Housing Industry’s Foundation Is Firm

Home sales and prices are rising in California and many other parts of the country. Stocks of home-building companies have been raising the roof.

But now some experts are crying “bubble,” predicting a downturn in home buying and home prices and financial distress among mortgage holders.

Is housing a bubble about to burst? It’s not likely, thanks in part to old-fashioned American bureaucracy.

Land-use regulations, anti-sprawl ordinances and other regulations on building, abundant not only in California but in Florida, Texas and most other areas, are having the unintended effect of limiting land for home building. This is creating housing shortages in many locales.

As a result, home sales probably will set new records again this year as the economy recovers. Home prices are unlikely to fall. And the home-building industry will continue to demonstrate its new strengths in finance, technology and changing competitive dynamics.

And as they always do, regulations favor larger home-building companies over smaller ones, because only the big firms can absorb the costs of lengthy permitting processes, lobbying of local councils and meeting community and environmental demands.

Thus, an industry of about 79,000 home builders is consoli- dating into a dozen or so giant national firms, plus about 30 mid-size companies and a great mass of small, local builders.

The industry has changed profoundly in the last decade. When recession hit in the early 1990s, the average home builder was caught with unsold houses or inventories of land that had to be sold to pay bank loans, which were the industry’s chief source of finances in those days.

But as the ‘90s progressed, publicly owned home-building firms built up their balance sheets, devised ways to option rather than buy land and to attract long-term senior debt financing from Wall Street.

The result is an industry of stronger firms that do business differently than a decade ago. Conscious of the need to earn higher returns on capital, they build no homes on spec but collect deposits--typically 5% of the eventual price--from buyers before starting construction.

With less land available, they build fewer houses. “In the late 1980s, when California was booming, the industry built 260,000 homes in the state,” says Bruce Karatz, chairman of KB Home, a Los Angeles-based nationwide builder. “Now California is booming again and the industry will build 140,000 homes in the state this year.”

Housing shortages are endemic in California. “Supply can never meet demand in virtually all price ranges in California,” says Karatz, who has led the company since 1986.

But California is not alone. “That statement is true for many other markets in the country,” says Stuart Miller, chairman of Lennar Corp., a Miami-based builder that in the last decade has spread by acquisition to California, Texas, Arizona, Nevada and Colorado.

In other words, Miller is saying the days of worrying about a housing glut are over.

The Maryland-Virginia area around Washington “is possibly the hottest market in the country right now,” says Chad Dreier, chairman of Ryland Group Inc., a major home builder that is based in Calabasas but builds homes in most regions of the country.

Ryland specializes in homes for first-time buyers. Yet the median price of the 13,095 homes it built and sold last year was $208,000--and Ryland does only a minor fraction of its business in California, where median home prices are 25% to 50% higher.

Such price levels are the reason some experts predict that dwindling affordability will stop the housing boom or threaten the economic system with overly debt-burdened mortgage holders.

But Brian Hale, executive vice president of Countrywide Home Loans, the nation’s largest mort- gage lender (and a subsidiary of Calabasas-based Countrywide Credit Industries Inc.) sees no such danger. Reforms of credit standards by the Federal National Mortgage Assn., or Fannie Mae, and the Federal Home Loan Mortgage Corp, or Freddie Mac, have “broadened the market to more new buyers” without undue risk. Mortgage default rates are falling, not rising, Hale says.

To be sure, sharply higher interest rates would clobber housing affordability. But the small rises in mortgage rates seen in the last week are not cause for concern as long as the economy truly is recovering. “Short-term movements in mortgage interest are less of a factor in home markets than essentials of job growth and consumer confidence,” says Miller of Lennar.

The housing market today is being driven by population growth--the grown children of baby boomers plus generations of immigrants and children of immigrants. And home ownership, now a reality for more than 68% of of the U.S. population, will continue to rise, analysts predict.

The market is vibrant and innovative. It is routine for home builders to offer prospective buyers options for interior decor before construction. Specific orders then can be sent to the construction site via the Internet, and the cost of extras can be included in the mortgage and amortized over 30 years. Home builders also earn better profit margins on decor options.

Housing markets do decline to be sure. In the high-tech bust of 2001, home prices fell 25% in Silicon Valley, estimates analyst James Wilson of JMP Securities, a San Francisco investment firm. But even home sales in Silicon Valley are picking up again.

And in Southern California, where housing shortages are severe in Los Angeles and Orange counties, the relative availability of land in the Inland Empire for building and homes in the $200,000- to-$300,000 price range is drawing home builders such as Irvine-based Standard-Pacific Corp. and Red Bank, N.J.- based Hovnanian Enterprises Inc.--which recently acquired California’s Forecast Homes.

Strength in housing, of course, is a traditional support for the entire economy--the home purchase leads to sales of furniture and appliances, insurance, financing and many other products and services. That’s why the federal government has traditionally supported housing, with tax deduction for mortgage interest as well as the creation of mortgage support agencies such as Fannie Mae.

But home building as an industry always has been seen as a cyclical business of local, under-capitalized contractors.

In some ways it still is, with stocks of major home-building firms selling at low, eight to 10 times multiples of their rising earnings. “Industries being investigated by the SEC get a higher multiple than we do,” quips Miller of Lennar.

The homebuilding industry has changed. It will be interesting to see whether Wall Street’s view of it also changes.

James Flanigan can be reached at [email protected]