In a recent Wall Street Journal Op-Ed piece, Alex J. Pollock wrote, "If private investors want to take credit risk, and borrowers want to take a chance in order to own a house, should they be allowed to, even if it might lead to consequences ... . I'd say they should. Credit is a central force in a market economy, and boom and bust cycles are the unavoidable price of achieving the long-term growth that markets -- and nothing else -- create."
Should builders consider Pollock's opinion as they look towards the future? Is the current subprime lending scenario as bad as the media make it out to be? Can the real estate marketplace endure $1.3 trillion in mortgage delinquencies and defaults?
"Builders are uncertain about the consequences of tightening mortgage lending standards for their home sales down the line, and some are already seeing effects of the subprime shakeout on current sales activity," said National Association of Home Builders Chief Economist David Seiders. "The fundamentals of today's housing market still are relatively strong, including a favorable interest-rate structure, solid growth in employment and household income, lower energy prices and improving affordability in much of the single-family market -- due in part to price cuts and non-price sales incentives offered by builders."
"Unfortunately for my residential, single-family builder friends, tighter lending standards in the short-term will cut demand for new homes, anywhere from five percent on the low end to as high as 15 percent," said Nate Hanks, President and co-owner of RealSource in Salt Lake City Hanks, whose Commercial Division helped real estate investors nationwide obtain more than $120 million in loans with national and local lenders. "The lack of demand will definitely squeeze home-builder profits, forcing many to look at other property types that may prove profitable in the coming years."
While many industry experts are predicting that the trouble in the mortgage market could spread beyond the subprime sector, some builders agree with NAHB's Seiders about the relatively strong economy and see real estate success in the age old adage, 'location, location, location.' As such, some builders are moving forward with new development projects, focusing on markets and property types within the country that are profitable and will enhance their overall portfolios.
"Of course, location is an important factor so we are currently only sourcing land for development in some of the target markets that have been identified by our research economists, including cities in New Mexico, Arizona and Texas," added Hanks. "With market factors making it more difficult to locate good existing investment properties, this is a prime time for RealSource to press forward in the development arena."
According to the NAHB, rental apartment buildings are showing signs of rebounding following the condo construction and conversion exuberance of recent years. The return of developers to the market-rate apartment sector -- the low-rent government subsidized apartment sector never really faltered -- is being fueled by increased household demand for rental units and depleted supply due to the earlier conversion of rental apartment buildings to condominium ownership. The subprime loans will also likely force many families and individuals into rental housing.
"We are forecasting that the rental and for-sale sectors of the multifamily market will rebalance during the next two years, with about one-third of multifamily starts representing condos and nearly two-thirds representing rentals by the end of 2007," said Seiders. "Last year, the for-sale market had grown to represent nearly half of all multifamily starts, a record share, and a correction now is under way."
According to the latest results of the National Association of Home Builders' Multifamily Rental Market Index (MRMI), the index level reflecting builder expectations for market-rate rental starts is 69.5 -- nearly 18 points higher than last year's 4th quarter index. Builders expect a slightly higher level of low-rent starts as well, perhaps reflecting the improved Congressional climate for funding affordable housing.
Builders looking to add multifamily as a means to enhance their bottom lines may want to give Mr. Hanks a call. "Part of RealSource's plans in the development arena is to forge partnerships with builders and to share in the potential windfall of building in markets where migration variables are strongest."
As Mr. Pollock noted boom and bust cycles are unavoidable. It is essential that builders build in markets that are riding the cycle up rather than down.