Southern California

SoCal Investors Fear New Home Construction

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John Burns

November 6, 2013

But should they?

Every time I attend a conference I learn something. Last month, legendary Inland Empire investor Bruce Norris held a charity event for 500 people with a number of top analysts. He estimated that at least $1 billion of Southern California residential real estate investment capital was in the room. These investors are anxious about new home construction and, surprisingly, were the most interested in hearing me speak about the future supply of new homes.

The highlight for me was the time I got to spend at dinner with Debra Still, CEO of Pulte Mortgage and outgoing Chairwoman of the Mortgage Banker Association. I haven’t met anyone who articulates the mortgage industry issues as well as she does.

Below are a few links to the event.

Link 1: My panel with Beacon Economics economist Chris Thornberg (starts at 3 minutes)

Here are a few reference points to debt mentioned:

  • MDC / Richmond American’s $250 million, 30 year unrestricted loan at 5.75%: Reuters
  • Ryland’s $250 million bonds 0.25%, convertible to equity when the stock reaches $75: Businesswire

 

Here is a chart showing the lack of supply and our forecast for Riverside-San Bernardino. While our forecast may look low, I spent one hour on the phone on Friday with one of the major land buyers telling me that there is no way that supply will equal my forecast because the entitled lots in the right locations just don’t exist. My takeaway was that tremendous price appreciation will be necessary for construction to double.

Throughout the interview, we discuss:

  • Design. The appeal of new designs with great rooms and energy efficiency, as well as lower maintenance homes
  • Age-targeted housing. The importance of the 55 and over buyer and the opportunities to sell different homes to 55-, 65- and 75-year old buyers
  • Multi-generational living. The growing trend, driven both by immigration as well as economic necessity, of multiple generations of adults living under the same roof

Link 2: Mortgage Panel with Debra Still and Mark Palim

Interesting points made in this panel include lender liability and 60% of home demand this decade coming from immigrants and first time buyers / Echo Boomers.

Link 3: Summary Video

I learned a new term: price aggression.

Leslie Appleton-Young from California Association of Realtors points out that the housing markets can change on a dime. In February 2012, the market changed. Inventory is the best leading indicator.

At 9 minutes, the point was made that last year’s price appreciation was not driven by the median income household. It was driven by affluent households, including investors.

Pay option ARMs work well when borrowers qualify based on the worst possible payment. They no longer worked when borrowers were qualified based on the initial rate.

At 16 minutes, Debra Still comments, “The ultimate change in dynamics is that Congress doesn’t believe consumers will behave rationally in an irrational environment. Lenders used to be protected by disclosing, but now the lending community has obligations even with full disclosure.” In my view, this is a permanent shift to mortgages trading at a higher than historical premium over Treasury securities.

At 39 minutes, Debra states that mortgages will get less competitive because too many banks will throw in the towel given the complexities of regulation. She notes that lenders need clear reps and warranty laws, definition of materiality, etc. from whom they sell the loans to (GSEs, etc.).

About Bruce Norris
I don’t promote others very often. Bruce Norris is an Inland Empire investor who has quite a following. He is not a client. He has made three big calls since I have known him—a bull call in 1997, a bear call in 2006, and a bull call in 2012. All three calls used the same set of charts, and all three were correct. Last December, he correctly told me he anticipated 20% price appreciation in the Inland Empire in 2013! He is quite optimistic on the outlook for housing in 2014.

In Summary
As I mentioned earlier, the investors who were at the event are concerned about the future supply of new homes. They are keenly aware that a surge in home building will cut deeply into their demand pool. I have a high level of confidence that they have nothing to worry about.

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John Burns
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As CEO, John grows, leads, and supports a team of passionate, articulate, likable, and smart experts. Together, we solve today so our clients can navigate to tomorrow.

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