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May 2013

Exciting time for local builders, consultants tell MBA

NWREporter May 2013

John BurnsAlthough the recent market correction was unlike any prior ones, a strong, fundamental recovery is under way, marked by solid demand, booming apartment construction and the ingredients for "tremendous price appreciation," according to the keynote speaker at a meeting of builders.

Ken PerlmanJohn Burns, CEO of John Burns Real Estate Consulting (JBREC), told members of the Master Builders Association of King and Snohomish Counties that the recovery is being accelerated by the federal government and investors, but emphasized the importance of resolving "legacy issues."

Joined by Ken Perlman, senior VP at the firm, the duo cited data illustrating the surge in master plan sales, but pointed out there are no Seattle master planned communities in the top 50.

Despite his optimism, Burns, whose national real estate consulting career spans more than 20 years, said construction and new home sales "have a long way to go." Construction starts are 47 percent of the way back to normal (pegged at 1.5 million units), while new home sales are only 18 percent of the way back to the normal pace of 800,000 transactions.

Burns also discussed his firm's "Housing Cycle Risk Index™," which is based on 25 calculations in four major categories (demand, supply, affordability and the U.S. economy), and 11 subcategories.

  • Demand is solid. The creation of 2 million jobs in the last year translates to the formation of 1.6 million households.
  • New supply is low - only 925,000 permits. Multifamily permits are up 47 percent year-over-year, with single family rising only 29 percent.
  • Demand strongly exceeds supply, with a 2.5 E/P ratio (employment growth to building permits). In Seattle, for the most recent period surveyed, 42,000 jobs have been added and 15,000 permits have been issued for a 2.8 E/P.  Burns doubts 22,000 housing units will be added in response to a forecast for 30,000 new jobs per year.
  • National affordability is "fantastic," according to Burns. (Affordability is measured by the percentage of buyers with median incomes being able to make mortgage payments for a median priced home.) "We monitor 105 metro areas in the U.S. on a monthly basis," he said, "and every market in the U.S. is good right now for first time buyers and 'move up' buyers." Most markets rated a "B" or better, with Seattle's fundamentals earning an "A" and "trending higher. He described Seattle as not as "underpaymented" as the rest of the country, but said it is still "very affordable." Based on his firm's Risk Index, he said 2016 is the best guess of when to reduce exposure.
  • U.S. home values rose 5.5 percent over the last year, with Seattle's 8.8 percent gains outpacing that average.

The recovery is sped by the fed and investors, Burns noted, citing data from an analysis of 55 markets. Cash investors now account for 36 percent of sales in that aggregate - with nearly half (49 percent) of Las Vegas homes being sold without mortgage financing. In Seattle, it is estimated to be around 15 percent.

"This will be a payment driven recovery more than a price driven recovery" Burns declared, noting payments are 32 percent below norm, while prices are only 1 percent below norm. (The calculations are based on ratios of median housing cost and median housing price to income.)  Seattle's price/income ratio is still 19 percent above normal.

To further illustrate the recovery, Burns turned to stock market data, a leading indicator. It shows all stocks related to housing are up more than 100 percent -- far more than the S&P 500.

The land market is pricing in a strong recovery too, Burns commented. "Good land is quickly approaching peak value - 72 percent of the peak in the Northwest." Land is back to 2005 levels, he noted.

Resolving what he called "legacy issues," such as the U.S. debt, delinquency rates and distressed sales will be important to the recovery.

Mounting U.S. debt continues to be the No. 1 concern. It will result in slow economic growth and volatility. Eight hundred years of financial history shows 90 percent or more of debt-to-GDP ratios result in recession and inflation, Burns remarked.

Delinquency rates fell to 11.5 percent in 3Q 2012. That's 5.8 percent more than normal, Burns noted.

Many markets are seeing boomerang buyers-those who went through recent foreclosures are shopping for homes again. An estimated 3.3 million buyers in this category are poised to return to homeownership.

Nationwide, distressed sales are declining while non-distressed are expected to jump 62 percent. He expects the move-up market to be the laggard.

Turning to a regional overview, JBREC reported California and the Southwest are currently the best housing markets in the U.S. Home values are up strongly, which bodes well for both private builders who need equity partners and public builders. The latter group is allocating capital to Arizona, California, Colorado and Washington.

Supply of resale inventory is squeezed. In the Northwest, there is about 4.8 months of supply, but it is down to 3.4 months in Portland and 1.8 months in Seattle. Rents are rising in most markets around the country, with Seattle being one of the exceptions. Thanks to new supply, rates here are flat.

The gap between owning versus renting is closing. Typically, owning costs $532 per month more in Seattle, but now it is only about $200 more, according to an analysis by Burns' firm.

Burns said the cycle is likely to play out in six steps:

  1. Investors buy homes below replacement cost;
  2. Renters buy homes to save on monthly housing costs;
  3. "Entry buyer urgency" occurs as pent-up demand, including boomerang buyers, unleashes (with a fury" as prices and mortgage rates rise;
  4. Speculative investors balloon in numbers, initially with cash, then with debt financing.
  5. Move up buyers increase as financing on existing home equity rises; and
  6. Sales decline as mortgage rates rise sharply, pricing out first-time buyers and encouraging potential move-up buyers to stay put due to their low fixed rate loans.

"If we are right about modest job growth and continued low rates, home prices in Seattle should rise about 9 percent per year," Burns told the audience.

Continuing the discussion, Ken Perlman, the senior VP at JBREC, said now is "an exciting time to be building in Seattle." He compared metro markets in Seattle (where activity is pushing into Snohomish County) and Tacoma ("which is stronger than you might think").

Indicator Seattle metro Tacoma metro
Current job growth 2.9% 2.8%
Current E/P ratio 2.8% 3.0%
Current SF permits 6,082 2,010
2017 SF permits (projected) 9,000 3,460
Current BHVI growth 7.7% .8%
Current to 2017 projected cumulative BHVI growth 29.2% 31.9%

Among market observations Perlman noted were solid traffic, strong prices and rising activity by public builders. Solid traffic is resulting in increased sales and declining incentives. In some instances, lot prices have doubled in the past 12 months, with raw land prices tripling. During the fourth quarter of 2012, public builders purchased half the lots in the Seattle area. In January 2013, the area had 74 public builder communities, up from 13 just two years ago.

"Watch out for rising prices," Perlman cautioned. He expects construction costs to rise and be passed on to consumers. He also believes land purchases will require considerable expertise and analysis; in secondary locations, varying degrees of patience will be necessary.

About John Burns Real Estate Consulting
John Burns Real Estate Consulting is an independent research provider and consulting firm focused on the housing industry. Based in Irvine, Calif., the firm provides analytical and other services for builders/developers, banks/lenders, investors, and building product manufacturers.

About the Master Builders
Founded in 1909, the Master Builders Association is a trade association comprised of nearly 3,000 companies involved in the residential and light commercial construction industry. It is the nation's oldest and largest local home building association affiliated with the National Association of Home Builders.