Builders Say They’re Ready for This Housing Slowdown. ‘I’ve Learned My Lesson.’ | Kanebridge News
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Builders Say They’re Ready for This Housing Slowdown. ‘I’ve Learned My Lesson.’

Meltdown of 2007-09 fostered less risky tactics; not as much debt

Tue, Oct 25, 2022 8:38amGrey Clock 6 min

NORTH LAS VEGAS, Nev.—A year ago, business was booming for Touchstone Living Inc. The Nevada builder had a list of 639 qualified buyers who wanted homes in its development about 15 miles north of the Las Vegas Strip.

Today, that list has shrivelled to about 30. Many would-be buyers are unable to qualify for loans since mortgage rates have surged to 6.94%, their highest level since 2002 and more than double the rate of a year ago.

Little of this is good news for Touchstone or its owner, Tom McCormick. That said, in a potential indicator for how this slowdown could play out, it isn’t looking like the last time the Las Vegas market melted down.

Mr. McCormick said his new company has less debt and fewer lenders than his former company did heading into the 2007-09 recession, and has grown more slowly and bought less land.

“I’ve learned my lesson,” he said. Still, he said, “I’ve never seen it change this fast,” referring to the rapid decline in sales.

After a pandemic-fuelled buying spree that unleashed the most powerful U.S. housing boom in 15 years, demand has plummeted as mortgage rates have risen. Finished homes are sitting on the market, hundreds of thousands of new ones are expected to be completed in the coming months, and many builders are cutting prices. Existing-home prices are declining from their springtime peaks, and single-family home construction in September fell 18% from a year earlier.

During the earlier housing downturn, which was triggered in part by the collapse of the subprime-mortgage market, about half of all home builders disappeared. Home builders that lived through that said they learned some hard lessons, and that the current slowdown won’t lead to another industry implosion. Also, mortgage lenders have tightened underwriting standards in recent years, reducing the risk of a wave of foreclosures.

Mr. McCormick’s former home-building company stopped construction in 2009 after losing projects to foreclosure. Home builders have been more conservative in recent years about taking on debt and owning a lot of land, industry analysts said. Some home builders have increased their use of land banks or other third-party arrangements that give them the option to buy land only when they need it.

Some home builders who have completed single-family homes but not yet sold them have turned to the rental market to bring in revenue, and others are selling them in bulk to investors at discounted prices to use as rentals.

This year’s rising mortgage rates, said Mr. McCormick, slashed the number of would-be buyers for his homes. “They still had the good credit, they still had the good job,” he said. But rising home prices and rates, he said, “just squeezed them out of the market.”

Other prospective buyers have backed away from buying anything now because of economic uncertainty, real-estate agents said. Consumer sentiment toward the housing market fell in September to the lowest level since 2011, according to Fannie Mae.

“How rapidly things have deteriorated is pretty remarkable,” said Ivy Zelman, chief executive of real-estate research and advisory firm Zelman & Associates, a unit of Walker & Dunlop Inc. But “there’s a huge difference from the go-go days of exotic mortgage products and no money down,” she said, referring to the loose lending environment before the 2007 crisis.

During the first two years of the Covid-19 pandemic, home builders couldn’t build homes fast enough to meet demand. Supply-chain issues and labor shortages slowed the pace of construction. Builders limited sales so they didn’t sell more homes than they could build, and selected buyers off wait lists or through lotteries. Prices soared, and builders ramped up construction as much as they could.

Now that new-home sales have slowed, the risk of a glut is rising. About 800,000 single-family homes were under construction in September, on a seasonally adjusted basis, up 11% from a year earlier and 52% from September 2019, according to the Census Bureau. Many of those homes were started before the market slowed.

Some are already sold, but not all. In an effort to lure reluctant buyers or keep others from cancelling, builders are paying upfront fees to mortgage lenders to reduce buyers’ mortgage rates and offering other incentives, such as long-term rate locks. Builders also are canceling deals to acquire land.

There was an 8.1-month supply of new homes on the market at the end of August, according to the Census Bureau.

“They are sitting on a lot of inventory that’s under construction, and that’s the stuff that they’d like to move,” said Carl Reichardt, a home-building analyst at financial-services firm BTIG. “I think it’s going to get worse before it gets better.”

Lennar Corp., the nation’s second-biggest builder by volume, said in a September earnings call that new sales orders fell 12% in the third quarter from a year earlier. Its average sales price for new orders rose 1% from a year earlier, but fell 9% from the second quarter.

“It’s clear that there’s going to be more increase in interest rates that we’re going to be dealing with,” said Stuart Miller, Lennar’s executive chairman, on the call. Builders will need to cut prices and offer incentives, he said, or sales would decline.

Rising rates have hit the existing-home market, too. Between January and September, sales activity declined 27% on a seasonally adjusted annualised basis, a faster decline than during the subprime crisis.

Even so, existing-home prices are up from a year ago on a national basis. The number of existing homes for sale remains well below historical levels, and millions of millennials are moving into their prime home-buying years—both factors that could limit price declines, economists said.

New-home construction, which accounts for about 10% of overall home sales, faces a bigger risk of slowing sales and price declines in the near term because new homes typically are more expensive than existing homes, and because the supply is continuing to grow.

For Mr. McCormick, the summer’s slowdown was a scary reminder of how easily the market can turn.

He was the owner of Astoria Homes, one of the biggest privately owned home builders based in Nevada during the early 2000s housing boom. At its peak in 2004 and 2005, Astoria built about 1,000 homes a year.

“It was so good for so long,” Mr. McCormick said. “I just became overconfident.”

When the subprime-mortgage crisis erupted in 2007, the housing market collapsed and many builders went out of business. Las Vegas became one of the faces of the national foreclosure crisis. Home builders, who had built a surplus of homes during the boom, couldn’t compete with existing homes that were selling for far less than new ones.

Astoria shrank from 170 employees to three, including Mr. McCormick. A few of its lenders were taken over by the Federal Deposit Insurance Corp. Mr. McCormick, who had made personal guarantees on Astoria’s debts, spent years settling them.

Some home builders were so shell-shocked by the crisis that they were hesitant to increase their building for years.

“The great financial crisis, even though that was 15, 16 years ago, still feels very current and very raw to the builders in Las Vegas, because they took it on the chin as much as anybody in the country,” said Ken Perlman, managing principal at Irvine, Calif.-based John Burns Real Estate Consulting.

As a result, the supply of new homes isn’t as excessive as it was before the housing crisis.

Nationwide, the number of residential builders declined by 50% between 2007 and 2012, according to the National Association of Home Builders. Single-family housing starts, a measure of new-home construction, fell from 1.7 million in 2005 to 445,000 in 2009, according to the Census Bureau. Builders didn’t exceed one million single-family starts in a year again until 2021.

By 2012, Mr. McCormick was ready to dip his toes back in. He expected Las Vegas’s population to keep growing and home prices to rebound. He started buying land that year, and Touchstone sold its first home in 2014. It is the largest Nevada-based privately owned builder, and it had about 4.8% market share in the Las Vegas area last year, according to Builder Magazine.

The S&P Homebuilders Select Industry stock index is down 36% this year, outpacing the S&P 500’s 21% decline. A measure of U.S. home-builder confidence fell for the 10th straight month in October to the lowest level since May 2020, according to the NAHB. About one-quarter of builders surveyed by the association in September said they had reduced prices in the prior month.

In the Las Vegas area, new-home sales have slid from more than 1,000 a month in the first quarter to 488 in August, said Andrew Smith, president of Las Vegas-based Home Builders Research Inc.

Most Las Vegas-area builders surveyed in September had reduced prices that month from their August levels, once incentives such as interest-rate buy downs were factored in, Mr. Perlman said.

Mr. McCormick is hoping Touchstone’s prices give his company an advantage in a slow market. Touchstone’s homes sell for between about $315,000 and $433,000. The region’s median new-home closing price in August was about $492,000, according to Home Builders Research.

In September, Touchstone decided to start renting out some of its properties because it expects home-buying demand to stay low.

“People still want to own homes, but they simply can’t afford it,” Mr. McCormick said. “So the business plan has to change.”


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A new trading year kicked off just weeks ago. Already it bears little resemblance to the carnage of 2022.

After languishing throughout last year, growth stocks have zoomed higher. Tesla Inc. and Nvidia Corp., for example, have jumped more than 30%. The outlook for bonds is brightening after a historic rout. Even bitcoin has rallied, despite ongoing effects from the collapse of the crypto exchange FTX.

The rebound has been driven by renewed optimism about the global economic outlook. Investors have embraced signs that inflation has peaked in the U.S. and abroad. Many are hoping that next week the Federal Reserve will slow its pace of interest-rate increases yet again. China’s lifting of Covid-19 restrictions pleasantly surprised many traders who have welcomed the move as a sign that more growth is ahead.

Still, risks loom large. Many investors aren’t convinced that the rebound is sustainable. Some are worried about stretched stock valuations, or whether corporate earnings will face more pain down the road. Others are fretting that markets aren’t fully pricing in the possibility of a recession, or what might happen if the Fed continues to fight inflation longer than currently anticipated.

We asked five investors to share how they are positioning for that uncertainty and where they think markets could be headed next. Here is what they said:

‘Animal spirits’ could return

Cliff Asness, founder of AQR Capital Management, acknowledges that he wasn’t expecting the run in speculative stocks and digital currencies that has swept markets to kick off 2023.

Bitcoin prices have jumped around 40%. Some of the stocks that are the most heavily bet against on Wall Street are sitting on double-digit gains. Carvana Co. has soared nearly 64%, while MicroStrategy Inc. has surged more than 80%. Cathie Wood‘s ARK Innovation ETF has gained about 29%.

If the past few years have taught Mr. Asness anything, it is to be prepared for such run-ups to last much longer than expected. His lesson from the euphoria regarding risky trades in 2020 and 2021? Don’t count out the chance that the frenzy will return again, he said.

“It could be that there are still these crazy animal spirits out there,” Mr. Asness said.

Still, he said that hasn’t changed his conviction that cheaper stocks in the market, known as value stocks, are bound to keep soaring past their peers. There might be short spurts of outperformance for more-expensive slices of the market, as seen in January. But over the long term, he is sticking to his bet that value stocks will beat growth stocks. He is expecting a volatile, but profitable, stretch for the trade.

“I love the value trade,” Mr. Asness said. “We sing about it to our clients.”

—Gunjan Banerji

Keeping dollar’s moves in focus

For Richard Benson, co-chief investment officer of Millennium Global Investments Ltd., no single trade was more important last year than the blistering rise of the U.S. dollar.

Once a relatively placid area of markets following the 2008 financial crisis, currencies have found renewed focus from Wall Street and Main Street. Last year the dollar’s unrelenting rise dented multinational companies’ profits, exacerbated inflation for countries that import American goods and repeatedly surprised some traders who believed the greenback couldn’t keep rallying so fast.

The factors that spurred the dollar’s rise are now contributing to its fall. Ebbing inflation and expectations of slower interest-rate increases from the Fed have sent the dollar down 1.7% this year, as measured by the WSJ Dollar Index.

Mr. Benson is betting more pain for the dollar is ahead and sees the greenback weakening between 3% and 5% over the next three to six months.

“When the biggest central bank in the world is on the move, look at everything through their lens and don’t get distracted,” said Mr. Benson of the London-based currency fund manager, regarding the Fed.

This year Mr. Benson expects the dollar’s fall to ripple similarly far and wide across global economies and markets.

“I don’t see many people complaining about a weaker dollar” over the next few months, he said. “If the dollar is falling, that economic setup should also mean that tech stocks should do quite well.”

Mr. Benson said he expects the dollar’s fall to brighten the outlook for some emerging- market assets, and he is betting on China’s offshore yuan as the country’s economy reopens. He sees the euro strengthening versus the dollar if the eurozone’s economy continues to fare better than expected.

—Caitlin McCabe

Stocks still appear overvalued

Even after the S&P 500 fell 15% from its record high reached in January 2022, U.S. stocks still look expensive, said Rupal Bhansali, chief investment officer of Ariel Investments, who oversees $6.7 billion in assets.

Of course, the market doesn’t appear as frothy as it did for much of 2020 and 2021, but she said she expects a steeper correction in prices ahead.

The broad stock-market gauge recently traded at 17.9 times its projected earnings over the next 12 months, according to FactSet. That is below the high of around 24 hit in late 2020, but above the historical average over the past 20 years of 15.7, FactSet data show.

“The old habit was buy the dip,” Ms. Bhansali said. “The new habit should be sell the rip.”

One reason Ms. Bhansali said the selloff might not be over yet? The market is still underestimating the Fed.

Investors repeatedly mispriced how fast the Fed would move in 2022, wrongly expecting the central bank to ease up on its rate increases. They were caught off guard by Fed Chair Jerome Powell‘s aggressive messages on interest rates. It stoked steep selloffs in the stock market, leading to the most turbulent year since the 2008 financial crisis. Now investors are making the same mistake again, Ms. Bhansali said.

Current stock valuations don’t reflect the big shift coming in central-bank policy, which she thinks will have to be more aggressive than many expect. Though broader measures of inflation have been falling, some slices, such as services inflation, have proved stickier. Ms. Bhansali is positioning for such areas as healthcare, which she thinks would be more insulated from a recession than the rest of the market, to outperform.

“The Fed is determined to win the war since they lost the battle,” Ms. Bhansali said.

—Gunjan Banerji

A better year for bonds seen

Gone are the days when tumbling bond yields left investors with few alternatives to stocks. Finally, bonds are back, according to Niall O’Sullivan of Neuberger Berman, an investment manager overseeing about $427 billion in client assets at the end of 2022.

After a turbulent year for the fixed-income market in 2022, bonds have kicked off the new year on a more promising note. The Bloomberg U.S. Aggregate Bond Index—composed largely of U.S. Treasurys, highly rated corporate bonds and mortgage-backed securities—climbed 3% so far this year on a total return basis through Thursday’s close. That is the index’s best start to a year since it began in 1989, according to Dow Jones Market Data.

Mr. O’Sullivan, the chief investment officer of multi asset strategies for Europe, the Middle East and Africa at Neuberger Berman, said the single biggest conversation he is currently having with clients is how to increase fixed-income exposure.

“Strategically, the facts have changed. When you look at fixed income as an asset class…they’re now all providing yield, and possibly even more importantly, actual cash coupons of a meaningful size,” he said. “That is a very different world to the one we’ve been in for quite a long time.”

Mr. O’Sullivan said it is important to reconsider how much of an advantage stocks now hold over bonds, given what he believes are looming risks for the stock market. He predicts that inflation will be harder to wrangle than investors currently anticipate and that the Fed will hold its peak interest rate steady for longer than is currently expected. Even more worrying, he said, it will be harder for companies to continue passing on price increases to consumers, which means earnings could see bigger hits in the future.

“That is why we are wary on the equity side,” he said.

Among the products that Mr. O’Sullivan said he favours in the fixed-income space are higher-quality and shorter-term bonds. Still, he added, it is important for investors to find portfolio diversity outside bonds this year. For that, he said he views commodities as attractive, specifically metals such as copper, which could continue to benefit from China’s reopening.

—Caitlin McCabe


Find the fear, and find the value

Ramona Persaud, a portfolio manager at Fidelity Investments, said she can still identify bargains in a pricey market by looking in less-sanguine places. Find the fear, and find the value, she said.

“When fear really rises, you can buy some very well-run businesses,” she said.

Take Taiwan’s semiconductor companies. Concern over global trade and tensions with China have weighed on the shares of chip makers based on the island. But those fears have led many investors to overlook the competitive advantages those companies hold over rivals, she said.

“That is a good setup,” said Ms. Persaud, who considers herself a conservative value investor and manages more than $20 billion across several U.S. and Canadian funds.

The S&P 500 is trading above fair value, she said, which means “there just isn’t widespread opportunity,” and investors might be underestimating some of the risks that lie in waiting.

“That tells me the market is optimistic,” said Ms. Persaud. “That would be OK if the risks were not exogenous.”

Those challenges, whether rising interest rates and Fed policy or Russia’s war in Ukraine and concern over energy-security concerns in Europe, are complicated, and in many cases, interrelated.

It isn’t all bad news, she said. China ended its zero-Covid restrictions. A milder winter in Europe has blunted the effects of the war in Ukraine on energy prices and helped the continent sidestep recession, and inflation is slowing.

“These are reasons the market is so happy,” she said.

—Justin Baer

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