Outlier Effect: What Builders Can Do, Other Than Wait For A Rate Cut

Widely used data-sensitive operational feedback loops among homebuilder regional, divisional, and new-community teams – pace, price, incentives, value-engineered expense cuts, new pace, etc. – are working at an algorithm's version of double overtime.

Outlier operations outperforming their market and submarket peers may divert more buyers, stealing market share to keep their pace running on or close to plan.

Despite exceptions to the rule, the trajectory remains unchanged. It's a downward path into a typically slower season and an atypically uncertain economic jag in the macro economy, narrowing most homebuilders' margins for error. Understanding these challenges is crucial for empathizing with the homebuilders' situation. It's also, if history repeats or rhymes, likely to reveal what it takes to be an outlier homebuilding enterprise in today's turbulent, testy market.

Eventually, the feedback loops – a series of switches and levers that swap profit margins to generate order volume. By finding a relative strike price that can re-stabilize a predictable absorptions-per-community-per-month rate – i.e., spend about $40,000 to $50,000 per new home to keep pace at an acceptable level, firms may reverse-engineer that new strike price as a source code back into their operational and overhead cost structures and feed refreshed resource allocations back into their supplier, vendor, and land seller networks.

A treading-water state – mitigating small challenges, warding off existential problems, and keeping laser-focused on spot opportunities and any new nuances in demand that may declare themselves – is roughly how most homebuilding firms we're hearing from describe their current operating conditions.

Right now, any encouraging new nuances out there are so nuanced as to be practically undetectable.

• Only 16% of homes listed for sale in 2023 met household payment power criteria for median-income households, down from 41% – a shrinkage of 243,000 homes – a year earlier. - Redfin
• A widening abyss separates what home buyers expect to pay for their home and homebuilders' ASPs. – Eye On Housing
• A little over half (53%) of Americans say the American Dream is "still possible." – Pew Research

There is zero nuance, nor any ambiguity, about the underlying causes for these saddening, maddening data points.

A Wealth of Common Sense analyst Ben Carlson gets at the rub of the crisis here, "Why don't we build more housing?"

Higher prices and mortgage rates have driven housing affordability to levels we’ve never seen before in the United States.

There are numerous reasons for the affordability crisis but if I had to boil it down to one thing it’s this: we simply don’t build enough housing units.

Housing is a national conversation, but everyone knows real estate is local. Different states and municipalities have different rules and regulations when it comes to building codes and such.

Certain cities have prioritized building, while others have made it exceedingly difficult over the years by adding burdensome layers of red tape."

That being said, it's hardly reasonable for homebuilding operators to expect favorable movement at a local policy level that can impact current risks to their business plans for 2024 and 2024.

Nor, even, can many of them afford to wait and white-knuckle a possible move by the Fed to begin bringing down interest rates as they try to achieve a Goldilocks economic landing.

So, let's dig for some nuance of current opportunity hiding behind these affordability data points, shall we?

First, let's unpack and accentuate the positive in the sobering Pew Research split-screen take on the achievability of the American Dream. The nature and characteristics of the bifurcation – older vs. younger, higher- vs. lower income, as well as race and ethnicity gaps – reveal at least nuanced opportunity for residential real estate and construction firms who can outperform peers to address those unmet needs.

For instance, Pew Research research associate Gabriel Borelli writes:

Americans ages 50 and older are more likely than younger adults to say the American dream is still possible. About two-thirds of adults ages 65 and older (68%) say this, as do 61% of those 50 to 64.

By comparison, only about four-in-ten adults under 50 (42%) say it’s still possible for people to achieve the American dream."

One perspective into this data point might suggest that three out of five adults under the age of 50 could be susceptible to having their own story – and belief system – change should builders develop product, location, and pricing solutions that can suspend their own disbelief in the American Dream's achievability.

The Visual Capitalist analysis of Redfin housing affordability's incredible shrinking pathway through time also contains an ongoing positive nuance, the new vs. used advantage that homebuilders have enjoyed for more than a year now due to mortgage-rate lock-in effects.

While new home sales have historically comprised 10-12% of the single-family home market, they have recently surged to 30% due to the collapsing supply of existing homes. But even as new supply enters the market, it will likely take a number of years for housing affordability return to historical levels."

The most important nuance of all in today's "treading water" new-home market environment comes through in National Association of Home Builders VP for Survey and Housing Policy Research Paul Emrath's note on the intractability of the gap between what would-be buyers expect to spend and what builders can build profitably.

In calling out the causes and rules of the mismatch, Emrath actually spotlights opportunistic pockets, niches, and tactical wins builders can seize on sooner than later, if only to gut out the indefinite wait until interest rate policy takes a turn.

Emrath writes:

Part of the explanation for the actual vs. expected price mismatch is the cost of new home construction. Builders know that a potential market exists for new homes priced under $150,000; they just can’t build homes at such a low cost.

All the inputs to residential construction interact to raise the cost of new home construction. Residential construction wages continue to rise. Although prices of many residential building materials have been stable recently, the stability comes after massive increases in the two years following the onset of the COVID pandemic. A shortage of lots has been a chronic issue since the home building industry started to recover from the Great Recession.

Moreover, regulatory costs can be substantial. NAHB’s latest study on the topic shows regulation accounting for $93,870 of the cost of an average new single-family home. The largest regulatory cost impact, $24,414, comes from changes to building codes over the past 10 years. This is followed by $12,184 in fees paid by the builder after purchasing the lot, $11,791 in regulatory costs incurred by the developer during site work, $10,854 in the value of land that must be purchased and dedicated to the government or otherwise left unbuilt, and $10,794 in required architectural details that exceed what the builder would ordinarily do."

In many or possibly even locations, Emrath's statement – "they just can't build homes at such a low cost" – may be the case.

Despite all of the odds against, however, that truism amounts to a nuance every operator is looking to exploit with every operational, design, and construction tactic they can employ in today's dodgy market.

As always, outliers will find a way. Others will have to wait for tides to change if they can.