next couple of years.

Homebuilding is the only business I know that relies heavily on information from its divisions with respect to product selection. While the corporate executives must approve all land purchases, product design and pricing, they rely on recommendations from their division officers. But few division executives have meaningful experience in dealing with a real slowdown in the industry.

I recently finished some consulting work for a public homebuilder at which the executives were all quite bright and strong in their divisional roles. But they weren’t at all aware of the macro picture because they lacked a frame of reference. Many had advanced degrees, but most were only in their 30s. Only a couple had been in the industry during the bear market of the early 1990s, and in relatively low-level positions. Those who were around during 1998-2000 or the post-9/11 slowdown considered themselves battle-hardened veterans. A few acknowledged that all of their experience had been gained during strong markets.

These bull-market babies were providing the corporate office with market studies, pro formas and product recommendations. Why? Because experienced executives long ago discovered that cheap money and ample demand for homes made it easy for them to start their own homebuilding companies. Their departures cleared the way for the newer staffers to move up the chain of command and shine during a spectacular bull market. But the bulls have stopped running, and the folks now at the helm are about to learn what happens when they do.

The older execs I know unanimously believe that 2007 will be much worse than 2006, and that 2008 will not be any better than 2007. As for the newer staffers and younger whiz kids with diplomas on their walls? The overwhelming assumption from that group is that 2006 is a really rough patch, but that the ship will be righted in 2007 and the next up cycle will begin. Consider this anecdotal evidence of the unwarranted confidence of today’s decision-makers: One vice-president recently told me, “Oh, this slowdown won’t be nearly as bad as it was back in 1990.” This “old warhorse” was in high school back then.

How Prices Really Get Set

The less experienced staffers on the front lines don’t understand the dangerous battle they are in, yet they’re the ones making key decisions. They continue to set high sales prices, but the bid-ask spread remains obscenely wide.

I recently heard an analyst touting the idea that sales prices have stabilized, meaning absorption rates were really the critical component. That’s just wrong. Sales prices have stabilized only because divisions are refusing to drop them. They want their 2006 bonuses, and that certainly will not happen if they start selling houses for a loss. So they hold back cancellations to give the impression that the price floor is firming up. It’s not.

In today’s market, most division officers are on edge. They fear division consolidation, or outright termination, due to poor performance. Their livelihood depends on capital allocation for new subdivisions. No money, no new subdivisions. No new subdivisions, no job. So they shade the numbers they submit to corporate headquarters. Here’s how they do it.

The division hires an outside consultant to provide an independent market study to present to corporate headquarters along with each new land-acquisition application. The recommended prices support the division’s profit projections for the project.

But these “independent” consultants are often pressured by the division officers to inflate their pricing recommendations, thereby making the project more attractive. A $20,000 per-unit adjustment can be the difference between approval and rejection.

Because of the belief that we are simply experiencing a brief slowdown, this dangerous tactic is used with alarming frequency. Remember, most of these optimistic real estate execs have no firsthand experience in a severe cyclical downturn, so their naïveté is leading them down a very slippery slope.

Another tactic for making new projects more attractive is to build inordinately large homes to justify the high sales prices. Theoretically, larger homes command higher sales prices. But homebuilders in Orange County, Calif., are finding out that few folks are interested in homes that are bigger than 3,000 square feet. That’s a problem when the only way to make your profit projections work is to build 4,200-square-foot homes. But a favorable market study goes a long way toward convincing the corporate land committee to approve the acquisition.

What’s Next

I believe that over the next several months we’ll start hearing about builders slashing sales prices by more than $100,000. This is already occurring Orange County; we’re just not hearing about it yet.

All builders subscribe to a local marketing report that provides monthly updates on pertinent data for all subdivisions in the region, including concessions offered. These data are obtained by calling the sales office and simply asking the sales agent for this information. But the sales agent would shoot himself in the foot by being honest; why tip off the competition that you are slashing your prices? The numbers in the local marketing report are rarely accurate.

But these price reductions are occurring, and they are bound to produce negative consequences far beyond a hit to the bottom line. First, appraised values will be impacted. This will anger recent homeowners. Over the next six months or so, I suspect that we’ll begin to see many homeowner lawsuits against the builders over those reductions. They’ll allege bad faith, fraud, misrepresentation and any other cause of action that the plaintiffs bar can think up to coerce the homebuilder into refunding the equity that just got vaporized by the latest round of price cuts. In essence, they’ll want a retroactive price adjustment. These high-profile lawsuits are likely to create even more hesitancy and suspicion among potential homebuyers. It’s a vicious cycle that is just in its infancy.

Builders also are simply walking away from land deals — forfeiting millions of dollars in nonrefundable deposits. These deals often are included in a division’s unit projections for the next several years. When these deals go away, anticipated sales revenue goes with them. Unless a division is able to replace a canceled acquisition with a new deal, earning projections must be revised downward. Most Wall Street analysts seem to limit their analysis to the multimillion-dollar deposits being forfeited and believe the worst of these forfeits is behind us. I’m more focused on the void left in a division’s business plan when it cannot find a viable deal.

Analysts and commentators have repeatedly mentioned that share prices of most homebuilders have dropped around 40% over the last several months. For example, since July 2005, Pulte (PHM) is down 40%, Toll Brothers (TOL) is down 55%, Centex (CTX) is down 38% and Ryland (RYL) and Beazer (BZH) both are down 50%. In my analysis, this is not even relevant. The market is a future-discounting mechanism, not a rearview mirror. The bull market in real estate values hid a lot of sins at the divisional level, but I think that dynamic has faded. That said, I am cautious about being too bearish in an already bearish environment.

But I think we are barely seeing the top of the flagpole stuck into an iceberg. In trading terms, this has been a blow-off top in housing, and all those who bought over the last couple of years are now sellers. Simply put, no one is left to prop up the bid.



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