Some Off Thoughts About Real Estate and Some Not So Off

For some time we have been hearing some really goofy ideas about what is happening in the housing market, such as these old chestnuts:

  1. Banks are holding onto their foreclosed REOs and only releasing them slowly.
  2. Institutional investors are dominating the market.
  3. First time home buyers are not participating in the market.

All of these are widely reported in the media but in Greater Phoenix they are certainly fabrications and can easily be proven untrue

But now we are hearing another idea that sounds goofy but may very well be true:.

  • Builders are deliberately slowing production to capitalize on rising prices.

The housing starts released this morning from the Commerce Department came in at an annualized rate of only 914,000 versus expectations of 950,000. Most of the increase of 6.8% was attributable to multi-family starts. Even 950,000 would be a low number by historic standards. If we have such a low supply of homes for sale, why are so few homes getting started? There are lots of reasons:

  1. There is not enough skilled labor to build at a much higher rate
  2. The supply chain is not geared up to deliver at a much higher rate
  3. Some builders are short of land to build on
  4. The price of desirable land is rising to unaffordable levels relative to today’s home prices.
  5. New land deals will only pencil out if you allow for a substantial rise in home prices
  6. If you build a lot of additional homes the price of materials sky rockets and trims builders’ gross margins
  7. Builders are applying the brakes to production to sustain the low inventory and capitalize on rising prices

Some people would question the last point as merely silly; why would a developer prefer two birds in the bush to one in the hand? I think the idea deserves more than a second thought. Demand is really not a problem for builders in most of their subdivisions. Why sell out now for today’s prices when you can sell much more slowly and keep rasing prices by 1% to 2% each month. Gross margins are going to be much better in the latter case. What would you do if you were the CEO of a large developer?

This strategy would not work if we had a lot of builders competing for business. But remember it is very much a seller’s market and developers like it that way. Why would they want to see the market return to balance?

Some people have said this undermines the robustness of the recovery. On the contrary, it will tend to make prices rise faster.

Most people have not got their head around the fact that there is a chronic lack of supply. They keep thinking it must be artificial in some way. No it is real, and unless the developers start to ramp up faster the shortage is likely to last a very long time. The prospect of exceeding the pricing highs of 2006 start to become credible in this scenario. Not in the immediate future, but much sooner than we thought two years ago.