Yesterday’s hot homebuilding areas and what we can learn from what we see

Implications: Sacramento is a unique large metro area tied to Northern California Bay Area’s coastal communities by commuting distances and to California’s Central Valley by it’s location n the northern portion of that 500 mile long N/S by 100 mile E/W area. The Bay Area is the home of Silicon alley with its world leading technology community and to San Francisco City with its enormous financial, professional and international assets. The Central Valley merely produces 25 % of the food this country grows. Moreover, Sacramento is the Capital of California with its 35 million residents and the 6th largest economy in the world. Yet Sacramento is isolated enough that it can be seen as a microcosm of the housing conditions throughout most of California.

Analysis:

That microcosm is not economically healthy now and is not likely to be so for the next five years or so in this writer’s opinion. The issue of affordability is key and the financial markets will not be ready to meet the needs of the average buyer with no cash and good to average to challenged credit. It appears that we will continue for some time to have the problem of not being able to produce replacement stock at costs less than the proceeds to be derived from the sale of the product. This business is in classic overcapacity status and a great number of major homebuilders will drop by the wayside as the next five unfold. At best, almost all major homebuilders will be reduced in size and operations will be remodeled to more classic land inventory positions. Like the auto business, the market will demand new, smaller product and the majority of yesterday’s plans will become obsolete. Unlike the auto business, this is a business without residual obligations to its workers and without a substantial investment in plant and fixtures. All that is needed is fresh capital and new blood with high egos and the required approach to the then markets.

In my opinion, though, it is way too early to recapitalize this business on an opportunity basis. I know that there is an awakening of such money now, but I think that the results of the next five years will destroy the possibility of adequate returns for these funds. We’re still on the way down as to housing prices and the end loan markets, and good money now will become a loss in most cases. The land markets where you invest opportunity funds are not near maximum distress. What I see in the limited number of transactions I have observed to date are prices five or more times higher than reasonable in my opinion. That capital ought better to be invested in the high growth areas of the near future other than housing and housing ought to be given a rest so that balance can return to a lower production business. Capital invested now will just serve to continue poor business practices without a reasonable chance of success.