Time keeps on slippin', slippin', slippin'
Into the future
Time keeps on slippin', slippin', slippin'
Into the future
Feed the babies
Who don't have enough to eat
Shoe the children
With no shoes on their feet
House the people
Livin' in the street
Oh, oh, there's a solution
Steve Miller Band--“Fly Like and Eagle”
Ten years ago, I started writing my By George! musings as we were just beginning to see the “green shoots” (remember them?) of recovery.
At the time, the best metaphor that I could conjure for the housing industry was that of “Humpty Dumpty”: he had fallen off the wall and there was a question of whether he could be put back together again in the same form that he had been.
My thought was that the housing industry would get put back together but would look different from what we had known before the great recession. How different was up to educated guessing, but I thought there might be some clues already in plain sight if you looked:
- The recovery of housing production was going to take longer than most were predicting. Many thought that we would return to a production rate of 1.8-2.0 mm homes per year by 2015. I just didn’t see it; the devastation was too great. My own forecast was that we probably wouldn’t reach that level until the end of the decade. Even that was wildly optimistic: we have finally made it to around 1.3 mm.
- Small private builders financed by local and regional banks were probably going to be the slowest to return, if ever. Dodd-Frank just made lending into home building unattractive, unless it was much larger regional and national builders. The inevitable result would be a smaller industry with more consolidation and larger player. This has pretty much happened.
- A rise in single family homes built for rent. People were pretty beat up and for many “the American Dream” of home ownership was in fact “the American nightmare;” a larger segment of the population was okay with renting. I suggested that we were perhaps reverting to a business model for home builders from the 1920s through the 1960s. In that model, builders built both for-sale and for-rent homes. If builders acknowledged that they were in the shelter business rather than just the single family for-sale business, this opportunity made strategic sense. It turns out that this segment, although only roughly 4% of new home construction currently, is one of the fastest growing and innovative segments of the current industry.
- An ever-rising importance of government in the industry: municipal, state, and federal. At the local level, entitlements, exactions, and hostility toward building were becoming major issues. Entitlements were taking longer, exactions were becoming normal and expensive, and NIMBYism was on the rise. All made it harder to create building lots and made new housing expensive and less and less attainable for the entry level and first and second time move-ups. At the federal level, a 70-year commitment, starting with Roosevelt in the 1930s, to the goal of having home ownership as a fundamental character and goal of US domestic policy, was both reversing and becoming even more centralized in the politics at a Federal level. At the time FNMA and FreddieMac were being bailed out and there was a question of what role they would play in the future. There was some discussion of whether tax incentives for home ownership might be changed. As we now know, the government entities FHA, VA, FNMA, Freddie now have even more market share of the home mortgage market and we still do not know their ultimate disposition. We do know that the quality of mortgages now being written is becoming riskier year by year. The tax reform act of 2017 eviscerated interest and real estate tax deductions and highly impacted many coastal and Democratic voting states, serving as a damper on new home construction in those states and impacting existing home values. The support for homeownership has, in fact, gone backwards.
What was missed looking forward from 2010 were the following trends:
- The decimation of immigration. From a housing perspective, immigration was one of the most important raw materials that helped make housing volume and attainability possible. Immigrants often found their first work in the construction trades. It was where they could learn skills, language and the culture of the country. Along the way, they needed shelter, often first in rentals but moving into home ownership at relative high rates. As both providers of new homes and ultimately consumers, they helped keep the housing industry going. There was also a darker, but economically beneficial element. Immigrants were a low-cost labor solution both in terms of what they were paid, but also in terms of benefits and taxes not paid. Working as essentially independent contractors, workman’s compensation, FICA, and other taxes were often dodged. On the other hand, that “surcharge elimination” served to keep the labor component of housing lower than it would be otherwise. The result was housing that was more attainable in terms of price than it would be using fully loaded labor costs, thus somewhat helping with the policy goal of more attainable housing for the population as a whole. It was a silent subsidy. As immigration had declined and more work has gone into larger subcontractors who can no longer avoid the taxes, the result has been lower volume and higher costs, thus declining attainability.
- The importance of innovation. Looking forward from a decade ago, we knew that we had an aging workforce in the industry that would play out in the decade. The prevailing thought was that immigration would fill that void as it always had. Innovation would probably take the form of incremental adoption of prefabricated wall panels and trusses, but that the core way of housing built primarily from basic materials assembled on site would not fundamentally change. As the labor situation became clearer and immigration was halted, the need for innovation came to the forefront, particularly in the latter half of the decade. ConTech, PropTech and other new players are bringing new thinking and businesses into the industry trying to reset the way that housing in produced.
- The severe underproduction of the decade and its implications. It looks like total housing production for the 2010s (single family, multi family, and manufactured) will average 1,063,000 per year. This compares to 1,702,000 in the 2000s, 1,621,000 in the 1990s, and a 70-year average from 1950 of 1,663,000. That equates to a deficit of about 600,000 per year or 6,000,000 homes for the past decade. No wonder we have an attainability problem: supply is less than demand, driving pricing and rents up faster than incomes and forcing “alternative housing solutions,” including a record number of young adults living at home with their parents, record homelessness, and a growing number of people and families living in their autos as their primary residence. The resurgence of rent controls will unfortunately not help this core issue, as history shows it suppresses the addition of supply.
- The permanence of young and middle-aged adults living at home with their parents. What we thought was a transitory effect of the Great Recession has become a major piece of housing supply for those who cannot afford to live on their own. John Burns has noted that there are about 40 million empty bedrooms in the US. This is a form of untapped housing supply that is now being utilized out of necessity, much to the chagrin of the parents.
So, what are my thoughts for the next 10 years: the Vision of the 2020s?
As was true a decade ago, one can see some of the future by looking closely at where we are now.
In addition, there are new “green shoots” of what might be growing trends for the next decade.
Together they form at least one person’s view of the operating environment, potential opportunities, and potential threats that the industry will be confronting.
- The excess of housing demand over housing supply will probably continue for a good part of the decade. The factors noted as limitations on supply for this past decade probably will not be corrected. NIMYism will be hard to reverse. Unless immigration policy reverses considerably, fewer and fewer citizens will be available for the trades. A change in government policy back to multi-faceted support for housing creation and ownership does not look likely, either. Meanwhile, housing production at the current level is not sufficient to create enough supply to meet the ongoing natural demand of 1.6 mm new homes per year much less make a dent in the 6 mm unit deficit from the past decade.
- The structural/societal bias toward homeownership will continue to erode. With government policy (tax benefits and subsidies) for homeownership declining along with the societal bias against rental continuing a long-term decline, rental property occupancy should continue to increase. Sometimes this will be by necessity (can’t save for the down payment; too much student debt inhibiting the ability to get a mortgage) and sometimes it will be by choice (job mobility, having someone else take care of the maintenance). The net effect will be a tailwind for rental apartment and single family for rent production. On the used housing side, there will most likely be a trend toward taking existing housing occupied by a single family and converting it to occupancy by multiple individuals or families, most likely via direct rental or quasi-rental solutions such as co-housing. This continues the trend of adult children living at home from the recession and expands it to other demographic categories.
- Productivity improvement will take on increasing importance. These improvements will be on parallel tracks: on-site and off-site. In the on-site world, look for a couple of sub-trends: industrial engineering focused on waste reduction in time, materials, and labor; using more sub-components built off-site; bringing critical labor components in-house vs. total subcontract. These all will have the effect of driving higher productivity in the on-site process. In the off-site world, look for these trends: pre-fabricated wall and floor panels and roof systems will become even more widely used; modules and whole homes built off-site will be more prevalent; the drive to productivity improvement and scale in factories will also increase to help make factory built solutions even more prevalent. Building product manufacturers moving up the supply chain and becoming the JV partners or outright owners of the factories producing the sub-modules, modules, and whole homes coming out of factories. It will allow them to create new, more efficient, and more-locked-in channels that are not as dependent on price alone.
- The increasing integration of up-front design and engineering with trade partners. Entekra’s “FIOSS” system is a model here. By doing the design/engineering with trade partners up front, waste and inefficiency are significantly conquered before material and labor are ever used. The result: higher productivity.
- The integration of purchasing and financial analysis at the builder level. Looking at just “apples to apples” comparisons for bricks and sticks alternatives misses impacts on other non-construction costs and leads to faulty conclusions. A holistic approach is needed and smart builder/developers will learn to create these approaches organizationally.
- A higher migration of women into the home building workforce at the builder and trade/factory level. Roughly 4% of trade contractors are female, yet 30-40% of factory workers are female. When we say we have an undersupply of trade contractors, we are really saying that we have an undersupply of male trade contractors. By moving more component and module creation into factories, a wider labor force opens up for the industry. Women and their influence will make a stronger companies across the industry and will drive improvements that we cannot imagine currently.
- Developers, particularly Master Planned Community developers, will be among the first to really embrace factory-built housing solutions. With often decades of lots ahead of them, they will see putting a housing factory on site as a double benefit: the transportation component of modules and components will be minimized and there will be a long-term job creation mechanism for the community in place early on. Some developers may use the opportunity to actually move totally into the builder shoes and handle sales/marketing/ and the simplified builder role in their communities once the bulk of production is done in a factory.
- New single family for rent builder/developers will be the other early adopters of off-site solutions. The simplicity and repeatability of the for-rent product will really allow factory solutions to scale and for cost efficiencies to be realized. I would not be surprised to see this technique carried over to a more simplified for-sale set of products addressing the attainable housing/housing supply shortage issue.
- In the single family for rent space, I would not be surprised to see a longer term (5-10 year) triple-net lease come into being. This would pass some of the variable costs of occupancy on to tenants in return for a longer-term claim on the residence and the stability that creates. Essentially, this product would get even closer to the ownership model in terms of duration but giving up equity creation in return for no down payment and an ability to break the lease (with penalty) if needed. A much easier solution than trying to sell a home, particularly in a down cycle.
- With the undersupply problem not going away soon, there will be growing pressure for other housing solutions. I believe that one will be how to take existing single-family homes, remodel them, and create updated homes that have been carved into multiple dwelling units. Some cities (Bend, OR) are working around solutions like this and I can see it expanding. To make it work at scale, regional and national remodelers/builders will be needed to bring scale and financial heft to the opportunity. I look with interest at what Zillow is doing and think that this company may be positioning to take complex data and combine it with a remodeling operation to create the updated residences with more household density and more inherent value.
- On the other hand, expect to see the situation get worse in some areas as the policy response to undersupply and rising prices and rents will be the introduction of rent control regimes. We all know that this does nothing to create more supply, but it will happen anyway, creating risk in land and property ownership in governmental jurisdictions that adopt this policy.
- Finally, expect to see more non-traditional players, foreign companies, joint ventures, and innovation from outside of the industry in the next decade. It is apparent that significant innovation is not coming enough from within the industry’s current players, leaving the opening to others to solve the big problems we face.
It is going to be an interesting decade ahead, particularly if you enjoy change.
The good news about residential building is that people always have and always will need shelter and, in that fact, will be the continuing demand to supply it.
How, where, and who supplies the shelter will be the interesting question requiring a certain 2020 vision.