Lead Story… Goldman Sachs published a research note last week that CNBC posted some excerpts of, making the case that the construction labor shortage isn’t to blame for the sluggish home builder performance:
“Our analysis of payroll growth and wage inflation data suggests that labor shortages may not be to blame for the mediocre level of housing activity,” Goldman Sachs analysts wrote in a report this week. “We find that, on the one hand, the construction sector has experienced the largest job growth over the past year.”
Construction growth has led all other sectors at 5 percent, according to the Bureau of Labor Statistics, but average hourly earnings in construction gained only 2.2 percent over the past year, which is about the national average.
“Economics 101 would suggest that, if labor shortages did in fact exist, upward pressure on wages would be more pronounced and payroll growth would be anemic,” the report said. “Therefore, the evidence from the industry-level employment and wage data does not support the existence of labor shortages in the construction sector.”
Goldman instead pointed to permitting delays and land scarcity as the culprits, citing a report from JBREC’s Jody Kahn that we posted earlier this month:
A survey of 100 builders nationwide by John Burns Real Estate Consulting backs that thesis. They asked about costs that didn’t exist 10 years ago, and found high levels of builder frustration, not just from labor, but from cost overruns stemming from new regulations for house erosion control, energy codes and fire sprinklers. They also cited understaffed planning and permit offices as well as utility company delays.
“New regulations to protect the environment and to shore up local city finances have made it extremely difficult for home builders to build affordable homes,” the Burns analysts wrote. “Now, more than ever, the demand for affordable entry-level housing will need to be met by the resale market, since new homes have become permanently more expensive to build. We were overwhelmed by the reply as well as the builders’ level of frustration.”
I agree with what they are saying to an extent as the construction labor shortage Isnt the sole culprit, but first we have to put things in context. Yes, we are rebounding but it’s from a very low level when it comes to construction employment:
The CNBC story made two important clarifications: 1) The labor shortage is a much bigger deal on the west coast (most of our clients would agree); and 2) The construction industry has failed miserably when it comes to to attracting younger workers and is stuck with an aging workforce (again, our clients have verified this):
There is a labor crunch, though, in some parts of the country, more so in the West, as a considerable number of the construction workers who left during the recession still have yet to return.
The average age of a construction worker today is far higher than it was during the housing boom, Michelle Meyer, deputy head of U.S. economics at Bank of America Merrill Lynch Global Research, said Tuesday on CNBC’s “Squawk Box.” Builders need to attract younger workers, but they seem, so far at least, unwilling or unable to pay them more.
IMHO, there are a number of issues conspiring to make this a very difficult environment for builders and developers. Permitting delays, a lack of developable lots, low affordability, more stringent mortgage underwriting, people forming households later in life, labor shortages, high costs, lack of development financing, almost no new entry level product, etc. Builders could probably overcome a couple of these but add them up together and you have the perfect storm for a relatively moribund home building recovery. This sluggishness is leading to capital market pessimism. Meyers Research noted last week that their investor round table is expecting a downturn in land in the not-too-distant future which is causing them to proceed cautiously:
The train may arrive early: While a national economic recession is still on the horizon, the recession is now expected within the next two years, which makes investing in a residential land opportunity more interesting.
Possible repricing ahead: In fact, some groups are suggesting that land will be “on sale” within the next 6-18 months. Widespread distress is not expected, but neither are decreasing home prices. It’s simply an expectation that some return-based land owners may be experiencing deal fatigue and be willing to accept a modest return rather than endure another cycle.
“Multiple” Opportunities: Some of the larger, more patient capital sources are expecting this to be an attractive buy opportunity where they can “play for the multiple”. The challenge is that few of these investors are looking to develop land. The heavy capital requirements of land development are not justifiable today and banks remain tepid toward land development. It is not a stretch to expect the for-sale market to remain under-supplied, or at least not oversupplied, for a protracted period. This condition surely will reduce the risk of capital loss for patient investors but make things challenging for home builders who need land as their most basic raw material.
At some point this becomes a self-fulfilling prophecy where lots fall in value due to a dearth of capital availability where investors pull back to wait for a better entry point. This couldn’t be more different than the 2007-2008 scenario where there was plenty of lot and home supply that weighed on the market heavily once subprime lending (and demand from marginal buyers) vaporized. No, in this case homes could actually keep going up in value, getting less affordable while new construction continues to slow and land development grinds to a halt. Why? Because people are still forming households and there is still demand that will likely continue to outstrip supply of development slows further.
Private equity investors made large investments in land coming out of the downturn, banking on a strong rebound when home values began to rise. Many of them have been disappointed with the results and many portfolios haven’t hit expected returns despite home prices and lot prices generally rising. This has mainly been due to the various headwinds facing development and home building that I mentioned above. The prevailing view on Wall Street appears to be that land is overvalued but home prices may not be which is why Meyers sees the potential for land to go on sale while low supply keeps home prices elevated. Ironically, developers and their capital partners could have been spot on underwriting finished lot values and still under-performed due to permitting delays and cost inflation. Developers and their equity partners are also struggling since home builders are now demanding finished lots whereas they were previously buying unimproved but mapped land and did their own improvements. Improving lots is very capital intensive as mentioned in the Meyers report above and your average developer has a substantially higher cost of capital than a public home builder does.
I’m of the opinion that the correction has been underway since 2014 when builders essentially stopped buying paper lots in all but the most infill locations since underwritten returns on land improvement and horizontal construction are now higher (ask a west coast based land broker and they will likely confirm this). All told, we could be setting up for a somewhat bizarre scenario where land prices languish as development risk gets repriced while home prices stay firm or go higher.
Look at the Bright Side: As lucrative oil jobs dry up, some workers are jumping ship to the growing solar energy sector.
Just Speculating: Spec construction is on the rise as tenant demand continues to fuel the industrial sector.
There’s a Freeway Running Through the Yard: Buyers in high priced markets like Los Angeles will put up with a lot, including a home adjacent to the freeway to find something even moderately affordable. See Also: Home price surge stymies first time buyers.
Keeping Up With the Googles: Traditional businesses are making their offices look like startups in a bid to appear “cool” to millennials. However, what many of these traditional businesses run by 50 year old execs don’t grasp is that the appeal of the startup lies in the excitement of the concept, the culture and the idea that you are getting in on the ground floor….oh yeah, I almost forgot about the ability to participate in the upside if the company makes it big. These are things that your typical advertising agency will never offer and nap pods, ping pong tables and hip office design in an old-school business are superficial and come off as pandering.
Better Off Just Dripping: The Dyson Airblade jet dryer is really bad for hygene. A new study shows that using one is akin to setting off a viral bomb in an already-disgusting public restroom.
Chart of the Day
The latest update of Bill McBride’s “Distressing Gap” doesn’t look to be closing anytime soon.
Makes Sense to Me: A woman in South Carolina crashed a car into a Walmart. She claims that God told her to do it.
The Law of Unintended Consequences: An animal rights activist group “freed” an ostrich from the circus. It was promptly hit by a car and killed. Turns out that ostriches aren’t well equipped to handle an urban environment in Germany. Who would have though?
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