Builders change tax-break stance

The Nat'l Association of Homebuilders (NAHB) has re-opened its donation coffers after shutting it down in February when it felt builders were being ignored by Congress. Now that the tax carry-back plan seems DOA -- and never made into the House version of a home sales stimulus plan -- the group is focusing on special tax credits to buyers to stimulate the market. From a Wall Street Journal story:

The National Association of Home Builders is playing nice with Congress again.

The trade group, representing thousands of home builders, has switched its lobbying tactics and its political action committee has resumed doling out political donations, after halting them in February to protest what the group said was policy makers' failure to help the housing industry and overall economy.

The association had been pressing for a tax break that would have allowed builders to apply losses to taxes paid four years ago, instead of the current two-year carry-back. But the group has backed off that effort and is focusing now on a proposed tax credit for home buyers to stimulate demand...

The trade group's shift on the tax break comes after the Senate came under fire for including it in its housing-relief plan. Critics said lawmakers were favoring builders over strapped homeowners. The House version of the plan doesn't include a carry-back provision...

Meantime, the home builders' political action committee, BUILD-PAC, is giving out political donations again. Ed Brady, chairman of BUILD-PAC, said the group lifted the ban last month because, "we felt like people were paying attention to us again."

During the current election cycle, the group has given about $977,000, with 45% going to Democrats and 55% to Republicans, according to the Center for Responsive Politics.

Builders and developers asked to dig deeper to pay down loans

At creditors tighten up lending requirements to builders and developers, many are asking clients to pay down existing loans. For smaller, private builders, this can mean tapping personal assets such as savings accounts, 401k savings and even home equity lines. From a Nation's Building News story:

A recent snapshot of builders and developers in a special survey by the NAHB Economics Group has found that acquisition, development and construction (AD&C) credit has tightened since last year.

In addition, while not a majority, significant numbers of builders and developers have been asked to pay down outstanding construction and land acquisition or development loans, according to the study.

More than 80% of all the respondents reported that the availability of new credit for land acquisition and land development had tightened this year compared to the second half of 2007.

Sixty-nine percent of the respondents said that credit had become more constricted over that timeframe for single-family construction loans, while 29% responded that loan availability remained about the same.

On the multifamily production front, 78% reported worsening conditions for construction loans, and 20% said they had seen no change...

Of those who had been asked to pay down land acquisition or land development loans, personal savings was the source of the money for 54% of the respondents. Twenty-six percent took out equity from an investment property, 21% took out equity from their primary residence and 20% said they borrowed from an investor or sold personal assets.

About 8% of those buying down loans borrowed from their 401(k) accounts and 5% borrowed from a friend or relative.

Homebuilders still see recovery a long way off

According to the regular NAHB/Wells Fargo poll, U.S. homebuilders are finding a market continuing to deteriorate and not expected to rebound anytime soon. From a CNNMoney.com story:

Homebuilders' confidence fell once again in May and their view of the state of the battered market hit a record low.

The National Association of Home Builders/Wells Fargo monthly index fell to its second lowest reading on record, ahead of only last December's reading.

Builders were asked for their view of the current market, the amount of the buyers looking at homes and expectations for six months from now.

Only 6% of the builders surveyed believe the current market is good while 69% view it as poor. Builders also reported a lower level of people looking to buy new homes.

And 51% of the builders said they now expect conditions to remain poor six months from now, up from 47% who were expecting a poor outlook in the previous reading...

The report comes a day ahead of the government's latest report on housing starts and building permits. Economists surveyed by Briefing.com forecast that starts fell to an annual rate of 940,000 April, which would mark a 17-year low. Permits, also viewed as a reading on builder's confidence in the market, are forecast to slip to 912,000, which would also be a 17-year low.

Earlier this week, luxury homebuilder Toll Brothers (TOL, Fortune 500) reported sharp drops in both revenue and new orders when it released preliminary results, saying that even many buyers who put down a deposit aren't taking the next step of signing a contract due to lack of confidence in the market.

Big builders must get out of land development, economists say

Economists Carl Reichart (Wachovia) and David Goldberg (UBS) contend that the nation's largest homebuilders need to get back to their roots as manufacturing companies and continue to pull back from land development, which ties up capital and reduces potential efficiencies. From a story in the Nation's Building News:

The large, public builders will have to consolidate operations and focus more on construction than land development or risk facing “hyper-competition” with each other that could prolong the downturn, Wall Street analysts said at NAHB’s Spring Construction Forecast Conference in Washington, D.C. last week.

The analysts, Carl Reichardt, Jr., with Wachovia Capital Markets, LLC., and David I. Goldberg, with UBS, also said that widespread acquisitions and bankruptcies among the big builders were unlikely as a result of the downturn ― even though the big builders compete with each other in nearly every major market in the country and their overall market share has shrunk from a peak of 26% in 2006 to about 20% today.

The big builders currently operate in 78 metro markets. Ten or more big builders are competing against each other in 19 of the markets and at least six big builders are competing in nearly half the metro markets.

Reichardt said the top public builders have increased their liquidity during the downturn and are beginning to reduce their “store” count — the number of communities where they operate.

But he added that they still risked remaining in a price-based competition with each other that would “mute the recovery” and “compound the cyclical excesses” largely because most of the big builders based their run-up during the boom times on land and are in too many markets.

Goldberg said the public builders have “cut prices pretty drastically” to reduce their inventories, but that during the boom years most of the builders got more involved in development and buying raw land.

“The industry must change,” Reichardt said. "Right now, the home building industry is a land-based business.” The large builders, he said, must “shift back to their core markets” and core competencies of “building and contracting.”

Reichardt said the builders could have to get out of land development and adopt a “land lite” business model.

“The home building industry is really a manufacturing industry,” Reichardt said, adding that he hoped the big builders would “reinvent themselves by focusing on processes and efficiencies.”

Going forward, Reichardt and Goldberg said that land development might eventually be conducted by developers partnering with “land finders” — people with enough money to invest in land development. Both said there were enough land investors waiting for the market to turn...

Goldberg said the tighter lending standards now in effect will drive less liquid builders out of the industry, but that the public builders will be able to survive.

Reichardt said the downturn is pushing the big builders and the home building industry into a period of slower long-term growth and lower returns. "The growth phase will be much slower,” he said.

In the short run, Goldberg and Reichardt both expect the big builder share of the market to shrink, but they said that, over time, their share would begin to increase again.

Economists dissect the current housing market

There were three different economists opining at the NAHB Spring Construction Conference. All are hoping that the worst is behind us, but that builders need to adapt, Congress needs to act and sales need to increase so inventory levels are reduced; From the Nation's Building News:

The outlook for housing and the economy should be gradually brightening within a few months, but before there can be any assurance that the worst of the downturn is over, there needs to be a pickup in home sales, according to panelists at NAHB’s Spring Construction Forecast Conference on April 24 in Washington, D.C.

Residential production and sales this year have declined “more sharply than anticipated,” said NAHB Chief Economist David Seiders, and the situation for the U.S. economy “definitely has darkened,” with more than an even chance that it has lapsed into a “mild” and brief recession in the first and second quarters.

Seiders said that he continues to believe that new single-family home sales will stabilize during the middle of this year, paving the way for an upturn in late 2008 and in 2009 and leading to improvements in housing starts next year. However, “the sales side has to be off the deck before starts stabilize and move up,” he said...

Through March, Seiders said, NAHB surveys of 30 large builders accounting for 25% of sales nationwide, showed “no signs of stabilization, although the rate of the decline may be slowing.” Likewise, the NAHB/Wells Fargo Housing Market Index, which polls builders to gauge their opinion of current sales conditions and demand six months down the road, remains close to its record low recorded in December and “shows no recovery yet, implying further deterioration of sales.”

“We need demand to revive to turn around the market,” Seiders said, and he suggested that a temporary tax credit for home buyers, an approach being considered in housing and economic stimulus legislation on Capitol Hill, could help provide the impetus to boost sales and end the downward spiral in home prices that is the biggest concern for the health of the nation’s economy.

As home prices have declined, he said, “underwater” mortgages with balances exceeding the value of the home have been adding to the deterioration of loan quality that began in the subprime sector last summer. This is “bad for the financial markets,” he said, and could result in further tightening of lending standards, yet more foreclosures and even softer housing demand.

Economists participating in the conference were fairly optimistic that the downward turn in housing prices, while substantial, will taper off before it takes a toll on the longer-range outlook for the economy, but nobody can know for sure, they said...

Nariman Behravesh, chief economist for Global Insight, cited a “sizable risk,” perhaps 30%, that the U.S. will experience a double-dip recession in 2009 because the fiscal stimulus enacted by Congress will pull growth into 2008 that otherwise would not have occurred until next year.

However, the current recession, like the one that occurred in 2001, is far different from those preceding it in the 1970s and 1980s, which were precipitated by high inflation, tightening by the Federal Reserve and rising interest rates.

In 2001, he said, “manufacturers were hammered, but housing was doing okay.” Today, just the opposite is happening, with U.S. export growth strong. Core inflation remains “reasonably stable” at 2.25% and looks headed back into the Federal Reserve’s 1% to 2% tolerance range.

The financial crisis precipitated by the subprime meltdown last summer “is off the front pages,” he said, “and things are calming down a bit; the worst may be behind us.”

The financial markets “woke up last August to the fact that there was a lot of toxic waste out there,” he said. Of the estimated $400 billion in global losses caused by the subprime problem, about $270 billion to $280 billion has already been declared, leaving about $100 billion in write-downs that the markets will have to face and probably be able to handle.

Behravesh added that he is “a little skeptical” of talk about the U.S. today facing the worst financial crisis since the Great Depression. At the height of the S&L crisis 20 years ago, 2,700 financial institutions failed, he said, compared to “very few” so far today.

Also, the Fed “has really cranked things up to calm the financial markets,” including its rescue of investment bank Bear Sterns and stimulative interest rate cuts, which most likely will include an additional one-half percentage point reduction in the federal funds rate before this summer. “I would have to give high marks to the Fed for crisis management,” he said...

Behravesh did, however, cite downside risks to his relatively upbeat forecast for the economy. Among signals that are “flashing yellow or red,” housing remains “a long way off from recovery,” consumer spending “has come to a halt” and will remain weak next year, and, most worrisome, the recovery will be “tepid” once it starts.

Housing sales should start turning around during the second half of this year, he said, concurring with Seiders, and house prices will continue to decline in the next year or so even as housing production improves...

Jim Glassman, managing director and senior policy strategist with J.P. Morgan Chase & Co., noted that the three out of four Americans who now believe that the nation has entered into a recession may well be correct if by that they mean that the economy is “not so great. But if you mean that the wheels are coming off the wagon, I don’t think so.”

If the economy were really falling apart, he said, job layoffs would be accelerating to 500,000 to 600,000 a week; they recently have been in the mid-300,000 range.

“The elephant in the room,” Glassman said, “is what’s going on with home prices,” which is still causing “a lot of stress in the financial markets.”

Home prices are down about 12% since the height of the housing boom in 2005 and incomes have grown 14%, bringing “prices relative to income to about where they were in 2003” during this year’s first quarter, he said. “We have flushed out most of the excess.”

Glassman said his guess is that home prices will decline 5% or so further, but gloomier forecasts foresee another 15% to 20% drop, and what will actually happen is probably somewhere in between those two views. “By fall, we will start to see that most of this is over,” he predicted, but he conceded that he wished he knew “where home prices would settle out.”

Once the economy does show signs of stabilizing, Glassman said it would be a mistake for the Fed to quickly reverse course on interest rates, as some have suggested it should do, because the financial markets will be going through a difficult transition for some time, and this will require a “different monetary policy.”

Last summer’s financial crisis was precipitated by investors discovering that they had assets with exposure to credit risks they hadn’t been thinking about, and this has challenged the concept of securitized finance that has taken hold, he said. It will take a decade to restructure the system and restore the confidence of investors and provide them with the transparency to see where the risks lie...

Glassman also said that prospective home owners will have to return to how their parents bought homes and start saving more money for a downpayment.

“The customer you have known for the past 20 years is not the customer you will know in the next 10 years,” he said, as the economy transitions into a new era that “won’t feel like it has as much oomph.”

The best news for the economy, he said, is that the emerging economies, largely in Asia, are doing fine and providing strong demand for U.S. exports and providing U.S. companies with “spectacular levels of profits.”

“The world has never seen such great economic performance since the dinosaurs,” Glassman said, and as a result, the winds are shifting in favor of regions of the U.S. that rely heavily on exports, including Michigan.

In NAHB’s latest housing forecast, new single-family home sales are projected to decline 21.8% this year, to 605,000, before climbing 18% in 2009 to 714,000.

Total housing starts are forecast to decline 29.5% to 948,000 in 2008 and rise 10.8% to 1.05 million next year. Most of this year’s decline will be concentrated in single-family production, which is expected to drop by 37.1% to 653,000 homes.

More bad news for homebuilders

Attendees at the NAHB Spring Construction Forecast were treated to even more bad news, courtesy of the latest new home stats from The Commerce Dept. From a BuilderOnline.com story by Ethan Butterfield:

New-home sales are down 8.5 percent from February and the months’ supply of new-homes rose to 11 months, a record-high, NAHB chief economist David Seiders told the several hundred audience members in attendance at the NAHB’s headquarters to a chorus of subdued groans and whistles.

And those numbers (http://www.census.gov/const/newressales.pdf) do not count cancellations, which many large builders are seeing at levels of up to 40 percent of sales. In other words, there is far more inventory of new homes than just 11 month’s worth, especially as home sales continue to decline...

Nariman Behravesh, chief economist for Global Insight, said Thursday that total financial losses from the subprime mortgage mess would be about $400 billion, but that only $250-$280 billion of that has been declared so far. That means there may be as much as another $150 billion in losses to come.

“There will be more bad news, and it could create a revisitation of this crisis, but it’s probably the case that the worst is over,” Behravesh said.

Still, housing is far from a recovery, he said. Consumer spending has slowed to a trickle in the first half of 2008, but will likely pick up with the fiscal stimulus’ tax rebates, then will likely trail off again, creating a “W”-shaped recovery, Behravesh said.

“What these rebates are doing is pulling growth forward from next year to this year,” he said.

And if energy prices continue to rise, the fiscal recovery may be undermined, Behravesh said...

Mark Zandi, chief economist for Moody’s Economy.com, said Thursday that 8.8 million home owners are now in just that negative equity position, and that number could rise to over 12 million without federal intervention.

And today’s American doesn’t have the savings to weather the storm, Zandi said.

“If there is any disruption to their income, they’ve got a real big problem,” he said, pointing out that major disruptions in income used to be if somebody lost their job, or there was a divorce or death in the family. Now, needing to replace a hot water heater is the equivalent, because people do not have the excess cash. “They are living on a tenuous financial edge, and they are going to end up in foreclosure, and add to that mountain of inventory.”

And consumers owe far too much money to creditors, with over $700 billion of debt (of all kinds, not just mortgages), in default or delinquency, Zandi said.

“That has more than doubled in the last couple of years, and that’s putting a lot of stress on the system,” he said.

Zandi, now an advisor for Senator John McCain’s Presidential bid, also pitched a three-pronged plan to save housing. First, a temporary tax credit for buying a home. Second, the Federal Reserve could hold reverse auctions for banks to allow credit to flow more cheaply, and so more freely to help the housing market regain its footing. Third, a mortgage write-down plan to save home owners from falling into foreclosure could be enacted...

“In times of crisis, we should use the triple-A credit of the United States,” Zandi said. “If they don’t, (the economic trouble) is not going to be short, it’s going to be a rather painful, prolonged downturn that extends through the rest of the decade.”

Zandi projects new-home sales to bottom in the second quarter of 2008, over 30 percent below their peak levels from the boom. New-home starts are likely to bottom in the second half of 2008 more than 60 percent below their peak level. Home prices will likely finish about 24 percent below their peak levels, and likely not until the second half of 2009, Zandi said.

Are homebuilders asking Congress for too much?

In a recent post, I discussed a recent presentation by reps from the NAHB on how the credit crunch is now impacting loans for land purchases, development and construction.

My friend Brian, a banker with a mid-sized regional bank, took issue with this story and has written a response, which follows below:

To broaden sources of AD&C credit, Mitchell called for:

• Fannie Mae to ramp up activity in its AD&C loan purchase program and for Freddie Mac to create a similar program. Federal Home Loan Banks to improve AD&C liquidity by accepting housing production loans as collateral for the secured advances they make to member institutions. These institutions were not set up to be collateral lenders. Collateral lending represents a much higher tier of risk taking than cash flow lending. The source of repayment for these loans is the completion and sale of the project, not an individual's capacity to repay a loan over time. This would incrementally worsen the risk profile of these psuedo-government agencies over time, resulting in higher insurance costs for all depositors, which would be required to increase the reserves associated with the much higher loan loss rates associated with AD&C loans. Simply put, he is asking the tax payers to bear equity risk of banks and developers.
  
  
• The Federal Housing Administration to help increase competition in the AD&C market by insuring the construction portion of these loans in order to attract new originators such as mortgage banking companies. “As in the case of the end-loan mortgage market, FHA could be a crucial stabilizing force in AD&C lending in turbulent times such as these,” said Mitchell. Looking to add to the basket of implicit government guarantees. The developer and bank should assess these risks up front. He wants to create a securitization mechanism for construction loans. Securitizations ultimately depend on cash flow for repayment, and not project completion and resale. Looking for Wall Street to be collateral lenders made possible by Uncle Sam's mitigation of repayment risk through an implicit guarantee that would make securitiaztion possible.
  
  
• Wall Street specialists to develop a prototype private security instrument for AD&C loans. In particular, changes to tax provisions relating to Real Estate Mortgage Investment Conduits and Taxable Mortgage Pools could be helpful in securitizing construction loans. Wall Street doesn't go to Washington when it wants to develop new products. Again, security instruments are repaid from cash flow, not resale. Wants third parties to assume risks that builders arguably cannot quantify themselves. If the builders and banks are incapable of quantifying and valuing this risk (as they are now), then the he wants Washington to legislate a better fool theory.
  
  
• Banking regulators to take a balanced approach when evaluating bank lending, especially in regard to AD&C loans. “Small businesses, including small builders, are vital to the economy, and arbitrary or unreasonable regulatory restrictions would only serve to harm many builders, and potentially, many banks,” said Mitchell. “It would be ironic and tragic to have the positive work of the Fed undone by bank regulators taking a totally different vision and approach when it comes to lending matters.” Lambast the Activist Judges if you don't agree with their ruling and seek to throw them out. The regulators are concerned with individual bank and aggregate banking system solvency. The Fed is concerned with monetary policy and keeping markets liquid. These objectives are not necessarily counter to each other.

Credit crunch increasingly impacting homebuilders

Not surprisingly, loans for builders to purchase land or fund land development and home construction is also being impacted by the general credit crunch. From a story in the Nation's Building News:

The mortgage credit crunch has spilled over into land acquisition, land development and home construction (AD&C) lending, increasing the challenges faced by builders in the current housing downturn, NAHB told the Congress last week...

Residential AD&C loans are used to purchase land; develop lots; build a project’s infrastructure such as streets, curbs, sidewalks, lighting, and sewer and utility connections; and construct homes.

Presently, funding for viable residential development and construction projects has been severely limited or blocked entirely at federally insured depository institutions, which are the sole source of housing production credit for the small businesses that comprise most of the home building industry, Mitchell told lawmakers.

“The current financing quagmire for home builders vividly illustrates the importance of developing additional sources of AD&C credit,” said Mitchell. “Furthermore, there is no secondary market for residential AD&C loans where community banks and thrifts could turn to help manage their balance sheets and obtain liquidity for additional lending.”

He noted that a viable secondary market for AD&C loans would directly benefit builders and lenders by transferring risk away from lenders; increasing the availability of funds so that projects could be more reliably completed; and mitigating the devastating impact of equity calls on builders, or transfers of partially completed projects to banks under capital and/or regulatory pressure.

To broaden sources of AD&C credit, Mitchell called for:

• Fannie Mae to ramp up activity in its AD&C loan purchase program and for Freddie Mac to create a similar program.
  
  
• Federal Home Loan Banks to improve AD&C liquidity by accepting housing production loans as collateral for the secured advances they make to member institutions.
  
  
• The Federal Housing Administration to help increase competition in the AD&C market by insuring the construction portion of these loans in order to attract new originators such as mortgage banking companies. “As in the case of the end-loan mortgage market, FHA could be a crucial stabilizing force in AD&C lending in turbulent times such as these,” said Mitchell.
  
  
• Wall Street specialists to develop a prototype private security instrument for AD&C loans. In particular, changes to tax provisions relating to Real Estate Mortgage Investment Conduits and Taxable Mortgage Pools could be helpful in securitizing construction loans.
  
  
• Banking regulators to take a balanced approach when evaluating bank lending, especially in regard to AD&C loans. “Small businesses, including small builders, are vital to the economy, and arbitrary or unreasonable regulatory restrictions would only serve to harm many builders, and potentially, many banks,” said Mitchell. “It would be ironic and tragic to have the positive work of the Fed undone by bank regulators taking a totally different vision and approach when it comes to lending matters.”

Builders admit no strong rebound until 2010

The latest outlook from the National Association of Home Builders foresees a full recovery in the housing sector being delayed until 2010. While this date has been largely debated by economists and other housing experts, I can't recall any other time before this when the NAHB has actually agreed with the assessment. From a CNNMoney.com story:

Demand for new homes may not return to normal levels until next decade, according to the latest outlook from the National Association of Home Builders.

"Traditionally when housing has been in a recession, it recovers very quickly. We don't see that happening this time," said Jerry Howard, CEO of the builders' trade group. "It could be 2010 before we see sustainable, long-term stability in the home building sector."

As recently as the end of 2007, the trade group was forecasting a pick-up in the demand for new homes in the second half of this year.

But Howard said the best case scenario now calls for stabilization in the market in early summer, with no signs of improvement until early next year...

...with the construction slowdown now spreading beyond housing, home builders and contractors won't be able to keep workers busy by branching out beyond residential construction as they did last year.

Howard said this year's spring selling season for homes is already shaping up to be a bad one. And while he praised legislation now gaining steam in the Senate aimed at helping demand for foreclosed homes, he said the effort is too late to make a difference this year.

"While we congratulate the Senate for taking the bull by the horns now, it would have been much more helpful for the economy in this calendar year if they had done this in the stimulus bill," he said, referring to the more than $150 billion in tax rebates passed by Congress in February...

Still, the new legislation would help hombeuilders since part of the bill calls for tax relief for many homebuilders. The bill would allow homebuilders and other firms affected the by the mortgage meltdown, such as investment banks, to use losses in 2008 and 2009 to get back taxes they owed over the previous four years. That's a change from the two years allowed under current tax law.

That provision, if passed, will cost the government between $6 billion and $28 billion in future tax revenues, according to a range of estimates. It's uncertain just how much of that money builders would see but the sector is expected to be one of the biggest beneficiaries of the bill.

Howard said many smaller privately held builders are not likely to make any money this year. So the tax credit proposed in the legislation is crucial for them.

And it will be helpful for the industry leaders too. Luxury home builder Toll Brothers (TOL, Fortune 500) is the only one of the larger, publicly traded homebuilders expected to report a profitable quarter during calendar 2008...

Builders lost out on the chance of getting even more help though. Provisions that would have given a tax credit for those buying new homes sitting vacant for a long period of time were cut during the final negotiations on the bill Wednesday.