Dowell Myers, USC professor

Dowell Myers, a professor at the University of Southern California school of Policy, Planning, and Development calls this 1%–which holds generally true in good years as well as bad years–the “Minority Dictatorship of New Construction.”

His assertion is that the growth or decline, the recovery or the downturn, the V or the L or the W of the broader economy, all spring essentially from what happens to this 1%.

When the 1% of those of us who are in new construction have a lot of people who are there by virtue of the combination of “ease of financing, production constraint, and a proliferation of buyers,” that destabilizes the world for the 99 out of 100 households living in the nation’s existing home stock.

Pretty simply, it’s where the thought and theory that “housing is the engine” that drives the economy springs from.

The issue with that 1% of households is that some of them have lost a job, some of them are having trouble getting one (at the younger end of the spectrum), some of them are afraid they might lose their job, and some of them need to save money either because they spent too much or they just haven’t earned enough.

After spending a couple of days with folks who make their living in the for-rent and the land development worlds, we’re getting a sense of deja vu from that community. There’s a lot of talk about distressed sale opportunity, a lot of talk about vulture fund cash waiting on the sidelines to pounce, a lot of talk about solid fundamentals, a lot of talk about balance sheet management and patience to see assets through to their eventual value.

In multifamily there’s resolve, there’s flashes of realism, and there’s a fair amount of hope at work. Just like their was among single family for-sale builders in late 2007, who said that that year would “suck,” fully believing that 2008 would be a happy recovery story.

We keep hearing of frenzied demand for homes at the margin. We keep hearing of multiple, motivated bidders and hesitant, reluctant sellers who feel that selling into the teeth of the down market is not the time. We keep hearing that deal structures, return multiples, risk appetites are all seeming to show flickers of sanity.

But clearly, just as events plunged many of us into a “where’s my bailout?” funk last October and November, the new “where’s my bailout?” is “where’s my recovery?”

News articles keep cropping up that talk of a recovery among “the builders,” noting that they’re generating some orders, and they’re in the market for lots in submarkets that have some volume.

At the same time, we’re talking every day with “the builders” and here’s a news flash for you, “the builders” aren’t in recovery. A few of them–i.e. well-managed publicly traded home building enterprises are managing the siege game well, and are flexing their muscles to drive volume, capture market share, and position for higher margins when they own more of the market.

Others–namely privates–are playing out brilliant counter programming strategies, based on pre-selling, differentiation, staffing levels that border on burn-out productivity, and hope.

To a person, nobody we’re talking to has certainty around two essential parts of the real estate equation–value and demand.

Value is still an unknown because demand is an unknown. Even the “buyer frenzy” of today doesn’t add information to real demand. The “what” and the “how many” of real demand can be discussed, USC’s Professor Myers probably has a better grip on that than many we’ve listened to.

It’s the other, extremely important part of demand–i.e. timing–that is completely clouded out for the time being. Myers attributes part of that to the fact that people don’t like to buy houses when prices are going down.

Why? Because we’ve begun to think of houses like an investment, vs. just our homes.

That’s why there’s such a fuss about the 1% of U.S. homes that lives in new construction. It’s where the money is.

Still, we can’t help the white knuckles, not after last September and October, and not after this past summer’s rally tapered into talk simply of protecting some of the year’s gains.

Every measure of growth, stagnation, or decline gets hyper scrutiny. This morning we have data out on jobs from ADP, which serves as a proxy for government employment data, with a particular sensitivity to the payrolls of small to medium-sized businesses. That report sent futures for U.S. stock markets from flat to negative. 

What struck us this morning, though, was a moment CNBC Squawk Box co-host Becky Quick experienced as she was talking with RBS analyst Michelle Girard. In a split second, it revealed how daunting it is for most semi-intelligent business journalists to get our heads around the maelstrom of technical data and trends as we cover the financial and housing crisis.

About five or six minutes into this eight-minute video, it all comes undone for Becky as she tries to make a point. To paraphrase her observation, she mentions that an analyst commenting yesterday on encouraging news from the Institute of Supply Management focused attention on one of the ISM measures as significant.  “There was a number; I forget what he called it, [but it had to do with] orders going out faster than they could refill them, which means these factories might need to hire people…”

In other words, she was saying, “I know there’s this smart thing somebody said that I should be referring to as an indicator, but I can’t think of it right now, but it really could be important.”

We have to say, we empathize. This downturn has brought us face to face with business finance, economics, and psychological phenomena that are utterly over our heads as we try to fix order to our reporting.

Things start to look good, and we report that things are starting to look good, especially if smart people add their blessing to their improvement. But still, we haven’t known how to look beyond immediate upticks and down drafts in the trends.

We have begun to understand that both to the positive and the negative, collective psychology trumps fundamentals, which is why markets are driving lower even as positive economic news flows into the headlines.

So we’ll go back to trying to understand that number that we know is important that has to do with consumers in households having money to spend on big, medium-sized, and little ticket items. Two out of every three dollars of GDP, and all the ability to pay back all the bills for the programs we’ve got to keep the trains running these days, comes from consumer household spending.

Take more than one in 10 households out of the mix because of lost jobs or lowered income, and the nine other households somehow need to make it up. That’s the number we’ll be looking at closely as we move through the next couple of months, watching the markets try to protect some of the gains it picked up from its March lows.

What has changed, per Zogby–author of a new book “The Way We’ll Be,” are the motivations driving people toward attaining their personalized version of the American Dream. Builder editor Boyce Thompson offers an analysis of Zogby’s remarks, with an eye toward connecting the dots between the pollster’s macro observations and specific opportunities and challenges for those trying to win new home buying and remodeling customers in the most dreadful of times.

Zogby outlined four pools of people who share this spiritual connection. A sizable portion of the population, he said, is now working for less. They have de-emphasized what they own or where they live to define themselves. “They are the new American consumer,” he said, adding that these are smart consumers who will shop for bargains but save money to buy something nice they really want. It’s a mistake to try to reach this group by marketing fantasy; reality is what appeals to them.

The blinding conclusion? Less is not only more; it’s all there is to bank on.

In Zogby’s own words:

Caculated Risk also observes, homeowner net equity is “Cliff Diving,” far below 41% when you account for the fact that 31% of homeowners have no mortgage to pay.

Still, consumer sentiment, according to the University of Michigan’s monthly survey, is inching up.

Not to where anyone should get excited, but up vs. the other direction.

Here’s a video clip from CNBC, with experts on the latest consumer sentiment data.

Calculated Risk says take it with a grain of salt.

Consumer sentiment is a coincident indicator – it tells you what you pretty much already know.

This would suggest that a positive outlook and a negative one are equally viable. So why not believe the more optimistic take?

Shiller is one of the smartest people today commenting on what makes the housing economy tick, and he’s the first to say he doesn’t know when it comes to predicting where it’s going to go. Mind his phrasing in an op-ed piece from the New York Times this past Saturday. He carefully uses the word “may” to say, “hey, it could go the other way, too.”

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

We’re ever concerned about predictions. We heard a lot of anecdotal good numbers for April, and have gotten word from a number of builders that May was just as good or even better. We heard of one home builder in the D.C. metro market who closed on 55 homes in May, a good 20% ahead of plan. In Phoenix, monthly sales in some communities are better than they’ve been dating back almost two years.

At the same time, the gathering financial storms of nonperforming commercial mortgage back securities and unrepayable credit card debt coupled with an expanding black hole of unemployment remain abstractions whose risks to forward planning may be too hard to calculate.

Have investors who’ve restored more than 40% of value to stocks from their low-point and gotten the Dow Jones in positive territory for the year factored in these forces already? Have government and Fed policies actually begun to find traction in the financial system that have started to slow the bleeding?

Here’s what we think. For most privately held home builders, especially the ones on life support who are one letter from the bank short of doom, there’s no gain whatsoever from a negative scenario. These companies are beyond scenarios altogether, and just pumping to get another sale done to keep working their way through their bank obligations for another month.

Housing prices–especially national ones–bear little relationship to the realities of these companies. They’re focused on the small ball. Build quick. Beat existing, distressed, and foreclosed properties to the punch somehow, and make it so that the monthly payments make sense to a home buyer exactly the way these companies’ own monthly payments to their lenders stay on course.

More macro financial shocks are coming. More job loss will put a drag on local economies. More household deleveraging will take money out of circulation as consumers curb their spending.

Even so, Shiller says, what happens time and time again in the history of economics is that people’s behavior frequently defies logical supply and demand behavior.

All of these people could be made to change their plans if a sharp improvement in the economy got their attention. The young couple could change their minds and decide to buy next year, and the elderly couple could decide to further postpone their selling. That would leave us with a buyer and no seller, providing an upward kick to the market price.

Can the 87% or more of people who may stay employed offset the negative feedback of those who’ll continue to swell the ranks of those involuntarily out of work during the next 12 months as the economy grapples for recovery?

Will those who are able to hang onto their jobs be confident enough in their income stability to strike while the pricing, interest rate, and Federal tax credit incentive irons are hot?

The expression one real estate/housing player uses to offer an answer to these questions is this: “You’ve got to fake it to make it.” There’s no upside to believing the downside outlook. 

For the moment, getting to ”the other side” of this mess means staying in business through tomorrow.

Same goes with selling homes. Whatever goes on in the macroeconomy, and however that connects with local markets and real estate trends, there’s going to have to be a psychological tipping point to jolt people into thinking now, or tomorrow is the time to buy before it’s a missed opportunity.

This is where excitement comes in, Weyerhaueser’s Winchester Homes in the D.C. metro area is working the innovation and design mode mightily to build excitement and differentiation into its model offerings. The moment lenders and buyers deem they’re ready to plunge, Winchester’s aiming to have a product line that differentiates them from the rest of the new-home market.

Which is where universal design comes in… recognizing that the demographics of the D.C. metro are diverse, but that many potential customers care about being able to age in place, Winchester’s incorporating more and more universal design features into its product line. Same goes with energy efficiency.

Big Builder executive editor Sarah Yaussi was out recently with Winchester division president Alan Shapiro for a first hand look at smarter approaches to accessibility, enhanced livability, and green as opposed to locally mandated accessibility regulations.

In her blog, Yaussi notes, essentially that most blanket mandates on accessibility merely add cost; whereas if a home builder or developer approaches the issue on a home by home basis, they can comply more efficiently by staying close to the ground.

Have a look at a 45-second explanation from Alan Shapiro on Winchester’s strategy and expectations from Winchester’s Your Home Your Way program, which comes down to learning what people will pay for in their new home.

[Caveat: It's low production but nails the insight in a jiffy!]

The reason for the extra costs is simple: Every piece of dirt is different. Even lots adjacent to each other can have a different grade or soil composition, making doing some of the structural work needed for accessible design, namely a zero-step entrance, not only more difficult but also more expensive. In fact, in some cases, a zero-step entrance would be cost prohibitive. (For a more in-depth look at the differences in cost structure between a no-step entrance and traditional step-up entrance, click here for a short presentation.)

However, under a voluntary program, builders like Winchester could earmark lots that naturally lend themselves to no-step entries, allowing buyers who want or need more accessibility to buy homes at production rather than custom home prices.

In this case, the home’s universal design features synch up with Montgomery County’s Design for Life Montgomery program. The voluntary program, which officially launched in March 2007, was the product of a push by local groups to increase the number of houses in the county that are accessible to people with disabilities. To date, the county’s permitting services has issued 12 permits for this type of project, eight of which are for new construction.

Here’s a quick Web seminar briefing from Sarah Yaussi on the edge Winchester gets through its program.

What’s more, here’s a Winchester Homes-provided video that walks viewers through the features, attributes and blend of UD and green building techniques Winchester is showcasing in its Clarksville, Md.-show home.

… as in not much to speak of other than talk.

Commentary on why the lure of downtown has remained a logical theory rather than a domestic migratory law is what William F. Gloede, author of Big Builder’s “Wall Street and Maine” blog, is best at.

The Pew Research Center late last month put out the results of a survey of 2,260 adults conducted last October that said, in effect, that not everyone, in fact, not even a plurality of Americans want to live in an urban environment. New York Times columnist David Brooks picked up on the survey last week, but I’ve seen little else reported about it. I am not surprised by either the results of the survey or the lack of coverage. It doesn’t fit the agenda, you know.

According to the survey, a majority of people (54%) who live in a city would like to move out. Hmmmm. Conversely, 54% of people who live in a suburb would like to continue living in a suburb. Likewise, 56% of those who live in a small town would like to stay in a small town, and 61% of those who live in a rural area would like to remain rural.

This does not mean they want to stay where they are, however. Among the entire sample, 30% said they would most like to live in a small town, 25% in a suburb, 23% in a city and 21% in a rural area. By a three-to-one margin, people said they wanted to live where the pace of life is slow, not fast. They preferred warm-weather places to the cold by a two-to-one margin. And they preferred to live where there is a McDonalds as opposed to a Starbucks by 43% to 35%.

When asked which metro areas near which they would like to live, the respondents top-10 included, in ranked order, Denver, San Diego, Seattle, Orlando, Tampa, San Francisco, Phoenix, Portland, Sacramento and San Antonio. The bottom-10, also in ranked order from the bottom up, included Detroit, Cleveland, Cincinnati, Minneapolis, Kansas City, Pittsburgh, St. Louis, Los Angeles, Baltimore and New York.

Now, let me see here. That Top-10 matches up pretty well with that supposedly worthless land the builders are holding.

Now, new urbanism proponents would no doubt argue that the public has simply not caught up to new realities. And they would point out, correctly, that young people, those all-important first-time home buyers, are far more city-friendly. According to the survey, of respondents 18-29, 40% said they wanted to live in a city, 22 in a suburb, 14% in a small town and 13% in a rural area.

Often, however, old realities trump new ones, especially when the reality is perceived as opposed to extant. The 30-49 age cohort turns those numbers upside down: 32% city, 42% suburb, 34% small town, 35% rural. This is precisely what occurred with the Baby Boom, and is now occurring with Gen X. Will the Millennials be different? Probably not. They are, after all, our children. A few years in the workforce usually dims the ideological blaze fanned by the professorial laundrymen of the university, and then there is that thing about age widening one’s frame of reference.

The American Dream, it seems, lives on in the minds of a majority as a house with a lawn in a place where one knows and need not fear one’s neighbors. It has not, thankfully, been rethought by Americans into conformity with the lyrics of John Lennon’s “Imagine.” Nor, I suspect, will it ever.

Yes, he’s right of the steak knife, but he’s right enough of the time to stir vehement agreement more often than not.

ProSales magazine and online editor Craig Webb reports on Lowe’s reel of fortune, both a 60% year on year earnings decline, and a sharply challenged 2009 outlook.

 Lowe’s Companies Inc. today reported its sales at stores open at least a year fell 7.2% in fiscal year 2008, ended Jan. 30, and predicted same-store sales will drop another 4% to 8% over the next 12 months. The company also said it will open just over half as many stores in the coming year as in 2008.

Net earnings for the fiscal fourth quarter ended Jan. 30 sank 60.3% from the year-earlier period to $162 million on a 3.8% drop in revenue to $9.98 billion. Net earnings for the fiscal year shrank 21.9% to $2.2 billion on a drop of just 0.1% in sales to $48.2 billion. Those sales numbers were boosted by the addition of 115 stores last year; as of Jan. 30, Lowe’s operated 1,649 stores in the United States and Canada.

Tuning into the company’s conference call with analysts, ProSales editor Webb reported Lowe’s senior strategists’ read on whys and wherefores of the sales swan dive and continued challenges. In short, consumers are simply shying away from the big bills that come with major home improvement undertakings right now. They’ll only do what they have to to keep their homes secure from heavy weather, financial or meteorological.

Larry Stone, President/COO of Lowe's

Larry Stone, Lowe’s president and chief operating officer, told analysts during a conference call that one reason why sales fell was that customers were doing fewer big-ticket renovation projects, such as kitchen projects. Similarly, Lowe’s revenue for installed sales projects, such as carpet and window installations, declined 14.4% in the fourth quarter from the previous year and was down 6% for the year. Discretionary expenditures accounted in 2006 for 45% of sales, he said. Now, they account for about one-third of sales. “[Customers are] hesitant to invest in large projects,” he said.

On the other hand, hurricanes and storms spurred purchases of shingles and other building materials. Had those purchases not occurred, the sales totals would have been one percentage point worse.

For those in dire need of a silver lining, look east, Stephen East, that is, Pali Research’s home building and building materials analyst. East reports that Lowe’s ebb-tide outlook is no surprise. What could non-plus industry observers, however, can be found under the rug. Here’s what we mean.

On Lowe’s conference call this morning, the details of the quarter were unsurprisingly negative for most categories, thereby transferring the pain to building products companies.  However, there were a couple of positives for our coverage, one surprisingly so.  Lowe’s saw same store sales start weak in November, improve in December then weaken again in January, which obviously causes consternation for investors of building products companies. 

Fortune Brands (FO) and Masco (MAS) likely suffered with most all product categories, while Mohawk Industries (MHK) may have been a beneficiary of a surprisingly positive performance.  Only two categories associated with our companies covered had positive commentary—Paint and soft flooring.  Management specifically mentioned that while total flooring was down double digits, Carpet sales remained strong.  Given that Mohawk is a significant supplier, we find that encouraging.  Paint was strong, which, while not helping Masco directly, implies that Home Depot will also turn in a good performance there, helping Masco and its dominant floor share in paint.  To the negative for both FO and MAS, both Cabinets and Fashion Plumbing were down double digits.  Given American Woodmark’s aggressive market share stance in Cabinets, we worry that these two companies could have not only endured poor comps, but also lost share.  In Fashion Plumbing, these two competitors dominate the floorspace, so expect that to impact sharply on results in the quarter.

In sum, we are pleasantly surprised with the ray of hope on Carpet sales and the potential impact on Mohawk, however, the overall trends portend more struggles for FO and MAS.

The data suggests that rather than tackle the big ticket home improvement projects, consumers–showing that good old American ingenuity–would like to sweep things under a new carpet for the time being.

Here’s how equity investors are discounting for Lowe’s continued headwinds. Above is an intraday chart that shows how the market reacted to the company’s earnings announcement. Below is a 6-month look at the stock’s trend.

Friday, Feb. 20, 2009... A tough outlook.

Lowe's stock performance for the past 6 mos.

It was the reason given for one of the more noteworthy chief executive resignations of the past year in our business. The fellow said, “I had to go to office after office and tell them that however hard they’d worked, and however loyal they’d been, and however skilled they are, we didn’t need their services anymore because the business was not there.” What an awful moment, and now it’s recurring in workplaces all over the country and all over the world as companies try to size for survival.

The management of the companies who are quaintly remembered now as The Big Three automakers are grovelling in the precincts of Capitol Hill to borrow enough billions in cash to make it alive to Inauguration Day. What’s next?

It’s fair to say that the 400 or so United States home building companies that operated under the aegis as Big Builders are but a shadow of themselves now. After the wave upon wave of reductions in forces, many of the bigger companies are staffed at 25% of their former size. Many of the smaller ones have cut every possible person and every possible expense, and now suffer the indignity of lenders who fail to see it in their business interest to return calls to discuss more realistic payment terms for monies owed.

In the decimation of the new-home building landscape, the number of moments you’d have to imagine where managers have had to tell other staff that their jobs were insupportable in this economy is staggering. The hit to morale for managers left in place at many home building and materials supply companies would have to be along the lines of a sailing ship caught in windless doldrums with dwindling supplies of food and water, and no prospect save to drift. 

In aggregate, home builder companies put America to work over the past several years in every bit as impactful and positive a way as the U.S.-based automotive industry, but it’s too complex an economic predicament for government to understand that, let alone do something about it.

So, we’ll get a bail-out for at least General Motors and Ford, and that will tourniquet the job situation momentarily.

Residential construction employment, it turns out, was the leading indicator of the lagging indicator that is employment. Per the U.S. Labor Department, “residential building construction” lost 6,400 jobs in the same month period from October to November 2008 that cost the overall economy 533,000 jobs, pushing unemployment up to a 6.7% level it has not reached since 1974, when fully half today’s Americans were not even born.

Labor Department numbers are a mere proxy for what’s going on. Barry Ritholtz’s The Big Picture has a succinct analyses of key deficiencies and corrective analysis for each of the government’s measures of employment loss.

Over the past few years, we have railed at the prettyfied numbers that come out of BLS regarding NFP job creation and the unemployment rate. From the Birth Death Adjustment to the understated unemployment rate, the official data (and corresponding headlines) painted a very misleading picture of what was going on. No conspiracy, mind you — just a creeping bias that has slowly distorted the data.

Hence, the past few years of aberrational, credit-driven economic growth was hidden from the public view. Many (tho not all) of Wall Street Economists were too hapless or cowardly to point this out. And some even cheerleaded the absurdity of the “Goldilocks” BLS data. Some simply declared the US a Nation of Whiners.

With the economy now in a full blown recession, and the Housing and Credit crisis getting worse, it hardly semed necessary to pile on BLS. Until Friday’s report. As bad as it was, looking beneath the headline data shows that it was worse — much worse — than reported.

The headlines belie the facts. The facts lag actuality. Actuality, in the words of more and more people we’re hearing from in the trenches of home construction, is that 2009 will be as difficult, if not more, than 2008.

A plan then is a three-year plan. During that period, financial viability must withstand bonds coming due for a number of publics, increasingly-impaired land assets for another stretch of months, covenants getting tested and tripped right and left, and people getting drummed out of their offices as banks come kicking and screaming into the real estate real asset ownership and sales business.

A still hopeful outcome of the new queue for priorities? Fix Housing Fourth. If we say that the financial system, car companies, and consumers rank ahead of housing in order of importance for stimulative measures, maybe that will have to be good enough.

Our fathers and mothers and grandparents who are still here to tell the tale may remember living through the Great Depression. They may have been “children” of the Great Depression, and may have endured its pain.  Even they were not grown up enough to have seen what was coming as adults. They’ll tell you now, “I’ve never seen anything like this,” when it comes to the sheer wealth destruction that’s occurring in their lives now.

One thing they grew up with that has scarcely changed is the sanctity and necessity of jobs. That’s where consumer confidence and sentiment come from. That’s going to have to be what Capitol Hill and the next President will need to work on for the next 24 months: jobs.

The Wall Street Journal notes:

Economist Dean Baker

Dean Baker, co-director of the center and a frequent critic of the government’s approach to promoting homeownership, calls for the mortgage-finance giants to use rent-based appraisals to help drop housing prices.

The center’s proposal suggests that using rent-based appraisals would instill confidence among homebuyers in non-bubble markets, where prices have appear to have stabilized. The report acknowledges that the further decline in home prices would come at the expense of homeowners in bubble markets, but that it would save prospective homeowners from buying homes “at bubble-inflated prices on which they will subsequently lose money.”

“If homeowners will lose most of their home equity over the next year, it is better that they recognize this fact as soon as possible so that they can adjust their behavior accordingly,” the report says.

Fact is, deflating home prices don’t happen in isolation. The domino effect of such wealth destruction would carry across every company’s earnings outlook for years to come.  Remember, “back to trend” might look harmonious on an economist’s longitudinal analysis, but “trend” in housing in America for the first 75 years of the last century hearkens to a different household reality. Remember nuclear married with children families? That is trend. That’s a different economic engine altogether, and one we’ll never see again.

So economists who assert housing should and will correct to trend levels ignore household economic realities that are dramatically different than the household landscape of the 1900-to-1999 period they’re trending. This economist, Dean Baker, wouldn’t know an anomaly from an anemone.