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S Calif Housing Market Could Pull Homebuilders To New Lows
Tuesday August 22nd, 2006 / 15h23
By Janet Morrissey Of DOW JONES NEWSWIRES NEW YORK -(Dow Jones)- Watch out, California. Your housing market is about to get smacked.
The Southern California housing market is "in the early stages of a tsunami wave of cancellations and price cuts," predicts JMP analyst Alex Barron. Home builders with big exposure to this market could potentially take a hit that's even bigger than the beating many took in Florida.
Barron, who recently returned from a three-day tour through Southern California, said he sees similarities between market conditions in this area and those in the troubled Florida market.
"Demand has hit a wall" in Southern California as skyrocketing prices over of the past few years have made homes less affordable, said Barron. Builders have responded by offering higher incentives and steep price cuts, and by allowing buyers to put down shockingly small deposits - of less than 1% - on homes, he said.
"Deposits below 1% are a very ominous sign as it signals to us that demand is very weak and homes have now become very unaffordable," said Barron.
"If it's a $700,000 home and suddenly the builder has cut the price for similar homes to $650,000 or $600,000 - and you only put down a $5,000 deposit, why wouldn't you walk away from it?" he asked. "We would expect cancellations to rise dramatically in coming months as it will be relatively painless to walk away from such a small deposit."
He sees California's market conditions following in Florida's footsteps by only a few months. Florida has led the quickly deteriorating housing market for many of nation's homebuilders, where huge inventory gluts have forced builders to slash prices and offer extraordinary incentives in order to move sales.
However, a key difference between the two states is that Florida's woes were driven primarily by speculative investors and flippers who flooded the market and drove up prices over the past few years. Many of those same investors were forced to dump the homes they purchased back onto the market at fire-sale prices when the market softened.
By contrast, speculative investors were never as big in California. Instead, homebuilders themselves have been driving the inventory buildups in the Golden State, according to Barron.
"One of the more troublesome developments we saw in Southern California was that most builders were spec building entire communities at a time, with very few sales to support this level of construction," said Barron. "In one instance, we saw a community of about 100 homes where there were over 20 complete unsold homes, and yet the builder was already building the next 100 homes in the community next door with five sales."
That particular community was being built by Beazer Homes USA Inc. (BZH). Beazer, however, isn't alone, Barron said. He sees similar speculative building from other major publicly traded builders, including D.R. Horton Inc. (DHI), Lennar Corp. (LEN), Meritage Homes Corp. (MTH), Centex Corp. (CTX), California Coastal Communities Inc. (CALC), and Brookfield Homes Corp. (BHS).
"Many wrongly think that 'if you build it, they will come.' Well, they're not coming anymore," said Barron. As a result, he said that homebuilders that sell homes in California could be potentially hit even harder than they were in Florida.
"It appears to us in Florida, the one left holding the bag was the flipper or speculator," said Barron. "In Southern California, it appears to us the one left holding the bag is the homebuilder." He added that California is the state where the builders have most of their capital parked.
Michael Carliner, an economist with the National Association of Home Builders, disagrees that Southern California could be the straw that breaks the camel's back.
He said California tends to have longer land and zoning approval processes than many other states, such as Florida. As a result, he said California tends to be "underbuilt" in general.
In 2005, the number of housing starts per 1,000 people in California stood at 5.34, which is below the national average of 7, and far short of Florida's 15.08 and Nevada's 17.58, he said. In the first six months of 2006, the number of starts per 1,000 people was 4.7 in California, 6.7 nationally and 13.8 in Florida. This means the pace of construction in Florida far outpaced California based on population growth.
Still, if speculative investors account for fewer buyers than in Florida, then they will also be responsible for fewer of the unsold homes in the market.
Data gathered from LoanPerformance, a mortgage information and analytics company, appear to back this up. Nationwide, the number of speculative buyers has surged in the past two years, with cities in Florida, Nevada, and Arizona dominating the top 30 spots.
LoanPerformance found that 16.8% of all mortgages issued for new home purchases in 1995 and 16.7% of those issued so far in 2006 were given to speculative investors and those purchasing vacation homes. This is up from 11.7% in 2003, 9.7% in 2002 and 7.9% in 2001.
Markets with the biggest percentage of speculative and vacation home buyers were in Myrtle Beach, S.C., and Naples and Fort Myers, Fla., where these investors represented 66.5%, 54.1% and 48%, respectively, of new mortgages in 2006. California markets only held down two of the top 30 spots, according to LoanPerformance.
Joe Snider, senior credit officer at Moody's Investors Service, said he still believes speculative investors were quite prominent in California and isn't convinced that public builders will take a tougher hit in California than they did in Florida.
However, Snider was surprised to hear that public builders were constructing entire communities on spec right now.
"The last time homebuilders did something like that was in the late '80s and early '90s, and some of them just didn't make it," said Snider. "There were seven homebuilders that went bankrupt in 1990, and the reason in every case was that they were long on land and they were financing it with short-term debt."
Snider said homebuilders learned tough lessons back then, and most no longer use short-term debt to finance their land purchases.
"If they've gotten back to a practice of building entire communities on spec - like they did in the late '80s and early '90s - that would definitely be a worrisome trend. But I've seen no evidence of that yet," he said.
Barron downgraded two builders that have large exposures to California - Standard Pacific Corp. (SPF) and Beazer Homes USA Inc. Standard Pacific gets about 49% of its revenue from California while Beazer currently gets about 20%.
Many of the major builders rely on California for a big percentage of their total revenues, including California Coastal Communities, 100%; Brookfield Homes Corp., 73%; William Lyon Homes Inc. (WLS), 72%; Lennar Corp., 32%; KB Home (KBH), 31%; D.R. Horton, 25%; Centex, 24%; Hovnanian Enterprises (HOV), 24%; M.D.C. Holdings Inc. (MDC), 22%; Meritage, 21%; Ryland Group Inc. (RYL), 21%; and Pulte Homes Inc.(PHM), 19%.
-By Janet Morrissey, Dow Jones Newswires; 201-938-2118
Tuesday August 22nd, 2006 / 15h23
