Land

A Slew Of Fast-Unspooling Risks Pressure Land Underwriting Data

Where homebuilders pick up a pivotal signal of a cyclical downturn ahead often comes clear in a typical Monday land committee meeting with corporate finance and treasury. Those meetings are suddenly taking a new tone and new data points.

Land

A Slew Of Fast-Unspooling Risks Pressure Land Underwriting Data

Where homebuilders pick up a pivotal signal of a cyclical downturn ahead often comes clear in a typical Monday land committee meeting with corporate finance and treasury. Those meetings are suddenly taking a new tone and new data points.

March 25th, 2022
A Slew Of Fast-Unspooling Risks Pressure Land Underwriting Data
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About those reports from the field the market has softened...  As one of our trusted strategic and operational level sources indicates, "We're past the peak." Traffic counts are falling; order pace is checking up; pressure's building.

It's making people think."

The "it"  – our senior-level strategic homebuilding and real estate confidante sharing a view that the housing boom, as we've known it, has peaked – refers to several converging forces, each a locus of challenge in its own right.

When people start thinking, it's not a good thing."

What It Means For Homebuilding Operators

Net, net, an inflection in market momentum sends a signal that intensifies pressure to three vital operational areas – construction, sales, and land/finance – that have already endured a bumpy ride from the moment the pandemic pronounced itself in early 2020.

Turbulence now surges, as price, supply, and would-be buyer wherewithal variables collide. The mash-up of both supply and demand risks and constraint imposes even greater pressure on construction operations to complete homes in production and get unstarted homes started. All the while, geopolitical and economic wild cards send shocks, stresses, and shivers into a demand-side pool that has been rocked by inflation and a barrage of other vague threats and risks.

The challenge for homebuilding business leaders – no matter how disciplined they try to be vis a vis the cyclical nature of residential real estate – is that, historically, they don't do well at preparing, detecting, and proactively responding to a business and market downturn.

Until it's too late.

The calculus – and crystal-balling – focuses on whether and when it's the moment to kick into a more aggressively proactive mode of behavior for a downturn before it does become too late, at great cost.

Capitulation to a cyclical slowdown is a last resort tactic for many of the business' stalwart leaders.

Already, our sources tell us, weaknesses are pronounced and spreading. They're particularly impacting price-sensitive lower-tiered product and community offerings and sectors. Pressure's on sellers to keep pace up and steady with each release, and on construction operations to get the inventory turned and full revenue booked. Meanwhile, the land game has swiveled almost 180-degrees, from barely discriminate pounces toward an abundance of caution.

Our senior-level executive source – who was willing to be candid about deteriorating market dynamics on the condition of anonymity –  notes that it's not just single-family for sale operators feeling the heat, but built-to-rent developers whose pro formas model an upward trajectory of rent power.

We're 30-, or 60-, or at most 90 days from when cancelation rates will be going up and you're going to see all the incentives start rolling out to move inventory," our executive source tells us. "How do you buy land now? You've got to be reducing IRRs and using a lower multiple in your models, even for BTR. Lease-up rates are stalling as theses places get pricier and pricier."

Already, land committee meetings need to take a sharper pencil to hurdle rates on any deals, our source tells us. Corporate finance chiefs and treasury should be modeling – even based on impacts of inflation and construction cycle elongation to backlog pipelines – reduced internal rates of return.

The underwriting on land has to be reeled in," our source tells us. "Land spend, basically, should be hitting a pause. Or if not, lots should not only be modeled with no appreciation in value, but also for slower absorption pace, more carry costs. Who knows how much you're going to have to pay to buy down mortgage rates to keep sales pace at tolerable levels?  Anybody who's guiding to a particular margin, even on their order backlog for 2022, is full of it."

To wrap this week, two more red flags – not isolated instances, but developing a downward trend:

Not yet in everything, but in a growing number of areas, consumer households are pressing pause.

A Nationwide Retirement Institute study this month adds both heft and specifics to the view of a general pause among consumer households:

Declining purchase power has led all generations to make the tough decision to postpone or cancel major life events. Over one-third of Gen Z and Millennials have already postponed or are considering postponing their weddings and plans to start a family. Consumers are also more likely to delay buying a car or home and have cancelled their vacations. For older generations, more than 10% near retirement age have or are considering postponing plans to retire.

In addition to these cancelled or postponed major life events, all are making changes in their daily lifestyles to combat inflation. This includes:

  • Eating out less (48%)
  • Driving less (35%)
  • Relying more on credit cards (21%)
  • Looking for a better paying job (19%) – higher for Gen Z at 32% and millennials at 30%
  • Moving in with family to save money (14%) – higher for Gen Z at 30% and millennials at 21%
  • Reducing contributions to their 401(k) (10%)

The daily lifestyle shifts and the high-priority area trade-offs mean that while some households step back to the sidelines on new-home pursuits, others may be doubling-down efforts with even greater urgency to secure a new home.

People were tired of the question "what inning are we in?" more than half a decade ago. Now, however, it may be time to reckon with the answer, "The bottom of the 9th."

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ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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