Change the skill-set from capacity to ability.

That’s the way FMI Corp. principal Clark Ellis described the challenge for home building companies. It sounds so simple.

Home building companies, until around Spring 2007, had four key stakeholders: home buyers, financial investors, suppliers and local decision-makers, and staff. No longer. A fifth critical stakeholder has emerged out of the profound dislocation that came along with deleveraging household, business, and government economies: Broad public perception and Congress.

Going back to Clark Ellis’ phrase to describe the structural challenge of every home builder to migrate from being a Capacity organization to an Ability organization, the addition of this fifth critical stakeholder makes the challenge that much harder.

Look at the nation’s car business. It grew into empires based on capacity. It has become rubble because it has not found ability. For two deathwish decades Detroit pitted its gearhead engineers against its blustery marketeers. They one-upped and undermined one another into oblivion.

When Capacity was the goal, home builders rose to it with gusto. Now that Ability is the goal, it means having to blow up a lot of the way things worked before. Financial realities forced some of that, but downsizing and other cost actions only get organizations part the way there.

For practical purposes, value engineering, as most people use the term in new-home construction operations, is a misnomer. It’s really a cost strip-out process, as opposed to engineering process and product for optimized value.

So taking out product costs, and getting leaner in overheads and operational expenses, and cutting production time, and renegotiating loan terms and land deals, and eliminating waste are necessary actions. Those steps are strides toward Ability, but they don’t get you there.

What will get you across the chasm from Capacity to Ability is not just cost engineering, but making the new-home a purchase experience like no other. Ability means giving a home buyer prospect something that sets your home apart from a design, community experience, value, and quality standpoint. To become an Ability organization, it’s not enough to be efficient, althought that is a must. You’ve got to be different as well as efficient.

Clearly, save a few anomalous markets, new-home builders are either going to have to compete with distressed home sales for months and months to come or they’re going to go away.  Home prices continue to come farther down to earth in relation to household incomes and rent comparisons, and interest rates hover at historically manageable levels.

The three question marks for Josephine Homebuyer are these: Can I get a loan? Will I keep my income at its current level? and Will the price of the house stay stable enough that I won’t be underwater on the loan in a year?

In the economic, financial, and credit environment that we’re in now, a total cost of homeownership analysis could be an increasingly strong argument for people to buy new. More efficient, more repair-free, easier to maintain homes in more sustainable communities may prove to offset the apparent price advantage of buying a foreclosure.

Ability needs to happen holistically. You can’t have it in sales without achieving it in land strategy, operational processes, finance, product development, purchasing and sourcing.

Getting to expanded Capacity was levering up the model and accelerating its output. Getting to Ability is changing the model.

It’s putting a name and a face and an identity on your home buyer. According to yesterday’s new home sales data, there’s only about 32,000 of them a month (unadjusted) to go around for everybody. That’s not nothing, but it certainly calls for Ability vs. Capacity to meet their need.

If you do that though, you’ll be taking care of those other four stake holders, the financial partners, suppliers and municipal decision-makers, employees, and John Q. Public and his elected U.S. representatives.

Lawrence Meyer, the seasoned economic forecaster and former Fed governor, says one of the most important differences between “people who are bearish on the economic outlook and those who are less bearish” is their prediction about home prices. Mr. Meyer is in the less-bearish camp. He sees a slowdown in the pace of home-price declines and expects the U.S. economy to be growing at better than a 2% pace by the fourth quarter, faster than many other forecasters.

Three things could prove Mr. Meyer and the like-minded wrong about their encouraging outlook: a sustained increase in the thriftiness of U.S. consumers, which would depress overall growth; a relapse of financial turbulence, which would do the same; and persistently steep declines in the price of houses.

This morning’s Wall Street Journal headline is limbo in 36-point type.

• Markets Await Housing Reports

Worries about the potential for an economic recovery dragged U.S. stocks to their worst one-day decline in two months Monday. The Dow Jones Industrial Average fell 201 points while the S&P 500 slid below the 900 level and turned negative for the year to date.

In addition to concern about the potential for an economic recovery, heavy stock selling by corporate insiders has also weighed on the markets. Insiders of S&P 500 companies have been net sellers for 14 consecutive weeks, according to InsiderScore.com, the longest stretch since June 2007.

At 10 a.m., the National Association of Realtors will report on May sales of existing homes and the Federal Housing Finance Agency will release home-price data for April.

Wall Street analyst consensus calls for a 2.6% month to month increase to 4.8 million home sales. UBS Homebuilding research analyst David Goldberg expects actuals to slightly eclipse the Street. He’s citing a gust of seasonal tailwinds, “still below year ago levels.”

Further, as defaults rise through the back half of 2009, we expec t further pressure on existing home prices.

Also at 10 this morning, the FHFA House Price Index is due. Covering home sales exclusively with conforming loan financing, the HPI has shown none of the volatility nor dramatic cliff diving that the S&P/Case-Shiller Index shows.

The Street consensus calls for a decline in HPI of -0.3% sequentially. UBS notches it down a bit worse, at -0.4%.

Also under lots of scrutiny among housing players will be the FOMC meeting for the Fed’s stance on interest rates and quantitative easing.

What’s your over under on existing homes data just minutes before the release?

Wouldn’t want to start the weekend on a high note, would we?

At least we have more immediate worries to deal with between now and hyper-inflation.

Will applications for refinancing and purchasing new and used homes reverse a four-week downward trend? We only have to wait less than a week to learn how sensitive the number of applications is to a dramatic change in direction of mortgage interest rates.

In any event, at an average 30-year fixed rate of 5.38%, rumors of the rising interest rate-driven demise of housing’s newfound flutter of a pulse are premature. Good news headlines of a housing bottom–in sales unit volume, anyway–can resume. The wrenching job of digging out from a three-year hole can go on.

It is only guess work, but we think that in the first half of 2010, we’ll look back to a couple of months early in 2009 and see where housing’s most anemic days of this cycle describe the literal lowpoint in the cycle for the movement of new homes.

Builders of new homes finally have just a smattering of something they really need: Good ink. Now, positive press can do only so much. Word of an uptick in some long leading indicators, or the possibility that GDP will nudge back into the black somewhere around the turn of the year, or that global demand is rising from the ashes can all soothe the psyche somewhat.

So, massively lower prices, historically low interest rates, a love-pat from the U.S. government in the form of a tax credit, and a brightening economic horizon that will eventually produce greater demand for goods and services that should increase the value of hours worked… these things are the pluses.

But one would be hard-pressed to guess that these positives can nobly offset three crushing negatives–the effects of continued high job losses, foreclosure-driven home price declines, and really daunting home mortgage lending conditions.  

Perhaps the most intimidating negative force of all? It’s that credit-worthy and income secure people don’t–and won’t–think it would be really stupid not to buy a home right now.

There are two things a home isn’t any more. One is this, it’s not an investment in the money-making sense of the word. For the better part of five years, the economy designed itself around the notion that demand for houses could be strong enough to put the equivalent of an extra wage earner into every homeowner’s household. And that’s the way households bought things, as if they were earning half again as much as they were earning.

The other thing a home isn’t is practically blasphemous to point out, but it’s true among more than 75% of households: it’s not a married-with-children sanctum. Home–especially a new one–is more and less than a cul-de-sac lot in a good school district.

People who are obstinate enough to deal with today’s credit conditions and lenders, and job market volatility, and financial gyrations, and actually get into the new-home market are there for different reasons today than they might have been 36 months ago, or five years ago.

The toughest code anyone in the residential real estate game has to crack is not the credit crunch. It’s the de-levering of the household balance sheet and what that means to you, me, Joe the  Plumber, and his Ph D. sister. Nothing in the demographic pipeline right now says buying a home is going to make people rich, so if you’re in the game, it’s got to be another appeal.

Still, the motivation that you’re going to find is one of the more effective ones getting people back off the sidelines–and we know you’re going to do that–is that classic twist on the fear-vs.-greed  principle.

In this case, fear is not the enemy, but rather a profound, unconscious force that can work entirely in your favor. It is the fear of “have not” that will stir prospective home buyers toward being a “have.” And it is the fear of being a dummy for not acting at the moment one should have that will turn 1.6 absorptions per month per community into four or five within the next 12 months.

With all due respect to both John Zogby and J. Walker Smith, I think they’re out of their league when they wax on about what homes of tomorrow should be. Smaller and walkable is the opposite of larger and more drivable. Time will tell what home buyers prefer when it comes to dimension and proximity.

What they want now is one thing: To be Smart. Smart is the new Easy Money. Smart precludes disasterous financial decisions and bears an uncanny correlation to fiscal soundness.

There’s no time like now to pull out the stops and work like the dickens to understand how dramatically prospective home buyers’ needs have changed recently.

The Ohmann’s company is not alone in its plight. The way they’re handling it is what may set them apart from peers.

Click for St. Lawrence Homes' Web site. Bob Ohmann (left) and his brother Rich.

Since they entered bankruptcy, they’ve been working their way out of it. St. Lawrence’s emergence from this state is not happening as swiftly as, say, Chrysler’s, but hey, Fiat’s not planning inroads into U.S. home building anytime soon, so the company’s principals are working their way through the hard way. They’re selling houses, generating cash flow, paying bills, and trying to keep the lights on every day.

We’d received a few choice missives from Rich (who’s head of marketing and chief cook and bottle washer at St. Lawrence Homes) about society, big business, policy, and how it all affects trying to be a home builder in today’s tough market conditions. We asked him to write for readers, because we think his candor, insight, and values as part of the home building community reflect how more than a few colleagues feel.

Here’s Rich’s first post, which he entitled “Blah, Blah, Blah, Blah.”

I have to tell you that I’m not a fan of funny t-shirts with smirky messages. ‘I’m with stupid’ with an arrow pointed to the left or right isn’t for me. ‘My Mom and Dad went to Hawaii and all I got was this lousy t-shirt’ isn’t cute to me. The list is endless. This is not a recent issue for me so you can’t pin the economic malaise on my disdain for message t-shirts.

What’s this got to do with my need for screed? Last night, after a mind-numbing, rotten, catastrophe of a day I walked into my home, greeted by my wife and kids. Smiling and happy, full of the news of a couple of idyllic summer days with an order from my wife to start up the grill and handle my end of dinner.

I was struck with how wrong the old t-shirt was, the one that could easily be worn as uniform for most of us in homebuilding these,  ‘Life sucks, then you die.’ Contemporize the message: ‘Confidence plummets, then you go bust.’  ‘You default on your loans, then they take your truck’. I’m not willing to accept it though and I’ll try and tell you why.

First, you gain your worth from who you are not what you are. If your material possessions and self important position defines your lot in life you have nothing. As a home builder things are tough. But I’m just a home builder and nobody else is either. For me, as a Dad, as a husband life is grand. Regardless of what comes my way I’ll have success if I keep my eye on the important things in my life. Am I by necessity having to make tough decisions about what I can provide for my family? Certainly. The material things aren’t as important to them as I thought they would be. It turns out that they just want our family, and everything else is optional.

Second, care for others more than you care for yourself. Self-worry, self-pity, self-loathing evaporate when you look for ways that you can help others. A family in my sons school has a gravely ill child. I pray for them and think about them often and what I might to do help them. My problems are small by comparison. I was in line at the grocery store and recognized a former employee a few customers back, a young father with a wife, 2 kids and another on the way. I knew that he was facing tough times, tougher than what I was facing on that day. I bought a gift card at the checkout counter and told the cashier to use it to help pay for his groceries.   It kept me focused on the fact that no matter what I face I can always find someone who needs more help than I do and that feed my soul by helping others.

Third, cut the negative noise off. Les Brown is a motivational speaker. Very early in his career I hired him to speak at a small convention. He was a great speaker and so uplifting. I can still remember that he encouraged everyone to find unreasonable people and hang around with them.  Reasonable people will logically tell you why you can’t do something, why the obstacles are too great. Unreasonable people walk on the moon.

Finally, find inspiration. Sure it’s a dark time but you can find things that inspire you if you keep your eyes wide open. Inspiration will lift the burden of impending doom from your shoulders. You’ll come to understand that you aren’t defeated by today but rather that you have opportunity around you. I like to think that I’ve taken the middle years of my life as a sort of vacation time and, because the market was grand, had my semi-retirement early. 

Now?  Back to work. Work is what we all did before mortgage money was easy, labor was cheap and the stock market lulled us to sleep. Work is what built this country and what my parents taught me. Mom and Dad told me to save where I could, spend what I could pay back and to look upon the future with great hope. Turns out that they knew what I realized last night standing in front of my Weber grill.

Time to close some houses.

Now, just when data starts rolling in that supports this alignment, interest rates have begun shaking loose from their virtuous bond with more affordable house prices and a kick-back from Uncle Sam or a state for a home purchase.

The Wall Street Journal leads this a.m. with its take on the quantum leap percentage point-plus increase in mortgage rates since the end of May.

“Mortgage rates at these levels will hobble the [housing] recovery, and it was just the beginning of the recovery,” says Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley.

Investors have been anxiously watching bond yields climb over the past few weeks, pushing up mortgage rates, which normally track 10-year Treasury notes. The yield on the those briefly hit 4% on Wednesday afternoon for the first time since mid-October before ending the day at 3.937%.

Many policy makers see the rise in Treasury yields as a sign that investors are optimistic that the economy is on the mend. But many market participants say higher long-term bond yields indicate investors are increasingly worried about inflation.

What unfortunate timing! Look at a key “take-away” from Wachovia senior analyst Carl Reichardt’s latest “Neighborhood Watch Survey” of new-home community sales managers. 

With three straight surveys and a broader base of SMs reporting better-than-expected sales and traffic, we now believe that field conditions saw their low ebb in early 2009. While seasonality plays some role in our data, SMs expect strength this time of year, yet still see activity above these expectations.

This verbiage is rosy, given where it’s coming from. Reichardt notes that upward pressure on interest rates may stall the new-found momentum. Other analysts point also to the fact that tax credit programs for first-time home buyers expire on a Federal level by the end of calendar 2009, and state-funded programs will only last until the coffers run dry.

Hanley Wood Market Intelligence has done an extensive market-by-market analysis that ties the effecitve date of California’s $10K tax credit to new-home purchase activity. The Orange County Register’s Jonathan Lansner quoted the HWMI study at length in his blog post about how the O.C. was SOL when it came to an upside of the combined California and U.S. government tax credits for home purchases.

Click to Enlarge graph of Hanley Wood Market Intelligence Data.

Costa Mesa-based Hanley Wood Market Intelligence reports that Orange County buyers signed 35% fewer sales contracts for new homes in March and April, the first months of a homebuyer tax credit designed to spur the purchase of newly built residences.

The California program gives homebuyers a tax credit of up to $10,000 for new single-family homes selling after March 1. (Uncle Sam will chip in another $8,000 if you’re a first-time buyer!) But while demand has been high statewide for the California tax credit, that has yet to impact the pace of sales and construction here:

What Lansner neglects to report on is whether the 35% decline year-on-year for the two-month March/April period is more or less than the decline year-on-year from, say January-February of 2009 from a year earlier.

He does acknowledge that statewide, the $10,000 tax-credit appeared to have jumpstarted sales in many communities. 

In Reichardt’s Neighborhood Watch survey, he notes:

Trends in the West — especially No Cal — made a surprising turn as SMs cited the strongest sales trends compared to expectations.

The big question post the “Spring Selling Season” uptick must be how to keep whatever momentum there is in the market going through the balance of the year… especially without the critical tailwind of low, low interest rates.

California, as of June, is said to be 85% through its $100-million allocation for home buyer tax credits, and nobody expects below 5% home loan rates to come back to roost anytime soon.

Here’s Calculated Risk’s take on mortgage rate trends, and how to stay ahead of the curve on them:

Here is a new tool from Political Calculations: Predicting Mortgage Rates and Treasury Yields
This is based off the chart I posted last Friday and is very timely with the Ten Year Yield pushing 4%.
Using their tool, with the Ten Year yield at 3.99%, this suggests that 30 year mortgage rates will rise to 5.8% based on the historical relationship between the Ten Year yield and mortgage rates.

The question is, does the demand resubmerge when the three stars are not in alignment? Will those who move off the sidelines because of the sense that “there will never be a better time to buy” now begin to feel they’ll do better if they wait out further house price declines?

As most new-home builders have discovered, the monthly payments riddle is the one they need most critically to solve. If interest rates go up, prices have to go down to solve that riddle.

It strongly suggests that in the current policy environment, a strong likelihood is that Fix Housing First’s original plan for both a compelling tax credit and a mortgage buy-down may do the trick of sparking demand, clearing more inventory, restoring scarcity, and putting a new floor of value under residential real estate.

We see a Stimulus 2.0 package emerging during the Fall session of Congress, designed to capture any green shoots still out there, and accelerate the economy’s ability to begin paying down the “Wall of Capital” with which the Fed and Co. met the economic crisis starting last Fall. A mortgage buy-down might likely be in that program, to test new residential construction’s capacity to serve an accustomed role as an engine driving the broader economy.

Only those who are compelled by an old-fashioned sense of obligation might continue making payments.

This is the opinion of the Milken Institute’s director of regional economics Ross DeVol and president and chief executive Michael Klowden, which appeared this past Friday in the Financial Times.

They’ve mapped out a plan that the HUD Secretary Shaun Donovan, FDIC’s Sheila Bair, Treasury Secretary Tim Geithner, and the Fed’s Ben Bernanke should consider in light of the feeblest signs that  home buying demand does exist if just a few of the foreclosure headwinds can be muted.

DeVol and Klowden note that the big flaw in Obama’s program to stem foreclosures is not in its mission nor even its structure, but in its math. A 105% LTV ceiling just doesn’t cover enough troubled homeowners, nor does the current program forcefully enough incentivize wavering borrowers to weather the storm and keep repaying.

To fix this conundrum, the Obama administration should add the homeowner principal forgiveness vesting plan to its program. Here’s how it works: After a valuation of the property and proper income and credit verification, two separate loans are made. The first loan, from Fannie Mae, would be for the current value. A second, interest-only loan, from the Treasury Department, would make up the difference between the current home value and the original mortgage.

We wonder how widely shared the two authors’ view is on the following assumptions:

• 6 out of 10 purchases since 2004 are underwater
• Every 100,000 foreclosures prevented translates into .5% on home price stabilization

The big time conclusion:

So, if 1.5m foreclosures were to be avoided, home prices would be 7.5 per cent higher than without the plan.

That’s a lot of wealth destruction avoided, a lot of consumption capacity preserved, a lot of jobs saved.

Still, it’s sad that the sense of obligation to pay back what one borrows is “old-fashioned.” Passe.

• Home prices are correcting.
• Or, house prices are in a deflationary spiral.

Has the question ever been one of strict economics, or is the debate a mix of economic theory and political leaning? An Adam Smith purist would say that a worker’s willingness, personal need, and capacity to pay to own his or her home will set house prices where they ought to be–often closely bonded with area rent trends and/or household income trends.

A behavioral economist might have an equally strong argument around the negative multiplier effect of home price deflation, which powerfully impacts how consumer spending, which is about 68% of GDP, works. 

Clearly, the way that too many American homeowners treated their home’s deed and title as if together they represented a bonafide additional wage earner in the household was lunacy.

Also clear, is that unregulated financial productization set off a feedback loop of structured investment vehicles that programmatically trumped human judgment and accountability.

So it stands to reason that a once-bitten market is twice shy about resuming business with much of a normal set of rules of engagement. Everything must be hyper-vetted and de-toxified for any decision-maker to stick his or her neck out about financial exposure anywhere.

So we’ve gone from being a society that was practically telling people that owning a house was better than having a real job to being a one that is more or less saying that if someone wants to buy a house, we’re going to make it as difficult as possible for them to do that.

One of the new barriers to entry for buyers and especially sellers of new, used, and abused homes–appraisals. A) They’re going to have to pay more for an appraisal thanks to new rules that went into effect May 1. And B) Comps in every submarket are sending appraisals into algorithmic value destruction when they factor in distress and stagnation.

Who this helps other than investor flippers is a mystery.

We know appraisals were one of the phenomena that got sucked into the vortex of financial insanity. Like everything else, there were people who were doing appraisals irresponsibly because the way the system worked, it rewarded jacked-up prices and punished realistic, accurate ones. What’s more, prices had so de-coupled from their historical trends, that appraisers could mark prices up willy-nilly because the system rewarded that.

Now, the overshoot effect has taken firm hold as LTV has morphed into CYA. 

• Here’s Big Builder editor Sarah Yaussi’s analysis of home builder reaction to the recent ramifications of the new appraisal code.
• Yaussi dives into the topic in her blog post today, getting at one of the key issues in the appraisal flap. “Comp-ing” real estate assets in this environment is ludicrous, and puts new-home offerings at a severe disadvantage in light of the premium value new construction offers the buyer.
• The Wall Street Journal followed Big Builder on the story with a consumer take on the same hot-button issue.

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.