Builders and their suppliers coursing through the International Builders’ Show (IBS) in Orlando, Fla., in early February couldn’t be blamed if they walked the aisles of the Orange County Convention Center with a noticeable spring in their steps and their heads held higher.
They were, after all, survivors of that war of attrition better known as the housing recession, which in many markets is finally showing signs of recovering. Attendance at the show rose 10% from 2011’s IBS to top 51,000, in fact. But like the industry it represents, that growth must be viewed in perspective; it’s still less than half 2006’s peak of 105,000.
The generally happy mood at IBS has got to be a positive signal for pro dealers, many of whom have begun thinking about how to retool for growth. To be sure, alert dealers are well aware that the housing industry’s recovery could be wrecked if land mines that include foreclosures, stingy financing, and a broken supply chain aren’t defused. But assuming those problems don’t blow up, pro dealers that start gearing up their own distribution capacities now expect they’ll be better positioned to reap the benefits of expanded new-home construction and sales.
“We are beginning to see some grains of good news,” said David Crowe, NAHB’s chief economist, pointing specifically to expansion in the nation’s Gross Domestic Product, “solid” job growth reports, and sunnier consumer confidence.
Builders could take away more good news from a nationwide telephone survey of 1,500 likely voters NAHB conducted in early January and presented at the show, which found three-quarters of those polled saying that owning a home is still “very important” to them, regardless of the economy’s ups or downs.
“What makes us bullish” about the housing sector, asserted Charles Schwartz, a partner with the private equity firm Avanti Properties Group, are the facts that, despite the severity and length of the economic downturn, the country continued to add people, and household formations are on the rise again.
Only days before the show opened, builders were buoyed by the news that the nation’s unemployment rate had dipped to 8.3% in January, its lowest level in nearly three years; and GDP in the fourth quarter of 2011 grew at a higher-than-expected 2.8%. The general consensus within the industry is that reducing unemployment is one of the keys—along with an easing in mortgage lending—to not only get customers buying again, but also keep current homeowners in their houses and out of foreclosure.
An improving economy lends credibility to projections about housing’s future by economists whose track record during the downturn often proved overly optimistic. Industry watchers from NAHB and Hanley Wood Market Intelligence to the Portland Cement Association now foresee single-family home starts increasing in the single-digit percentage range this year (with more robust growth on the multifamily side), and then taking off by anywhere from 28% to 33% in 2013.
On the other hand, economists are still hedging their bets about when, if ever, the industry might return to the million-plus levels of starts and sales seen before the recession.
Such caution is understandable. For one thing, banks’ lending practices have become so constrained that even buyers and investors with good credit scores and available down-payment cash are being turned down for loans, to say nothing of the difficulty that builders are having getting financing for construction projects and growth.
Equally problematic are the millions of foreclosed homes that continue to flood certain markets. Distressed sales—including short sales and non-auction sales of foreclosures—now account for at least 30% of all U.S. home sales, according to Federal Reserve estimates. Those purchases invariably put downward pressure on home values and prices and stunt demand for new homes.
What’s scarier is that no one seems to know how many foreclosures are actually out there. Ed Sullivan, chief economist of the Portland Cement Association, believes the 1.9 million foreclosures reported in 2011 were understated by more than one million due to processing delays. And in a speech he delivered during IBS, Federal Reserve Chairman Ben Bernanke stated that the number of properties currently in the foreclosure process could be more than four times the current amount of foreclosed inventory.
REO to Rent
Among the suggestions Bernanke offered to shrink this “shadow inventory” is what he called an “REO to rent” solution, through which holders of real-estate-owned properties (essentially commercial banks and the government-sponsored entities Fannie Mae and Freddie Mac) convert those properties to rental units to take advantage of a strengthening rental market nationwide. “REO-to-rental programs could potentially … minimize the amount of time a vacant property languishes in REO inventory,” Bernanke speculated.
Rental is where it’s happening right now. Hanley Wood Market Intelligence estimates that multifamily construction will account for one-third of all home starts this year, and many of those units will be rental.
Private equity firms already see rental gold in REO properties. Bloomberg reported recently that GTIS Partners intends to spend $1 billon through 2016 to acquire 200,000 single-family foreclosed homes in Florida, California, Arizona, and Nevada, which GTIS plans to convert to rentals. Oaktree Capital Management (which owns ProSales’ parent company Hanley Wood) intends to spend $450 million to buy foreclosed homes that a management firm then would put up for rent.
A certain portion—perhaps even the majority—of these foreclosed properties will need to be renovated and repaired to be ready for sale or rent. So as owners put more foreclosed properties back onto the market, a fertile opportunity opens for builders and remodelers willing to fix up these buildings. (With spending on improvements to owner-occupied housing nearly equal to spending on new residential construction, and with remodeling spending expected to increase by nearly 9% this year, many builders have expanded their services to include renovations.)
Building material dealers and distributors would benefit, too, as suppliers for these projects. But is that supply chain prepared to handle a significant spurt in new-home construction and remodeling over the next few years? Certainly, a housing sector that is producing 750,000 homes again—about 45% of the 1.68 million single-family starts at the peak of the last boom—would put considerable strain on a tattered distribution channel that, according to ProBuild Holdings’ former CEO Paul Hylbert, has lost a significant number of its branches during the recession. Pro dealers also face allocation restraints on certain products such as insulation, and rising prices on petroleum-based materials.
Consequently, an improving housing and remodeling sector could be a double-edged sword for dealers that scaled back their operations to serve a much smaller customer base. At the very least, dealers that want to participate in the housing industry’s revival may need to re-evaluate their internal distribution and warehousing capabilities to keep up with greater demand, if and when it appears again.
For those pro dealers who have gotten through the housing recession relatively intact, the next two or three years could be a bonanza as long as they don’t lose sight of the fact that many builders are refocusing their businesses on customer service, and will expect the same from their trade partners.