The Dash for Cash
We are still on our uncertainty kick, as it’s the only lasting phenomenon we both be certain of and need to plan around.
Consider a comment from investment guru Jeremy Grantham in an analysis The Big Picture blog’s Barry Ritholz is raving about for its keen guidance on “what we should expect over the next few years.”
“The uncertainties of the economy are so great that when the uncertainties of the stock market’s anticipation are laid on top of them, you simply must have big ranges of outcomes and hedge your bets.”
In home building, we see parallels to this principle.
The first quarter of 2009 has now made it clear that, by violently turning the screws on their gross margins, public home builders can at least stir the pot on home sale volumes, especially if it’s the right time of year and there are a couple of “x” factors like a California home buyer tax credit around to help.
Here’s how Citigroup’s home building sector equity analyst Josh Levin puts it.
While most investors entered [the just-concluded] earnings season focused on y-o-y (year-on-year) net orders, we think many were surprised by the q-o-q (quarter-on-quarter) gross margin deterioration reported by most home builders.
In the next three quarters of 2009–especially after there are no more $10,000 tax credits to hand out to Californians who step up to buy now–home building companies will be left even more to their own devices to get the job done moving inventory.
Seasonal forces, rock-bottom prices, record-low interest rates, and money back on income taxes for a home purchase have been working.
Take away seasonality, and add back the toll of continued economic weakness leading to a weak recovery, big layoff numbers, another wave–maybe two–of credit meltdown shocks in the form of widening credit card defaults and commercial real estate implosions, and one can get a sense of genuine challenges to the kind of consumer confidence it takes to make that largest of consumer purchases.
Home building companies that have made it to this point with a truck load of cash need a plan to try to expand their “range of outcomes,” even as they hedge their bets.
A truck load of cash, a delevered balance sheet, a skeleton-crew cost structure, a few tax-carryback induced inventory turns, and few if any false moves, serve as Part I of the plan–the part that has gotten the stronger companies to where they feel they still have cards left to play.
Part II is where a broader ”range of outcomes” comes clear, because even the stronger companies can’t sit around for the next three quarters waiting for the home buyer market to suddenly tilt their way. Both public and private companies with cash will in the next several months begin to try to slide in unobserved to pick of lots that pencil to new hurdle rates. Those lots, and the business plan around them, and the product on them, will all have one mission. Generate cash from sales.
Whatever goes on by virtue of “the visible hand” of government, home building operators need just one more critical part of the downturn’s plot line to kick into effect. Capitulation. “Ask” prices need to succumb finally to new, uncertain, sustainedly weak realities. And they will, but first only discreetly.
So, what we’ll be observing, even as clouds of uncertainty continue to sit over residential construction’s landscape, is the beginning of chapter that will see home buyers pop in and buy land, hoping finally that it’s cheap enough that they can put a home on it with one of their existing or new products that will get them inventory turns at a greater than one-or-two-a-month pace by the end of 2009.
We invite you now to jam our comment box with questions and challenges for leading home building executives, either about their companies, about the markets they operate in, or about the business environment ahead. who’ll gather in Chicago over the next several days for the 2009 Builder 100 Conference.
We hope to see you there, but if not there, then let us know here what you want to have these folks address in the days ahead.
Reality Bites as Ratings Agencies Downgrade REIT Debt
From MULTIFAMILY EXECUTIVE, by Les Shaver: Single-family sneezes and the world economy, including apartment real estate investment trusts that are assumed to run contracyclical to single-family for-sale trends, get pneumonia. The reason this venue is called Housing Crisis is that the convulsion hits equally both the supply and the demand side of housing, whether you’re talking for-sale or for rent. And it’s hitting not only the balance sheet but also the daily and weekly access to normal working capital, assuming steady cash flow.
There’s an analysis on how tumbling fundamentals and squeezed access to credit have put a pall on REITs’ business and risk outlooks for the next stretch from Multifamily Executive senior editor Les Shaver.
S&P said the ratings were prompted by constrained access to debt and equity capital and concern that the struggling economy will put even greater pressure on cash flow. The agency said “heavy credit revolver usage (in excess of 50 percent), weak debt service coverage, and an over-reliance on earnings from fee-driven and/or asset sales activity are key areas of focus.” It also views the common dividend coverage as a “drawback,” given the need for REITs to preserve liquidity.
“Fundamentals in the multifamily sector are coming under pressure,” says George Skoufis, a director for Standard & Poor’s. “Their debt protection measures are kind of weak. In the previous cycle, they came in with a little bit more of a cushion. Their numbers are a little weaker, and their leverage is a little higher.”
Multifamily and commercial construction lagged the residential for-sale downturn, and many have another leg or two down as employment deteriorates and corporate earnings erode by virture of more conservative money habits among consumers and challenged consumer sentiment. Too, anecdotally anyway, demand for one- and three-bedroom apartments has decline while demand has stayed strong for two-bedroom apartments–an indicator of increased “doubling-up” among people who might choose to live with roommates to weather the downturn.
Distressed Out or In?
Public home building companies keep on impairing the owned land pipeline that is on their books; privates battle the slippery slope of owing lenders more on land they own than what it’s worth today. Talk about distressed assets! And the thing is, even the bargain hunters with cash and capital horded up right now as “dry powder” have been paralyzed by the swan dive in land values.
For a glimpse into where potential distressed asset opportunists–the vultures–may be looking to embed their talons, have a look at this video from The Deal.Com.
At the TMA/The Deal’s Distressed Investing Conference in January, Rothchild’s David Resnick, Cerberus Capital Management LP’s Kevin Cross and KPS Capital Partners LP’s David Shapiro discussed the opportunities and challenges for strategics investing in distressed assets. – Maria Woehr
Foreclosure Flip and Win: “The 40 Thieves” Ride Again
CNBC’s Diana Olick reports on what we’ve been hearing will be a burgeoning investment practice once bargain hunters get convinced they’ll be able to move their bargains up the purchase foodchain.
This CNBC report — 40 Thieves & Your Home – first takes a look back to a California housing crash in the 1970s at an investor vigilante group that would outbid banks by a nose on some foreclosure auctions, and subsequently sell the property below market but for a profit after a quick fix up.
Risk’s Assessment: Extreme Home Makeover Edition
Infographic daytime dramas.
It’s serialized data, visualized so that it tells an unfolding story, backstabbing and adulterous behavior unnecessary to the drama. You guessed it, it’s Calculated Risk at his trade, flashing fever chart insight by adding datapoints and boiling down the take-away to haiku brevity.
He writes today about a topic near and dear, i.e. how much housing contributes to the economy, or more accurately residential investment. Per the different-colored lines knifing across the chart below, residential investment has different parts to it.
The soap opera part is to the right of the chart, where you see the blue line dive beneath the red line that had been underneath the blue for so long.
Calculated Risk's "Components of Residential Investment" analysis. Click to open CR's commentary.
One of the two key observations relates to the blue line, which indicates where “investment in single family structures” is, notably at 1.05% of GDP vs. a 50-year norm of 2.35%. The other relates to that red line–the level of home improvement investment as a percentage of GDP–which is at 1.20% of GDP, vs. a 50-year norm of 1.07%.
So, if investment in single-family structures has fallen so far so fast for the reasons it has, CR’s conclusion is that home improvement investment is a lagger [and, likely investment in multifamily structures as well, the purple line].
Get ready, or if you have gotten ready, get readier for worse than that. It’s usually meaningful when a CR post starts, “This is a first.”
REIT or Wrong, They’re Minding Their Balance Sheet
From MULTIFAMILY EXECUTIVE, by Les Shaver: Households are doing it. City governments are doing it. Lenders are doing it. So, why wouldn’t it make sense for residential REITs to get on the bandwagon of spiffing up their balance sheets, even if the longterm fundamentals remain strong for the rental market? Well, of course, they are doing just that. Multifamily Executive senior editor Les Shaver reports on a number of key players who’ve shed debt and pushed maturities to later in a prospective recovery cycle.
Here’s the rationale:
Says Taylor Schimkat, senior associate for Green Street Advisors, a Newport Beach, Calif.-based REIT consulting and research firm: “If the REITs have the capacity, it makes sense for them to retire their near-term, unsecured bonds early [and where possible at a discount to par] and push out their maturities.”
Looking to pare debt-related expense is not the only way REITS are trying to get ahead of a tidal wave of job and commercial real estate deterioration sweeping into the multifamily landscape.
Shaver also reports on a number of companies who need to write-down assets based on underwhelming demand vs. pro forma-ed properties. Here’s his take on strategic and tactical moves by AIMCO and Camden ahead of a spate of Q4 earnings calls among REITs in the next couple of weeks.
Still, there is no shortage of bulls still at large in the residentail REIT arena. Have a look at commentary from Investment U, picked up at SeekingAlpha this morning.
Design without Reach–Architects with Less Portfolio
Architects’ billings, a leading indicator of commercial construction development, are out and they’re down, posts Calculated Risk.
CR observes:
There is “an approximate nine to twelve month lag time between architecture billings and construction spending”, so we should expect the first decline in architecture billing to impact non-residential structure investment this quarter (Q4 2008), and a further downturn in non-residential construction activity in mid-2009.
Lunch today with principals at an international architecture firm left the distinct impression that billings opportunity comes in many shades of green for the near term. Or sovereign wealth.
Coining a new word–Metafraud
Fraud, chicanery, thievery, fiendish scoundralism of the highest order… not to mention idiocy, incompetence, nincompoopism, and cluelessness.
As things go so wrong, all economics is divided, like all Gaul, into three parts: one part is supply-and-demand forces; a second is sheerly technical, mathematical behaviors; and the third is behavioral.
To understand the third set of forces, at least a passing acquaintance with behavioral economists Richard Thaler of “Nudge” note, and Dan Ariely of “Predictably Irrational” fame will help.
One speaks of human frailty as a “cause” of the economic crisis. One speaks about how we’re apt to “fall in love” with our investments.
That would explain some things.
- Madoff, a big-time crook
- Blagojevich, a small-time crook
They’re metafrauds. They stand for a bigger thing than their actions. Wall Street, Main Street.
This Modern Word, By Tom Tomorrow, Salon Comics
Source: This Modern World, by Tom Tomorrow, Salon Comics, http://www.salon.com/comics/tomo/2008/12/09/tomo/
Hat tip: Paul Krugman, “The Conscience of a Liberal,” NY Times, http://krugman.blogs.nytimes.com/2008/12/10/odds-and-ends/
The Price of Falling House Prices
In case you missed The Wall Street Journal this morning.
-
“The Future of Home Prices” concludes that the very local bank that was 70 million homeowners’ homes won’t be in the business of dispensing free-and-easy cash for years to come.
Case-Shiller by Market (WSJ)
Karl Case, an economics professor at Wellesley College whose name adorns the S&P Case-Shiller home-price indexes, has studied U.S. house prices going back to the 1890s. Over the long run, he says, home prices tend to increase on average at an inflation-adjusted rate of 2.5% to 3% a year, about the same as per capita income. He thinks that long-run pattern is likely to continue, despite the recent choppiness.
The tenor of the story echoes the comments of the other side of the Case-Shiller equation picked up by Calculated Risk and posted by The Big Picture, Yale economist Robert Shiller. Dr. Shiller dons a somewhat unfamiliar hat of “behavioral economist” in his assessment of a factor that led to such widespread dislocation in the economy: Groupthink. At any rate, he asserts the crisis has legs, and that it’ll be with us for “years and years.”
Our problem–accelerated by groupthink–appears to have been not recognizing that we should have constrained our financial risk to equities investment rather than to look at home purchases as a sugar daddy for all our extravagant desires, including the next move-up house.
Still, we think most analysts are running the same predictive models that got us into this mess to track where we are and where we’re headed next. The patterns won’t hold. Household income to home price ratios, nor cost-to-rent vs. home price ratios, nor home price trending ratios will either give us a view of a critical indicator–the magnitude and duration of the overshoot–or a look at what “normalized” prices will be once demand returns as a factor.
Demand is academic right now. Only those who have to buy are buying, and the decimation of earnings and the job market is whacking the heck out of that shrinking bunch.
Gets you to thinking crazy thoughts about what the solution might be; like this one from Ira Artman.
Taboo Topic Two — Down But Never Out
A report in today from Zelman & Associates’ home building guru Ivy Zelman notes that home builders–normally optimistic on a bad day–have met their match at last.
A landscape rent into two unequal and unfair parts puts what can not be controlled into a dark, limitless stretch of peril, and what can be managed into a tiny sliver of high ground reserved but for a few who played their cards with the utmost conservatism well before the game changed.
Zelman’s litany of worsening conditions maps out a pall over the present and a storm clouded future on every mentionable front, from home builder sentiment itself, to credit conditions that affect both supply and demand of new homes, to real economy tailspins in jobs and earnings, to policy agendas on Capitol Hill, to share valuation trends that are supposed to be a bellwether of brighter fundamentals for the home building sector.
Our October homebuilding survey results came in at the lowest level of the downturn. In our opinion, the continued deterioration in fundamentals witnessed over the past two months indicate a new leg down, fueled by a tsunami of rising job losses and eroding consumer confidence. Each additional month of deterioration makes it increasingly likely, in our opinion, that some sort of housing stimulus will ultimately be passed to address these issues. However, despite continued heavy lobbying by the industry, discussion of a housing stimulus package has not received a significant amount of media coverage or public discussion on Capitol Hill. While we continue to believe that some form of stimulus is inevitable, the lack of recent discussion makes it less likely (but not impossible) that a plan will get passed in the lame duck session before President-elect Obama takes office in January.
Ivy’s data and sources that more than one in five private home builders have capitulated amid banks’ existential identity crisis regarding whether to get back into the lending business and whether to begin marking real and paper assets to a value that can be transacted.
So, as one industry observer remarked at a conference in the past two weeks, “My guys are dropping like flies! It’s not even funny.”
There are but a few options, none of them really palatable. One is to develop a winddown plan that would allow principals in the company to escape with their shirts, the better to put one on and come back to work in the business in two to three years when capacity is needed once again. That will take careful and painful corporate law and taxation planning, and it’s better to be active about it rather than have it happen to you.
Another option, find capital fast. Cash is sitting on the sidelines among professionals who’ve taken a portion of their investment portfolio out of the stock market, and it’s possible that you can reach out to the doctors and lawyers groups to buoy your outfit through what will be a 48-to-60 month storm of unprecedented fury. NewCos may get capitalized as OldCos get mothballed, but the pounds of flesh in equity and control are going to be piling up like a meat packing district.
See a previous post on “Taboo Topic: Going Broke the Right Way,” to improve odds that you can resurface in this business with your name and trustmark in tact. It may be the only move that makes sense.
If home building’s “Permabear” Ivy Zelman can forecast a bottom in 2010, we might have to start considering that the best news we’ll hear all day.