The construction industry is out of balance, and everyone—from a casual observer to the veteran economist—knows it. According to the national Case-Shiller Home Price Indices, home prices are down 15 percent from the second quarter of 2007, yet raw materials prices are increasing. There is more inventory now than there ever has been, some priced at or below value, yet there has been a drop in sales between July 2007 and July 2008—of 35 percent.
Did you Know? |
What happened? And more important, what will it take to restore industry health and consumer confidence?
Surplus Inventory Depresses Prices
In the late 90s and early 2000s, excess demand caused by low interest rates and lax lending standards drove home prices steeply up. This so-called housing bubble caused a flurry of sales and production.
Now, following the burst, the market is left with a glut of available homes. According to the National Association of Homebuilders, that excess went from 1.1 million vacant units to more than 2.3 million units by the first quarter of 2008, most competing at the bottom line to be sold.
Motivated Sales Depress Prices, Too
In the current economy, where some homeowners have little equity and a mortgage that now exceeds the value of their home, many have found it in their best interest to walk away, leaving banks with large numbers of foreclosed properties and bad debts to recoup.
Unlike traditional sellers, lenders are motivated to sell—even at a loss—if it means the property will move quickly. In the Los Angeles area, where the average home sells for more than $300 per square foot, banks compete by offering comparable foreclosed homes below $250 per square foot.
These “motivated sales” affect home prices because they are so prevalent. In Los Angeles, 34.3 percent of all 2008 sales have been on foreclosed homes (up 578 percent since last year), and in Riverside County, California, it’s well over half.
Raw Costs Increase
Conversely, it’s becoming more expensive to build. According to the Associated General Contractors of America, steel and copper have increased in price 13 percent between January and June of this year, posting an 85 percent increase in the last five years.
Manufactured lumber, PVC and gypsum wallboard are also skyrocketing, and transportation costs only exacerbate the problem, with diesel costing more than 68 percent more than it did this time last year. Rapid cost increases affect builders’ abilities to accurately bid jobs—bid too low and risk absorbing an unknown series of price hikes, or bid too high and risk losing the job altogether.
The Good News
A slowdown may be just what the market needs to right itself. Freddie Mac economist Frank Nothaft estimates that 2008 will have the fewest single-family home starts since Eisenhower’s presidency, 50 years ago. While potentially disastrous to industry professionals and building departments over the next four to five years, there is a silver lining.
The treasury is currently trying to put a stop to the worsening cycle by urging banks to rewrite mortgage terms and avoid foreclosures while the market recovers. Until then, leaders in the building industry will have to get smart by reducing overhead, outsourcing services and diversifying. Then as the surplus is gradually absorbed, prices and lending practices will begin to normalize.
And when the market does return, it will be to the industry’s advantage to remember the lessons in efficiency that these lean times have taught.
