U.S. News

Woe Is Housing: Hurt's On Homebuilders

For those who may have thought the worst was over for the housing industry, none other than Federal Reserve Chairman Ben Bernanke this week threw cold water on that hope when he revised his own prognosis.

Back in May, at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Federal Reserve Chairman Ben Bernanke downplayed the mortgage meltdown.

“We believe the effect of troubles in the subprime sector on the broader housing market will likely be limited," said Benrtnake. "And we do not expect significant spillovers for the subprime market to the rest of the economy or to the financial system.”

Fast forward to the House of Representatives this week, where Chairman Bernanke admitted that, “conditions in the subprime mortgage sector have deteriorated significantly, reflecting mounting delinquency rates on adjustable-rate loans.” He went on to say that, “the ongoing housing correction might prove larger than anticipated, with possible spillovers onto consumer spending."

While Bernanke's comments were striking at the time, he is really just one in a long line of prognosticators changing their collective tune. The CEO of KB Home, Jeff Mezger, who just a few weeks ago said he couldn’t predict a bottom to the housing market, now says it may not happen until the end of 2008.  Mezger and others in his line of work had been predicting a recovery by the end of this year or the beginning of next.

“The builders are accepting reality and acknowledging what’s happening out there,” says Banc of America Securities analyst Dan Oppenheim. Buyer traffic continues to deteriorate, even as prices drop. With any other product, lower prices would mean improved interest, “but with housing it doesn’t happen that way,” Oppenheim adds. Buyers are simply scared and willing to wait it out.

Dave Seiders, the chief economist for the National Association of Home Builders, has revised his forecast for recovery back quite a few times, thanks to the mortgage woes. After the latest builder sentiment recorded its lowest level in 16 years, Seiders wrote, “Builders are actively trimming prices and offering buyer incentives to work down their inventories, but meanwhile there is a large supply of vacant existing homes on the market, and affordability problems persist despite efforts to attract buyers.”

The market is still quite weak, as new and existing home sales show no sign of recovery, and prices for both continue to slide from their peaks in 2005.  “The single most important issue facing the industry is excess inventory,” says Robert Curran at Fitch ratings. During the boom, builders rushed to buy up land, and that land now isn’t worth much without a house on it.  That’s why some builders keep going, only adding to the inventory glut.

But many others are walking away, taking huge hits to their company bottom lines. Witness Pulte Homes, which is forecasting second quarter impairment and land-related charges of between $740 million and $770 million. That’s 8% of the company’s book value.

“The difficult conditions that plagued the home-building industry in the first quarter of 2007 worsened in the second quarter,” says Pulte CEO Richard Dugas. He cites, “increased competitive pricing pressures, elevated levels of new and resale home inventory, and weak consumer sentiment for housing affecting the entire industry.”

Pulte’s earnings forecast, and the expected earnings announcements by several other major public home builders next week, indicate that weakness in the sector will persist. “It is important that the builders restrain themselves in building particularly speculative homes in order to help to work down the inventory,” Curran says.

Building permits for single-family homes are down 43% from their peak in 2005, according to the Dept. of Commerce. While some, like Pulte, are taking huge lumps in land charges, others are continuing to build on their land in order to generate cash flow. Others are ramping up the incentives.

Pennsylvania home builder, Keystone Custom Homes, is offering potential buyers the chance to, “Live free for a year.  Really.” The advertisers for Keystone might have thought they needed the “Really” to convince skeptical buyers, but nowadays, incentives like this are not surprising.

“It’s definitely a challenging time to be building homes,” says Keystone president Jeff Rutt.  “Probably one of the biggest hurdles that I’ve seen here locally and just from what I’ve seen nationally, is buyer sentiment, buyer confidence.”

So far, 231 families have taken Rutt up on his offer; company sales are up 16% year-over-year, he claims. That’s better than some of the bigger guys, a lot better. 

Confidence is clearly key, and until Americans start believing a home is a good investment again, stories like Keystone will continue to be the exception in this troubled housing market, not the rule.

Homebuilders In A Slump