Building Market Intelligence 3Q-4Q 2015

BUILDING MARKET INTELLIGENCE Q 3 - 4 2015

Increased Pet Ownership Inspires New Design Trends

By Isabell Kerins & Jenni Lantz December 2015 Several of the best-selling new home designs we found this year incorporate specific spaces designed for pets. More than half of US households own a pet, led by 71% of Vermont households.

And according to our most recent Consumer Insights survey of more than 20,000 home shoppers, 45% of pet owners indicate that they treat their pets like royalty.

As shown to the right, pet suites have become a hot new feature that many builders are offering as an option in new homes. The suites include dog

wash areas, a bed, plenty of storage and sometimes even a camera so you can check on your pet while away.

With prices ranging from $1,500 to over $16,000, these pet suites can be a simple upgrade or more elaborate additional square footage within the floor plan configuration. Pet suites are often incorporated into optional enlarged laundry rooms, such as the dog wash in K. Hovnanian’s Line K at Willowsford in Virginia (shown on left page). Although appropriately merchandised for our four-legged friends, homeowners also see the opportunity to use this space for their two-legged children.

In our survey, the optional dogwash upgrade shown below was selected by 40% of their buyers.

Laurelton by Standard Pacific Homes in Sacramento illustrates another great example of the more extensive pet suite. While still contained within the laundry area, Laurelton’s pet suite has been separated from the main use of the laundry room and includes a pet shower and cabinetry. We estimate that 25% to 35% of buyers select this costly option.

“

Happiness is a warm puppy.

”

– Charles Schultz

Pet-friendly spaces are not just for the luxury market. Clever merchandising can be used for those hard-to-merchandise spaces, as seen at Brightwalk Townhomes in Charlotte, North Carolina (pictured to the right).

According to our Consumer Insights survey results, 44% of those surveyed would like to see a dog park within walking distance of their home. These parks also serve as a great place for homeowners to connect with neighbors while allowing their dogs to play.

We featured pet spaces in our DesignLens subscription report this month. For more information, contact Isabell Kerins at ikerins@realestateconsulting.com.

88% Difference in

Price Appreciation Explained by S u p p ly a n d D e m a n d

By Erik Franks | December 2015

Consider these trends: • Frothy markets: In 9 markets, home prices have risen faster than can be explained by falling mortgage rates and rising incomes.

• Beat-up markets: In 2 markets, income growth has outstripped home price appreciation despite receiving a 44% boost from falling mortgage rates.

Income growth should drive home price gains. In a stable world of flat mortgage rates and balanced demand and supply, incomes and home prices should grow at the same rate because rising incomes are what allow people to pay more for a house.

Yet, home prices have grown faster than incomes in 28 of the 30 largest housing markets in the country. To make the illustration simple, 0% on the chart to the right would indicate where home prices and incomes grew in tandem.

Falling rates have increased purchasing power 44% since mid-2001. Because borrowers can afford to borrow more when rates are low, falling mortgage rates push home prices higher, and vice versa. Many forget that the Federal Reserve dropped the Fed Funds rate from 6.50% in mid-2000 to 1.0% in mid-2003 in response to the recession and stock market correction at that time. Accordingly, 30-year fixed-rate mortgage rates have plunged from 7.2% in June 2001 to 3.9% today, allowing home buyers to qualify for a 44% larger mortgage purely due to falling mortgage rates!

The black line in the chart above illustrates the price boost received from falling mortgage rates.

Demand and supply imbalances have also contributed to price increases/decreases. Prices in 9 of the 30 markets have experienced more appreciation than the sum of income growth plus the 44% mortgage rate benefit.

Some of the markets, such as Los Angeles and San Francisco, have clearly become permanently more expensive places to live due to rising demand and shrinking supply. Other markets, such as Chicago, have become much less expensive places to live. In the chart above, we show the 9 markets whose appreciation exceeds income growth plus the benefit of falling rates.

The chart above demonstrates how much prices have outpaced incomes since 2001.

In summary, while incomes and mortgage rates impact price appreciation, demand/supply conditions can impact home prices even more. As always, keep a close eye on the two demand/supply indicators we track most carefully: • New home demand/supply. The annual job growth / building permit ratio most closely represents the balance of new homes needed versus new homes supplied, with the caveat that the market needs to reach normal occupancy levels first.

• Resale home demand/supply. The months of supply of resale homes on the market most closely represents the balance of home buyers and home sellers in the market, with the caveat that new technologies have probably permanently reduced the balanced level of demand/supply by 1–2 months.

Note the huge differences by market above. California homeowners have clearly been the biggest beneficiary of demand/supply imbalances, while other areas have lagged substantially due to lack of demand, high supply, or both.

December 2015

By Dean Wehrli & Andrew Stubblefield

Airbnb

Ready to Invade the Apartment Space In only its 8th year, Airbnb is on pace to book 80 million nights this year, double that of last year.

It is the third-largest unicorn (a start-up valued at one billion dollars and above) in the world with a valuation estimated at $25.5 billion. But will Airbnb migrate from challenging the hotel market to

AIRBNB

becoming a part of the apartment market?

Will we see apartment developers plan for an Airbnb alternative?

Revenue will tell the tale. We recently conducted an apartment feasibility study for a proposed new building where the developer was considering including some units devoted to Airbnb users.

Even at conservative assumptions on rental rates and occupancies, the Airbnb apartments were likely to generate more revenue per unit than the standard leased units. Regardless of additional expenses (e.g., household supplies, furniture), it was clear that Airbnb was a viable option to consider.

We sense a trend developing, especially if the apartment markets soften. Apartment developers—even those building large rental complexes—could set aside a portion of their units as a kind of Airbnb rental pool to maximize revenue and market flexibility.

But how about the downside? An Airbnb presence could, for instance, alienate regular renters. It would require different management skills and policies, necessitate regular cleaning

and upkeep, and possibly come with insurance and tax issues. Some jurisdictions, as almost recently happened in San Francisco, could restrict Airbnb offerings.

These caveats, however, do not appear all that onerous. The key will be having a location that can tap into the burgeoning Airbnb user stream. The right location will appeal to tourists or business users, have an established Airbnb user pattern, generate strong rates and occupancy levels, not be oversupplied with hotel rooms, and have a favorable political environment.

If Airbnb becomes a fad that fizzles, or if you don’t have the right location after all, not a problem—fold those apartments back into the normal rental market. Airbnb units could even be added or subtracted annually as the market for them waxes and wanes.

Time will tell if this potential becomes real in the apartment world, but it is possible that someday soon your neighbor will be heading out the door to Disneyland as you trudge off to work.

2015 Mid-Atlantic Sales Disappoint In early November, 10 residential homebuilding executives in the mid-Atlantic area shared their thoughts on the state of their local markets based on sales performance in the third quarter.

Albeit a small sample, the responses provide some insight into the health of the local market. About 30% of respondents reported they met their 3Q 2015 sales goals.

No respondents reported they exceeded their goals. And, 80% are less optimistic now than at the end of 2Q 2015 that they will meet year-end sales goals.

Compare Trends by Quarter in 2015 In general, disappointing sales volume increased in the midAtlantic over the course of 2015 and in our latest survey, 80% of respondents were less optimistic about meeting yearend sales goals (compared to 7% last quarter.)

By Rosemary deButts November 2015

3Q 2015 Question of the Quarter Incentives are on the rise in the mid-Atlantic to boost sales this quarter with increased advertising in second place. Other options were less popular.

Tech Buyers Only A Small Portion of San Fransisco Bay Area Cash Transactions

By John Burns & Rick Palacios Jr.

November 2015

With so much attention focused on the billion-dollar Bay Area tech company valuations and San Francisco rents and home prices that have escalated to all-time highs, we decided to work with powerhouse San Francisco Bay Area real estate brokerage

Pacific Union to build a profile of the most affluent home buyers—those who are paying all cash. Pacific Union analyzed 323 cash transactions their agents were involved in from February to June this year, with some very surprising findings.

Diversified Buyer Intent 66% of the cash buyers purchased a primary residence, while 31% purchased long-term investments and 3% purchased homes to flip.

Tech Buyers a Minority The profile was far less international and tech industry than we thought it would be, with the breakout as follows: • 6% international buyers. Only 18 buyers came from overseas, and only 8 (2%) of those were from China, despite Pacific Union having strong overseas brand awareness • 12% tech buyers. Only 40 of the 323 buyers came from the tech industry, and 24 of those 40 purchased in the City of San Francisco (28% of the all-cash activity in the City).

More on the Tech Buyer Not surprisingly, the tech buyer was geographically concentrated. Of the all-cash transactions in each market, tech buyers made up: • • • •

33% of the Silicon Valley transactions 27% of the San Francisco transactions 10% of the Marin County transactions Small percentages in Alameda, Contra Costa, Sonoma, and Napa Counties

Source: Pacific Union International Inc (Pub: Nov-15)

• 42% white collar professionals. Investment bankers, consultants, and other white collar professionals purchased 136 homes.

• 40% other buyers. Retirees, athletes, artists, and students with family money bought 129 of the homes. Retirees were the largest group. This is consistent with what we are seeing in other big cities such as Chicago.

Long-Term Investor Profile Exactly 110 purchases by investors composed 34% of the activity and was split as follows: • 3% to flippers. Flippers purchased 10 of the 323 homes.

• 7% investors to rent. 24 of the 323 transactions were completed by investors who intended to rent it out. This group included no international buyers and was all affluent domestic individuals.

• 24% investors to hold. Exactly 76 of the 323 all-cash transactions were completed by investors who intend to use the property as a second home, with the invest-to-hold pool split as follows: »» »» »» »»

2% overseas: 7 overseas buyers including 4 from China 2% tech: 7 buyers from the tech industry bought vacation homes 10% domestic professionals: 33 white collar professionals 10% other domestic investors: 29 other investors

Source: Pacific Union International Inc (Pub: Nov-15)

Primary Resident Profile The 213 primary residents who paid all cash for their house had a very similar distribution as the investor profile, with a slightly higher likelihood of being in the tech industry. The primary resident profile is as follows: • 5% international • 15% tech

• 42% white collar professional • 38% other buyers

The Venture Capital Impact Is Still Quite Large Following the dot-com crash of 2000, San Francisco and San Jose apartment rents fell 34% and 41%, respectively, and we think another decline this time around is inevitable. One of the best leading indicators we’ve come across in trying to identify inflection points in Bay Area apartment rents is venture capital (VC) funding patterns.

As seen in the following chart, the average VC deal size for Silicon Valley / Bay Area-based companies rose from $4.9 million in 1997 to a peak of roughly $17 million in 2000, equating to a 243% increase. In addition, apartment rents in San Francisco and San Jose increased a staggering

52% and 60%, respectively. Over the next three years, VC funding to local companies plummeted in lockstep with apartment rents. Fast forwarding to the current tech sector upswing, the relationship between VC funding and apartment rents is once again presenting itself clear as day.

After bottoming in 2010 at $6.9 million, the average VC deal size for Silicon Valley / Bay Area-based companies has since jumped to $23.5 million, equating to a 240% increase (almost on par with the 243% run-up of the last tech upswing in 1997–2000). During this time span

apartment rents in both San Francisco and San Jose have shot up a staggering 71%. At $3,200 and $2,800, rents in San Francisco and San Jose have respectively eclipsed prior dot-com bubble peaks of roughly $2,300 by a double-digit margin.

Conclusion In conclusion, the San Francisco Bay Area is on our watch list for a correction. While we strongly believe that San Francisco has become a permanently more expensive place to live and should be one of the most expensive places to live in the world, the recent increases in home prices and rents have also been fueled by speculation. Americans who do not work in the tech industry are purchasing approximately 82% of the all-cash homes in the San Francisco

Bay Area. Approximately 34% of the all-cash buyers are purchasing as an investment. The tech industry represents as much as 33% of the all-cash buyers in Silicon Valley and 27% in San Francisco, but much less elsewhere. International buyers are only 6% of the activity. Affluent older buyers, often for investment reasons, have identified San Francisco as a place they want to own or live and have driven up prices dramatically.

Methodology Pacific Union has approximately 10% market share in the Bay Area, with much larger market share in certain areas (like the Marina area of San Francisco) and lower market share in other areas (such as the Mission District), so the conclusions might be different if a 100% sample size were taken.

Loan Limits Stifling New Home Sales in California and Arizona

By Adam Artunian | November 2015

The pool of qualified new home buyers appears to be running thin in California. The median new home price now: • far exceeds the current GSE and FHA loan limits in Orange County, San Jose, the San Francisco East Bay, and San Diego; • exceeds the FHA limits in Riverside-San Bernardino, where so many potential buyers

have poor credit and limited savings after the tremendous recession; and • almost exceeds both the FHA and GSE limits in Los Angeles and Sacramento.

In other words, more than half of new home buyers have to qualify for a jumbo mortgage, which is much more difficult than qualifying for FHA or FSE financing. Jumbo loans require high incomes and

high down payments, or at least outstanding credit with mortgage insurance.

The chart above shows the relationship between median new home prices and loan limits in the major housing markets in California. Only Los Angeles and Sacramento currently have a median new home price below both the GSE and FHA loan limits.

For many of our home builder clients, the January 2014 decline in FHA limits hurt sales dramatically, particularly in Phoenix and Riverside-San Bernardino. FHA limits are 115% of the median resale price, as determined by FHA, and thus should increase slightly next year. GSE loan limits are determined annually by FHFA, the GSE’s regulator, and are not expected to change.

In summary, home sales depend heavily on government mortgage policy, and new homes are more impacted since new homes are usually priced above the median resale price. We have been working with builders and developers to develop strategies to maximize profits on homes below the FHA and GSE limits, which is much more difficult than simply building a smaller, simpler home. Today’s home buyers are highly discerning, which means builders should: • Not put any costs into the home that the majority of target consumers do not value and • Include all of the features that they do value and can afford, within the constraints of today’s mortgage policies

ch ica go Lessons From the Most Beat-Up Market in the Country

For years, our thesis has been that the national downturn and recovery will play out similarly to the mid1980s downturn in Houston and the early-1990s downturn in Southern California because both the job losses and bank/savings and loan destructions were similar. That theory has worked well nationally, but certain markets have fared much better or much worse. No major market has fared worse than the Chicago metro area.

Two Factors Are Unique to Chicago, but One May Be Coming to You Soon Instead of construction volumes falling 75%+/-, Chicago’s single-family market fell 90%! Now, while US construction remains 60% below peak, Chicago remains 80% below! One reason is that Chicago had a higher percentage of highly leveraged private builders who were unable to weather the recession (17 of the top 28 builders in 2005 no longer exist or left the market). But we believe there is another reason too: property tax fear.

Property Tax Fear As our team travels around the country, we rarely hear that fear of rising property taxes contributes to home buying hesitation. In Illinois, however, where property tax rates are eclipsed only by New Jersey, and where there are so many taxing authorities that our property tax bills look like a grocery receipt, potential home buyers have heard so much about the likelihood of additional property tax hikes to fund pension obligations, that most of our home builder clients regularly hear this “excuse” in their sales offices. Our CEO John Burns believes that home buyer confidence is lower in Chicago than anywhere in the country. If your local government has unfunded liabilities that are only getting worse, keep an eye

By Lance Ramella & Danielle Leach October 2015

on Chicago as a precursor to what could happen to your market as well.

Room for Optimism Chicago’s housing market will continue to improve.

Single-family construction has doubled from the bottom, and we believe current levels are not even enough to keep up with the need to replace homes that need to be torn down. Chicago housing is on the mend, and numerous builders have realized that parts of Indiana and Wisconsin are commutable to employment centers and don’t have the same issues.

Here are the fundamentals: • 1.0% annual job growth • Steady household formations • Solid resale market. Notwithstanding the property tax fears, 106,500 resale sales transacted over the past year in the Chicago metro area, up 6% YOY. Resale home prices rose 4% over the same period and remain far below peak pricing.

• Median new home price: $343,500, up 9% YOY

What Needs to Occur to Get Chicago Back on Track?

• Price appreciation. The new vs. resale price gap has pushed consumers to seek alternatives to new homes, such as resale housing closer to employment centers, different product solutions altogether, or simply staying put. Resale price recovery in the fringe, the traditional growth submarkets, is necessary for builders to compete in these areas.

• •

•

•

Resale prices need to appreciate roughly 10–20% in these areas to make new home development viable and competitive.

Location, location, location. Location continues to be the primary consideration for consumers. There has been a change in consumer preference for location, especially as younger buyers have expressed their willingness to live in smaller homes to spend less time commuting. The key is taking into consideration where buyers want to live versus where new home construction is viable.

Cost considerations. Land prices need to better align with consumer expectations; the days of simply taking price increases to cover increased house costs are over. Chicago continues to be very competitive with respect to raw and developed land, but builders, developers, and investors cannot afford to pay top dollar for land and pass those costs along to future home buyers.

Taxation challenges. Taxation continues to challenge builders, developers, investors, and homeowners, which is an issue we are monitoring closely. Our friend John Mauldin wrote an excellent educational piece on the subject.

If elected officials can devise a plan to appease the fear of rising taxes, we expect Chicago housing to rebound strongly. If officials are able to continue kicking the can down the road, we expect the slow recovery to continue.

With this level of uncertainty, our clients continue to invest aggressively in short-term projects in great locations or in adjacent states and cautiously in long-term projects, including paying agricultural value for long-term land.

HOUSING MARKET FALL CLASSIC

By Alex Martinez October 2015 October is here: the leaves are changing, jack-o-lanterns are carved, and builders are preparing to hit year-end sales goals.

October, of course, is also home to one of America’s greatest sporting events, the World Series. We thought it would be fun to combine our passions for real estate and sports by analyzing the housing fundamentals of the Kansas City and New York markets to see which area has a better jump on stronger growth next year.

Let’s introduce our two competitors:

Innings Summary 1. Job growth: New York +1 run.

Employers in the New York metro have added 127,000 payroll jobs to the employment base compared to one year ago, a 1.9% YOY increase. Comparatively, payroll employment has grown 1.2% YOY in the Kansas City MSA. 2. High-Income job growth: Kansas City +1 run. High-income sectors added 5,300 jobs in the Kansas City MSA compared to one year ago, a 1.9% YOY increase. Highincome jobs in the New York metro increased by 0.8% YOY. 3. Single-family permit growth: New York +1 run, Kansas City +1 run. Single-family permit activity in both markets are far below their respective historical averages. Current single-family permit activity in the Kansas City MSA is 39% below its historical average, and New York levels are 45% below their historical average.

4. Multifamily permit growth: New York +1 run. Multifamily permit activity (for sale and rental) in the Kansas City MSA has grown modestly over the past year, increasing 1.4% YOY. On the other hand, multifamily permit activity (for sale and rental) in the New York metro has grown substantially over the year and

is up 104.8% YOY. Some of New York’s surge was due to builders paying for permits to avoid a property tax abatement expiration, but New York’s multifamily growth still exceeded Kansas City’s.

5. Employment growth-to-building permit growth (E/P) ratio: New York +1 run. Both markets are new home demand heavy (E/P ratio greater than 1.2). However, the New York metro has a higher E/P ratio, at 1.9, than the Kansas City MSA, at 1.5.

6. Home price appreciation: Kansas City +1 run. Our Burns Home Value Index™ (BHVI) indicates that single-family home values in the Kansas City MSA are up 6.4% YOY. Comparatively, our BHVI indicates that home values in the New York metro are up 2.2% YOY. Our NY territory includes far more than Manhattan and Brooklyn, where prices have spiked.

7. Affordability: Kansas City +1 run.

Our Burns Affordability Index™ (BAI) indicates that ownership affordability is better than the historical norm in both markets.

Our BAI for the Kansas City MSA currently stands at 0.9 (0 = all-time best and 10 = all-time worst); our BAI for the New York metro is at 2.4 (again, it is a

different story in the Big Apple).

8. Intrinsic values: Kansas City +1 run. Our Burns Intrinsic Home Value Index™ (BIHVI) measures how home values would trend if mortgage rates were always 6.0% and the housing cost / income ratio was always 22.5% for Kansas City and 53.0% for New York (which we believe to be the correct long-term assumptions to use for these markets). According to these assumptions, today’s home values in the Kansas City MSA would be 4% underpriced, while home values in the New York metro would be 1% overpriced.

9. Economic diversity: New York +1 run. The New York metro has 8 industries with a location quotient greater than one, and the Kansas City MSA has 6 industries with a location quotient greater than one. A location quotient is the metro area’s share of total jobs in a given industry divided by the comparable share nationwide; values greater than one demonstrate a greater than national average share of jobs in that industry, indicating specialization. A metro area with a high number of specialized industries indicates strong economic diversity*.

Current score: Kansas City 5, New York 5 Looks like we are heading to extra innings.

Just as a reminder for all our fans, we have 18 offices across the nation. Feel free to reach out to us if you would like to subscribe to our research or can benefit from a consulting study. We are ready to field your questions and help you make your next project a home run. *Data and definition sourced from Brookings.

WOMEN & the Future of Housing Decisions

By John Burns | October 2015

As I head to Urban Land Institute’s Fall Meeting today, ready to present at four councils tomorrow, I ponder the rise of women in the working world. The ULI Councils, which are some of the most prestigious real estate industry organizations, are dominated by gray-haired men like myself, even years after passing a rule that women “won’t count” against the limit, in an attempt to recruit more women. Interestingly, the leadership of 3 of the 4 councils are now dominated by women. At the last ULI, the Young Leaders presentation at one of the Councils was 100% women. Hmm. I am going to bet that the makeup of real estate industry leadership will become increasingly female over the next few decades, not because of affirmative action efforts, but purely because women are getting ahead. Consider these four trends:

• 37% of women graduate from college vs.

31% of men.

• 38% of women earn more than their husband, up from 24% in 1987.

• Since 1973, real female incomes are up 34%, and real male incomes are down 5%.

• 20% of non-working dads born in the 1960s cite child care as the primary reason, up from 2% of non-working dads born in the 1940s.

I am also interested, obviously, in what this means for home buying decisions. For years, home builders have told us that the woman is the primary home buying decision maker. Does the career woman want a different floor plan than what exists in the resale market? Does the stay-at-home dad want a different floor plan? Is a career woman a driving factor in the preference to live urban or in suburbs close to work? Our team members have been noticing shifts throughout the country, and we look forward to discussing these trends with you at ULI and elsewhere.

Closer In or Farther Out?

By Pete Reeb | October 2015 It’s no secret that home prices in better-located Southern California markets (closer to the coast, jobs, and good schools) have held up better than prices in inferior locations (those farther inland with longer commutes and not necessarily great schools). But if you are a home builder, you know the more outlying markets have more land at substantially lower prices than do the more desirable closer-in markets.

So what’s the better strategy on land: try to find “safer” but scarce and expensive land in closer-in A or B locations or reach out into some of the C, D, or even F markets, where land is more plentiful and cheaper but where lower home prices might squeeze margins?

To try to answer that question, look at the upside potential on home prices. Have the prime or closer-in markets already achieved more of their upside potential in the most recent up cycle, therefore leaving them less “room to run”? Are the less desirable or farther-out markets poised for more of a rebound in prices the next few years, possibly making them the better play? Or do the farther-out markets simply have insufficient demand now? Has a fundamental shift occurred, meaning those outlying areas will not come back this cycle?

Great Locations Have Experienced Much Bigger Price Recoveries Housing prices in prime coastal Southern California submarkets have returned to prior peaks. It took eight years, but prices in the best-located submarkets in the three coastal Southern California counties (Los Angeles, Orange, and San Diego) have finally climbed back to highs last reached in the mid-2000s.

Single-family resale prices in the prime areas in the three coastal counties now exceed prior highs by 1%. “Average” coastal submarkets are 13% below prior highs, and less desirable / farther-out coastal locations remain 28% below past highs.

The Inland Empire (Riverside and San Bernardino counties) is nowhere near prior highs. Prices for homes in the most desirable and average portions of the Inland Empire stand at an average of about 28% below the prior peak, and the more outlying areas are still 41% below past highs. Is the Inland Empire poised for strong price appreciation as commuters see the tremendous value?

Commuters Can Find 13%–20% Higher Than Usual Price Discounts At the peak of the market, median prices in prime submarket locations in the Inland Empire stood at just 31% below the median prices in prime coastal markets, but today, prices in prime submarkets in the Inland Empire are 51% below prices in prime coastal markets.

Likewise, the price differential between inland and coastal average and less desirable markets remains substantially wider than at the peak of the market, suggesting that inland market prices have more room to run than coastal markets.

The outlying areas have historically had more downside risk, but today they appear to have more upside potential, too. During the downturn of the late 2000s and early 2010s, prices fell further across all submarket areas in the Inland Empire (-48% to -63%) than in the coastal counties (-29% to -53%). In the most recent up cycle, prices have increased faster in average and less desirable submarkets in the Inland Empire than in the coastal counties. (The Inland Empire price increases represent smaller dollar amounts since they start at much lower prices.) However, prices in prime coastal markets have risen faster (43%) than in prime inland markets (38%) Outlying Areas Have Better Sales Rates For all they tell, these data do not answer the question of whether there has been a permanent shift in where new home demand will be: higher-priced, closer-in markets or more affordable, farther-out markets. (Prices can appreciate in both locations, of course.) New home project sales rates can help answer this question.

In the Inland Empire, projects in the farther-out markets are averaging 3.5 sales per project per month YTD in 2015, while projects in average locations are averaging 3.2 per month, and projects in prime locations are averaging 3.1 per month. In comparison, county-wide project-by-project monthly sales rates YTD in the coastal markets are: Los Angeles, 2.9; Orange County, 3.2;

and San Diego, 2.7. Projects in the Inland Empire are achieving comparable to faster sales rates (on average) than coastal projects, and the farther-out parts of the Inland Empire have the fastest sales rates.

Conclusions As each submarket has its own dynamics, we cannot conclude that all outlying areas have a better than usual risk/reward trade-off right now. But the Inland Empire clearly has plenty of new home demand and good upside price potential relative to the coastal markets. Lower home prices mean you may not make as much per house, but if you want volume and price appreciation, you should look at the farther-out locations. The home values are there in the prime coastal markets, but high home prices are affecting sales rates. The “farther-out” submarkets in the coastal counties are worth a look as well.

For all they tell, these data do not answer the question of whether there has been a permanent shift in where new home demand will be: higher-priced, closer-in markets or more affordable, farther-out markets. (Prices can appreciate in both locations, of course.) New home project sales rates can help answer this question.

In the Inland Empire, projects in the farther-out markets are averaging 3.5 sales per project per month YTD in 2015, while projects in average locations are averaging 3.2 per month, and projects in prime locations are averaging 3.1 per month. In comparison, county-wide project-by-project monthly sales rates YTD in the coastal markets are: Los Angeles, 2.9; Orange County, 3.2; and San Diego, 2.7. Projects in the Inland Empire are achieving comparable to faster sales rates (on average) than coastal projects, and the farther-out parts of the Inland Empire have the fastest sales rates.

As each submarket has its own dynamics, we cannot conclude that all outlying areas have a better than usual risk/reward trade-off right now. But the Inland Empire clearly has plenty of new home demand and good upside price potential relative to the coastal markets. Lower home prices mean you may not make as much per house, but if you want volume and price appreciation, you should look at the farther-out locations. The home values are there in the prime coastal markets, but high home prices are affecting sales rates. The “farther-out” submarkets in the coastal counties are worth a look as well.

For more information on Southern California market trends, please contact Pete Reeb, Principal, at preeb@realestateconsulting.com or (858) 281-7216.

I N C R E D I B L E VA L U E S

to

By John Burns October 2015

In my 26 years in the business, the price discount available to someone who is willing to commute has never been greater. As shown in the 6 following maps created by our consulting team, this discount occurs throughout the country.

IMPACT OF SOCIAL SHIFTS While the closer-in locations typically recover first after a downturn, the recovery in the outlying areas is taking much longer, and the price discount for those willing to commute is as big as ever. Two countervailing demographic shifts that make this trend even more interesting are: • Fewer drivers. Only 78% of 20–24 year olds today drive, compared to 93% in 1978. While I don’t have the stats for older buyers, suffice it to say that more households are opting not to own a car, and Uber will likely exacerbate this trend.

• More telecommuters. 26% of workers aged 26–45 report that they telecommute, which is 5% more than those aged 46–55 and 10% more than those aged 56–65. The Internet has clearly enabled more knowledge workers to live wherever they want, as evidenced in our own company by great employees who live in Green Bay, Utica, and Portsmouth. So why aren’t more people opting for affordable housing on the fringes?

KEY QUESTIONS This raises huge questions: 1. Price appreciation. Will the discounts associated with being further from the job centers return to normal, resulting in far more price appreciation in these outlying areas, or has there been a permanent shift where homes in the outlying areas will be valued at a greater than historical discount—or is the answer somewhere in between?

2. Construction volumes. This lack of “commuter demand” is one major reason why new home construction remains low, as most of the available developable land is on the urban fringes. If a permanent shift in relative value between cities has occurred, how big are the negative implications for new home construction volumes?

3. Homeownership. What are the implications for homeownership, as housing close to job centers remains quite expensive? From 1900 through 1945, the era before highway construction opened up the suburbs, US homeownership was 45%+/-. We should note that mortgage qualification was also far more difficult prior to 1945.

DRIVE UNTIL YOU QUALIFY There is an old industry saying that home buyers get in their car and drive until they can find the home they want in their price range. $1,000 in savings per mile used to be an industry rule of thumb. This “drive until you qualify” discount far exceeds the industry rule of thumb today. To show this, our consulting team calculated the values in various cities in comparison to their prior peak values.

1

CHICAGO

Along Chicago’s I-294 corridor, consultant Lance Ramella calculates that values in Deerfield have recovered to within 15% of prior peak pricing, with much less recovery all the way out to McHenry, where homes are priced 30% below peak.

The same is true along Chicago’s I-88 corridor, where Naperville has recovered to within 6% of peak pricing, yet more distant Aurora remains 34% below peak.

2

LOS ANGELES

In Los Angeles, where the entire county average is 11% below peak pricing, consultant Pete Reeb calculates Glendale has recovered to within 2% of peak, Santa Clarita has recovered to within 14%, and Palmdale remains 37% below peak.

Pete notes that similar ratios ring true throughout the Southland, where Carlsbad in San Diego County now exceeds prior peak by 2%, but Vista remains 11% below peak, and Ramona remains 22% below. In the Inland Empire, which feeds off Los Angeles, homes in Fontana remain 28% below peak, while distant Victorville remains 43% below peak.

3

WASHINGTON,DC

In the Washington, DC suburbs, consultant Dan Fulton calculates that homes in Arlington are 8% above prior peak, while Reston is 6% below peak, Ashburn is 16% below peak, and distant Winchester remains a whopping 29% below peak.

4

PHOENIX

In Phoenix, Ken Perlman notes that Chandler is 22% below peak, while more distant Casa Grande is still 34% below peak, and the City of Maricopa remains 43% below peak.

5

SEATTLE

In Seattle, Ken notes that homes in Bellevue now exceed the prior peak by 9%, while homes in more distant Renton remain 9% below peak, and homes in even more distant Tacoma remain 18% below peak.

6

SOUTHWEST FLORIDA

Even in traditional retirement areas, the distant communities have appreciated less. Consultant Lesley Deutch notes that home prices are still 16% below peak in Naples, but they are 29% below peak in Bonita Springs and 41% below peak in North Fort Myers.

CORRIDORS VARY Phoenix and Chicago are also great examples of markets where certain corridors or sides of town have recovered far more than others. Phoenix’s West Valley recovery lags greatly. Chicago’s I-88 Corridor has outperformed.

Consultant David Kalosis notes that in Atlanta the drive until you qualify phenomenon really starts from North Atlanta’s Golden Triangle and then fans out in all directions, with lot and home prices decreasing in proportion to school performance and overall desirability as you move outward from these key submarkets.

CONCLUSIONS While our research has shown that the outlying areas usually correct more in a downturn and take longer to recover, and while we also believe that a growing percentage of people prefer to live urban for many reasons, affordability still matters. Because of the very large price discount to relocate to outlying areas, we expect more price appreciation in outlying areas than in better locations, to varying degrees and with some exceptions that are too big to list in an email. If you are a business leader and have a specific inquiry, feel free to contact one of our 31 consulting team members about your project.

Methodology note: We used Zillow.com to calculate the values shown above, showing cities where we agree that Zillow’s estimate approximates the correct premium or discount from peak we have observed.

Building Products Companies Sitting Pretty

by John Burns September 2015

two questions: 1. Which is a bigger industry: new construction or remodeling?

2. How many $500 billion+ industries can say that they are almost certain to grow 30%, even if interest rates rise?

In a survey at our Summit conference in June, industry executives voted building product stocks as the best risk-adjusted future return. The building products companies are sitting pretty, looking forward to 30%+ growth in new home and apartment construction, which will allow new construction to eventually surpass the remodeling business. • New construction. At least 90% of forecasters, including us, believe residential construction will rise at least 30% to 1.5 million+ units because we can all count the number of young adults delaying household formation, and 1.5 million has long been considered a normal level of demand. While the timing will depend heavily on economic growth and interest rates, the demand clearly indicates that the $235 billion spent on new residential construction in the US last year will grow dramatically. • Remodeling. Spending on home repair and remodeling has been very difficult to count and forecast, but not anymore thanks to a new report we issued this month!

Repair and Remodeling spending should grow 7.8% in 2016, with strong growth thereafter. Barring a recession, we see little downside in the US Repair and

Remodeling industry, which totaled $266 billion last year. If mortgage rates rise, which would hurt new home construction, we believe remodeling will benefit as move-up home buyers stay in their existing home with a low-rate fixed mortgage and tap their home equity line to remodel instead of moving.

Thanks to VP Todd Tomalak, a 6-time winner of the Most Accurate Category Forecaster by the Chicago Federal Reserve and previously the Manager of Economic and Industry Analytics at Kohler Co., we have completed the first comprehensive forecast of US Repair and Remodeling done by anyone, ever (at least that we can find).

Others have forecast portions of the business but not all of it.

We separated out the 2.2% growth attributable to Natural Disaster (ND) spending in 2014 and have sliced and diced the industry multiple ways: • By tenant type: 72% Owner and 26% Renter • By project size: 43% Big Projects and 55% Small Projects • By labor and materials: 33% Professional Contractor Labor, 41% Materials Purchased by Contractors, and 26% Materials Purchased by DIYers (including ND)

2016 growth • • • • • • •

will consist of:

7.2% growth in Big Project Spending 10.0% Owner growth 3.8% Renter growth 8.6% growth in Small Project Spending 9.4% Owner growth 2.8% Renter growth 4.0% growth in Natural Disaster Spending if 2015 reaches normal spending levels

After much testing, Todd settled on 18 major industry drivers, and we developed assumptions for each. Some of them, such as demographic shifts, are easy to predict. Others have more uncertainty. If you are a large building products manufacturer, installer, or investor, please contact Todd Tomalak at ttomalak@realestateconsulting.com or in Wisconsin at (920) 373-6727 for more information. To subscribe to our research, please contact Lisa Marquis Jackson at lmjackson realestateconsulting.com or in Dallas at (214) 389-9003.

Immigration Changes Mean Serge in Construction Costs Home builders tend to assume construction costs will not rise because even if they do go up, home price increases will cover the cost increases.

This time might be different, as the dynamics surrounding home price and labor supply are very unrelated. Smart builders are putting big cost increase contingencies in their budgets, which makes land acquisition very challenging, as land sellers are not willing to drop prices.

With so much discussion today about the lack of construction labor, despite low levels of construction, and rising construction costs, I want to share some research from our Chief Demographer Chris Porter who projects household formations for us. Chris notes that there has been a 67% decline in immigration from Mexico, and there are 570,000 fewer Mexico-born construction workers than in 2007. We believe many of those 570,000 workers have likely returned to Mexico and will not return to the US construction industry because of: • • • • •

By John Burns September 2015

Significantly higher border patrol investments Acceleration in court-ordered deportations over the last 7 years Implementation of E-Verify technology by employers Arizona’s SB 1070 bill passing in 2010 Economic opportunity in Mexico

To be clear, we are not policy advocates and we are not taking any position on the controversial immigration issue. We just want our clients to realize that many of the 570,000 experienced, Mexico-born construction workers are not likely to return to the US construction industry. Our builder clients are already learning this on the job site today.

By John Burns | September 2015

INTRINSIC HOME VALUES:

Is Your Market Over- or Underpriced?

Is your market over- or underpriced? Here is a map of our over/underpriced conclusions today. We explain our methodology and the opportunities this creates below.

• Speculation based on appreciation expectations • Capital availability • Mortgage rates Knowing the intrinsic value helps executives put today’s home prices into perspective.

Intrinsic values also change over time as areas become more or less desirable. For example:

To answer this question for our clients, we have studied the ratio of housing costs / income over time in every major market in the country, considering everything we know about each market to determine what the long-term ratio of housing costs / income should be. We call this the Intrinsic ratio, named after the investment concept of intrinsic value that has long been trumpeted by Warren Buffett and many other longterm investors. The Intrinsic ratio helped us wave a yellow flag in the early 2000s and a green flag in 2011.

Assumptions Intrinsic value estimates require a long-term view with long-term assumptions, and our industry’s biggest assumption is what the longterm mortgage rate will be. We use 6.0%, which is lower than the historical average but much higher than today. Our goal is not to help consumers with the buy decision, nor to help short-term investors.

Intrinsic value analysis is designed to help long-term investors, such as those buying land to build a new home community or those investing in building products companies. Even if we conclude that homes are overpriced today assuming a 6.0% mortgage rate, the interest rate savings could still make it a great investment for a consumer.

Variations over Time Home values deviate throughout the housing cycle from their Intrinsic value for many reasons, most frequently due to: • Fluctuations in the economy

• San Francisco, CA has become permanently more expensive over time as it grew its economy and desirability and became much more supplyconstrained.

• Detroit, MI has become permanently less expensive over time as demand has fallen, most obviously evidenced by a declining population.

Variations by Market Our Intrinsic ratio conclusions range from a low of 15.0% in Detroit to a high of 65.0% in San Francisco. That means that over the long term the median-income household in the Detroit metro area should be able to buy the median-priced home using only 15% of their monthly income to pay for the mortgage, mortgage insurance, and property taxes*. Not surprisingly, homeownership is much higher in the Detroit metro market than in the San Francisco Bay Area, and the median-income household in the Bay Area cannot qualify to purchase the medianpriced home.

The chart on the following page shows the Intrinsic housing costs / income ratio for many of the major markets in the country.

Changing the definition of housing costs will change the percentages but not the conclusions nor the rankings from most expensive to least expensive. This is just one of many tools we use to help business executives make informed decisions.

Intrinsic Value Analysis Creates Opportunity While unsophisticated people might panic, and alarmists may scream “bubble” in a few markets, wise executives know that Intrinsic Value is really a measure of risk. They know that Intrinsic Value incorporates a longterm view, assuming mortgage rates over the long-term are 6.0%. With mortgage rates today below 4.0%, and the bond market projecting that rates will rise less than 1.0% over the next 3 years, there is no reason to panic. Here is what some of my smartest clients are doing: • Requiring higher investment hurdles in the overvalued markets than the undervalued markets, everything else being equal (which is rarely the case), * Metro division ** Combination of metro divisions Source: John Burns Real Estate Consulting, LLC (Pub: Sep-15) • Investing with a shorter term horizon than they did in 2012, • Structuring deals with partners who have a more optimistic view, particularly if those partners are willing to fund operations, • Shifting to deals that involve less cash and more option payments In past cycles, plenty of money was made after housing became overly expensive, and plenty of money was also lost, but the companies who had structured their balance sheet and joint ventures appropriately for the high risk stage of the cycle weathered the storm best, and took advantage of the downturn. Opportunities abound.

Some Facts Regarding

Today’s Changing Home Buyer

By John Burns September 2015

Let me summarize for you some of the key findings from an NAR report on home buyer and seller generational trends. So often, useful facts get lost in big reports.

Household Compositions

11% foreign born.

Consistent with our demographic findings that 23% of those born in the 1970s were born abroad and that foreign born buyers are less prone to purchase, foreign purchases are heavily skewed to those born in the 1970s. 17% of buyers aged 35– 49 are foreign born—nearly double the percentage of any other age cohort.

13% multigenerational living.

13% of buyers have multiple generations over the age of 18, with 21% of those buyers headed by someone aged in their 50s. This ties in nicely with our last Consumer Insights survey of more than 20K home shoppers, where 50% of those in their 50s said they planned on living multigenerationally, either with a parent or a child.

37% of multigenerational buyers had an adult child, while 21% of buyers had an aging parent.

73% couples.

Married people buy 65% of all homes sold, with unmarried couples buying 8%.

16% single women double the men.

65% childless.

Homes designed for adults rather than families make more sense, as 65% of all home buyers do not have children. Resale homes were primarily designed with families in mind.

Single women are almost twice as likely to buy as single men, purchasing 16% of all homes sold compared to 9% of all homes for single men.

After the age of 50, purchases by single females rise even more.

Changing Buying Habits • 43% finding their home online. 43% of buyers found the home they purchased online, ranging from 51% of those aged under 35 to 34% of those aged 60–68.

• 25%+ of Gen X and Gen Y buyers finding their home on their smartphone. More than half of Gen X and Gen Y used a mobile device in their search, and more than 25% found the home they purchased on their mobile device— meaning 75% did not.

• Bigger more important than smaller. Only 10% of buyers cited home size as the primary reason to move, with 7% wanting larger homes and 3% wanting a smaller home. We show more on this below.

• 70% suburban. Suburbs dominate, with suburbs including small towns capturing 70% of demand. This is consistent with our demographic findings, which also include a finding that urban has taken market share from suburban in the last 15 years.

Young Buyer Profile (under 35) • Mostly first-time buyers. Young buyers comprised 32% of all buyers, and 68% of the buyers under age 35 purchased their first home.

• Less desire to renovate. Younger buyers who chose a new home did so to avoid to renovation headaches, while older buyers (60+) were slightly more likely to be drawn to new homes by the amenities.

• Convenience trumps affordability. Consistent with our demographic findings that today’s young buyers value their time more than prior generations at the same age, young buyers buy for job convenience (74%), affordability (58%),

schools (44%) and parks (28%), in that order.

Older buyers placed far less importance on these factors.

• The down payment is the hurdle. »» High LTV required. 63% of young buyers put 10% or less down, and 45% put 5% or less down. Without FHA financing and a recovering mortgage insurance industry, this buyer would be almost extinct. »» 31% get help. 31% of young buyers received a gift or loan from a friend or relative. »» Student debt a big hurdle. Student debt was cited by 54% of young buyers as the biggest impediment to saving the down payment. We estimate that student debt resulted in 8% (414,000) fewer home sales in 2014 than would have been the case if debt levels were the same as in 2005.

Big Differences between MoveUp and Move-Down Buyers* Younger move-up buyers who mostly bought in 2009 or later are selling at a profit to buy a larger home, while older move-down buyers are cashing out to buy a less expensive, smaller home. The key stats by age are as follows: • Under 35: Owned prior home 5 years (2009) and purchased a 590 square foot larger home for $73,000 more than the home they sold.

• 35-49: Owned prior home 9 years (2005) and purchased a 450 square foot larger home for $69,000 more than the home they sold.

• 50-59: Owned prior home 11 years (2003) and purchased a 40 square foot smaller home for $9,000 less than the home they sold.

• 60-68: Owned prior home 13 years (2001) and purchased a 160 square foot smaller home for $13,000 less than the home they sold.

In summary, the US home buyer has become quite diversified, including a rising number of foreign born and far more DINK (double income, no kids) and single female home buyers than ever before.

Urban homes and homes closer to work have appreciated much faster, which our consulting team has verified in markets across the country.

High-LTV programs have played a huge role in the housing recovery. All of these factors combine to create great opportunities for entrepreneurs who understand their local markets and can respond to these increases in demand that cannot be met by the resale market.

*Our original analysis incorrectly interpreted Exhibit 6-13 in the report as profit made on the sale of a home, when it is actually the difference in price between the home purchased and the home sold.

Future Growth in

Southwest Florida: Outwards & Upwards

By Kristine Smale September 2015

Southwest Florida remains a retiree mecca, but rapid job and population growth is increasing family-buyer demand. Affordability is a concern; the median existing home prices in Naples hit $345,000, surpassing 2008 levels, and Fort Myers has had double-digit price appreciation over the past three years. So how does one region adequately serve the affluent retiree and the price-conscious family buyer?

Here are our predictions: High-rise development: Four new high-

rises are pre-selling along the Gulf Coast in Naples and Bonita Springs, totaling nearly 400 units to be delivered beginning in 2017.

Downtown Fort Myers, meanwhile, has one high-rise condominium announced, with others under discussion.

Small infill communities: Although

most land west of Interstate 75 has been developed, builders are getting creative.

Investments in infill communities on 10–20 acres of land are bringing homes to the market that command top dollar.

Multifamily is back: Lennar recently

opened two townhome communities in Fort Myers, and D.R. Horton’s Cordera, a luxury townhome community in Bonita Springs, has been overwhelmed by high demand.

(Although, when a 1,765-square-foot, threebed-three-bath unit with a two-car garage five miles from the beach has a price of $259,990, who can be surprised?)

Rural lands: Plenty of land remains available

for development in southwest Florida; the challenge lies in gaining approvals from environmentally sensitive local governments.

Minto has announced plans for 4,000 units in Rural Lands West (Eastern Collier County), where it has committed to preserving three acres of land for each acre developed. Also, the recent years’ success at Ave Maria in Eastern Collier County has boosted developers’ confidence.

Success Means Hiring (and Retaining) Workers Who Are Passionate, Likable, and Smart

By John Burns September 2015 We hire and retain “PALS”: the most Passionate, Articulate, Likable and Smart people we can find. We also help under-performers find employment elsewhere.

Most believe they qualify as PALS, but most do not, so let me elaborate.

P A

• Passionate: You love what you do. You think about work during your free time. You are constantly in pursuit of being better. You have a competitive streak in you to make your team the best it can be. You read on your own time, and make friends in the industry who share your passion. You probably exercise to the best of your ability because you are just as passionate about your health, and have other passions as well.

• Articulate: You get to the point. You start with a well-thought-out statement, and can back it with facts, orally as well as in writing. You look people in the eye and speak confidently without filler words like “you know” or “kind of.” You use pronouns carefully, and people rarely ask you to repeat something or misunderstand what you say.

L

• Likable: You are even-tempered, humble, and smile frequently. You know people’s names and care about them. You follow Dale Carnegie’s secrets of success. People look forward to seeing you and talk positively about you behind your back.

S

• Smart: You are what Howard Marks calls a second-level thinker, synthesizing a lot of complicated and conflicting information into a cogent conclusion. You aspire to Einstein’s definition of genius: “taking the complex and making it simple.” You relentlessly pursue what you don’t know. Everyone except you remarks how smart you are.

As you can tell, finding PALS is a difficult task. I am not sure I would hire myself.

I should change my title to CHO, Chief Hiring Officer. I believe the most successful companies hire the best people, giving them the tools and culture they need to be successful, and then getting out of their way. I am always on the lookout for great team members. We hire a very small percentage of the people we interview, and every 6 months we actively review every employee’s performance to make sure they are performing at the high level we expect. If not, we help them achieve success at our firm or elsewhere.

To determine how Smart they are, we often administer tests specific to that job, and we call references.

I find it very difficult to determine how smart someone is in an interview. Education or job history can be misleading, although I do find that the smartest people tend to have been promoted quickly, have rarely been laid off, and many attended top schools and pursued advanced degrees. I always ask a reference, “What would you tell them they should work on to advance their career?” That sounds so much better than asking their weaknesses, but it is the same thing.

Once we determine we would like to hire a candidate, the real process begins. To help with our determination of Passionate, Articulate and Likable, we ask candidates to take three online assessments to help us determine if they are a fit. Usually, the assessments bring clarity to something we identified in an interview, provide great questions and topics to pursue in the followup interview, and help both the candidate and us determine if this is the right fit for both of us. The assessments always seem to give us more confidence in the hiring decision, and we use them throughout an employees’ tenure to set goals. The three assessments we use are the Berke, Devine and DISC.

One of my goals every year is to end the year with a stronger team than we started. Jack Welch and Reed Hastings have influenced my thinking there. Counseling people out is just as important as hiring and retaining. Every time we counsel someone out, several people usually thank me and I can see morale pick up. Early in my career, I would not have understood that.

However, great people want to be proud of their company and to work with other great people, and take more pride in themselves and our firm when they see under-performers get counseled out. Try it sometime. It sounds harsh, but handled properly, the departing employee usually finds something that is a better fit for them. A win-win.

OWNING COSTS MORE THAN RENTING In most areas of the country, homeownership costs more than renting. Many economists with calculators claim the opposite, but the calculations and conclusions are often highly misleading. As is often the case, the devil is in the details.

We recently reviewed one highly publicized calculation that owning was cheaper than renting in almost all markets. That calculation had a number of outdated assumptions, including:

#1

#2

#3

Buyers put down 20%.

Buyers are in a 25% tax bracket and thus save 25% of their interest payment in taxes.

Future home price appreciation should be included in the ownversus-rent decision.

Today, half of all home buyers obtain a mortgage less than the median resale price of $236K, and 100% of the annual interest on that mortgage is less than the standard itemized deduction of $12K per couple, so many entrylevel buyers actually save ZERO dollars in taxes. Those that itemize likely only save a small percentage of the interest payment in taxes.

Most indices show that home prices have historically appreciated 1%–2% faster than incomes, but over a 30-year period of falling mortgage rates. Assuming you believe rates will rise or at least stay flat, price appreciation might be an aggressive assumption.

In reality, own versus rent is a first-time buyer decision, and the vast majority of firsttime buyers today make down payments of 10% or less.

Don’t get me wrong. We believe homeownership is a great long-term investment for those with stable employment.

It is just not less expensive than renting.

Not All Markets Are the Same

By Erik Franks August 2015

The premium homeowners pay to own versus rent varies across all cities. While the average US homeownership premium over renting is $146 per month, the premium varies widely: • In San Francisco, housing payments are over $2,500 more per month to own an entry-level home than to rent an apartment, which is also expensive. In San Jose, the gap is almost $1,800 per month! • In some markets in the Midwest and the Southeast, the monthly payments (excluding maintenance) are currently cheaper to own than rent. These areas are still extremely affordable, thanks to ultra-low mortgage rates and home prices that have increased over the past few years but not enough to return to their long-term average.

To the left is a chart of major US markets and the premium it costs to own versus rent as seen through the eyes of most first-time buyers.

We assume that the decision is between renting an apartment in a large apartment complex and buying a home valued at 80% of the median home price (a reasonable assumption for firsttime buyers) with a 95% LTV loan.

Conclusion Potential entry-level home buyers focus on saving a small down payment and affording the homeownership costs. They compare the monthly cost of renting to the monthly cost of owning, realizing that the owned home is usually much nicer than the rental and is thus more expensive.

If owning were truly cheaper than renting, far more renters would be buying homes. Never forget that headlines can be misleading.

By Lesley Deutch August 2015

Where Do We

Grow?

Palm Beach County’s housing market has always been constrained: geographically, with the Everglades to the West and Atlantic Ocean to the East, and affordability-wise, as median home prices continue to climb. With families moving down from the Northeast and Midwest for jobs and a better quality of life—an influx of retirees and second-home buyers are arriving every day—where do they all go? For those buying luxury homes (priced over $500,000), there is a plethora of options, ranging from Kolter’s new masterplan Alton to Seven Bridges by GL Homes or Palm Beach Polo by Toll Brothers.

But where does the buyer who has less than $500,000 to spend on a home choose to live? Here are our predictions for growth in the region:

1

West. For the first time in nearly a decade, Palm Beach County will see a masterplanned community with multiple builders in Arden, located west of Lion Country Safari on Southern Boulevard. While the location is considerably rural today, it is in the future path of growth. Additionally, Minto Communities has entitlements for a 4,500+ home community called Westlake in Loxahatchee, which will add to the western growth. GL Homes also is considering plans for its Indian Trails Grove Property—up to 4,000 units—north of Westlake.

2

St. Lucie. While St. Lucie is two counties north of Palm Beach, it is just a 45-minute commute to Palm Beach County (similar commute time as living in the western suburbs) and is welcoming to new housing development. Affordability is key: in the masterplan of Tradition of St. Lucie, a buyer can purchase a 2,300-square-foot new home for $260,000, nearly 55% less than a similarsized new home in Palm Beach County, on average. With over 65,000 entitled residential units in St. Lucie County, we expect significant growth due to its fantastic housing affordability.

BETTING ON CHINESE HOME BUYERS IN THE US Chinese home buyers comprise roughly 2% of US housing demand—and far more than that in the gateway metro areas with excellent airport access.

• According to the NAR, 16% of international home buyers come from China and spent $29 billion last year, surpassing Canada, which has fallen from 24% of foreign activity to 13%.

• CNBC reported that 39% of foreign buyers in Manhattan are Chinese, up from 12% last year.

Passenger travel to the US from Beijing has increased 141% in the last 5 years and has increased 127% from Shanghai.

• Of the 8 currencies we track for foreign buying activity, the Chinese currency is the only one that has held up against the dollar in the last year, and that just began changing last week.

• The Chinese economy has grown more than 800% in 14 years, clearly creating many millionaires along the way.

I live and work in Irvine,

By John Burns | August 2015

California, which many consider to be ground zero for Chinese new home investment in the United States. In addition to everything else great about living in America, Irvine has fantastic schools, many new homes (Chinese have a huge preference for new over resale), a very well established Chinese culture, and is within one hour of Los Angeles International Airport. Some of the new home communities we have worked on in Irvine have sold more than half of their homes to Chinese buyers, and I am being conservative here. Prices often exceed $1 million, and frequently there is no mortgage. CNBC recently featured Irvine in their story on Chinese home buyers.

Since 2006, when I had lunch with Peter Navarro, the bearish author of The Coming China Wars and Death by China, I have been carefully watching the impact of Chinese buyers on the US housing market, and specifically in Irvine. We have written two white papers on the topic, interviewed countless numbers of sales agents, hosted an intern whose family had just migrated here and bought a home in Irvine, and are now partnering with real estate brokerage Pacific Union in San Francisco on a research project to learn more. To give you an idea of the Chinese interest in California housing, we presented at Pacific Union’s annual housing outlook conference last year, which was broadcast live at three venues in China.

Chinese interest in US housing is not confined to California, as our consulting team has noticed Chinese home buying in areas served by all of the major airport

hubs. In South Florida, agents have been flying directly to China to compensate for declining demand from South America.

While the recent Chinese stock market correction has caused a decline in sales (one of my builder clients has noticed a sharp pullback, another just told me about a home sale cancellation specifically due to the buyer’s stock market losses, and one publicly traded home builder even mentioned the pullback on their earnings call.), our research has convinced us of tremendous Chinese demand to buy US real estate for their families and as investments.

Nonetheless, we remain very uncertain about the level of future Chinese home buying: • Is the number of people who can no longer afford to purchase a home after the stock market correction and currency devaluation greater or less than the number of people who will be encouraged to buy here by the stock market and currency instability?

• How real is the economic growth, and is there underlying debt (as reported by the Wall Street Journal in December) that could cause Chinese wealth to unravel?

• Will the government lift the $50,000 annual overseas investment cap later this year as anticipated, which could cause a flood of Chinese investment in US housing?

We don’t know the answer to any of these questions, but the future success of many new home communities depends on the answer. If you have some particular insight based on your knowledge of China, please let us know. We are constantly in search of new and better information.

FOCUS ON THE MORTGAGE PAYMENT TO SELL MORE HOMES

By Dan Fulton | August 2015

Thanks to low mortgage rates, the monthly costs of homeownership in the Washington, DC MSA are among the lowest in the last three decades. If rates rise, as the bond market seems to suggest will happen, and prices and incomes rise as we forecast, affordability will return to normal three years from now. Buyers should really be buying now.

Falling interest rates, rising incomes, and relatively flat home prices, have increased affordability in the MSA over the last two years. Affordability now stands at a near-historical low of 1.3. (The cheapest time in 30 years would be 0.)

What are the appropriate strategies for a home builder during a time of historical affordability?

• Short-term: Promote low monthly payments and the impact that rising interest rates will have on home shoppers’ monthly housing costs—a 1% rise in interest rates equals a 12% rise in monthly payment.

• Long-term: Focus on the Millennials, who have been noticeably reluctant to buy a home in recent years, and consider how you will price and sell your homes if rates rise. We have been working with builders to identify cost-conscious home designs that will target this market successfully.

For more information on the other key forecasts we track every month and the full complement of our research and consulting services, please contact Dan Fulton at (703) 447-7171, Rosemary deButts at (703) 955-3487, or Melissa Jonas at (703) 244-5229.

Affordable Florida Housing Markets Take Off Lesley Deutch | August 2015 Price-conscious Florida home buyers of all ages have recently created mini-booms in the most affordable suburbs and rural areas.

Affordability in the Suburbs Sales have increased recently in communities within a 45 minute to 1 hour commute to major employment centers. Watch for growth in: • Lake County (Orlando MSA). In the city of Leesburg, a buyer can purchase a new 3,186-squarefoot home for $206,000.

• Osceola County (Orlando MSA). The first-time home buyer market is booming, with numerous additions to supply.

• Pasco County (Tampa MSA). Many of the masterplanned communities started in 2006–2008 have been reborn, with an influx of new builders offering affordable homes for the primary buyer.

• Fort Myers (Fort Myers MSA). D.R. Horton is selling over 10 homes per month at Lindsford, located in Fort Myers. Buyers are attracted to the community’s affordability and maintenance-free lifestyle.

Creating a Place in Rural Areas Targeting the retiree buyer, builders and developers are planning and creating affordable retirement destinations across the state. These communities may be far from urban centers, but retirees are willing to trade location for affordability. Watch for growth in: • Marion County (Ocala MSA). 3 large-scale, fully amenitized active adult communities are open for sale, and more are in the pipeline.

• Charlotte County (Punta Gorda MSA). Air traffic at Charlotte Airport increased 88% in 2014.

• Manatee County (Sarasota/Tampa MSA). Manatee County is bursting with new developments, particularly in Lakewood Ranch, where Del Webb is opening a 1,300-unit age-restricted community, and Lennar is eyeing a large parcel for a 2,000-unit bundled golf community.

• Indian River County (Vero Beach MSA). A 400-unit active adult community recently opened for sale in this MSA, which only had 676 permits over the last 12 months.

• St. Lucie County (Port St. Lucie MSA). An active adult builder has consistently sold 10+ homes per month in one community.

These markets may not be the most well known, but we are seeing examples of success in each of these markets across the state.

A New Opportunity T O B U I L D D E TAC H E D HOMES FOR RENT

By John Burns August 2015

10% of Housing Demand Builders and developers will now start building more detached homes for rent. For years, home builders have ignored 10% of housing demand, allowing resale homes to fill the demand. As shown below, 12.7 million of today’s 120 million households rent a detached home.

29% of Rental Demand 44.3 million US rental households occupy:

• 15.5 million individually owned rentals »» 12.7 million detached homes (29%) »» 2.8 million condominiums and townhomes

• 26.8 apartment buildings »» 13.2 million units in small apartment buildings (less than 10 units) »» 13.6 million units in larger apartment buildings (10+ units)

• 2.0 million mobile homes, boats, etc.

Historically a Mom and Pop Business The 12.7 million detached home renters have largely been ignored by builders and developers for years as both supply and demand steadily grew over many decades.

The vast majority of the growth of individually owned rental homes has historically come from households who lived in the home before relocating and decided to continue owning and renting the home rather than selling it. Approximately 54% of the landlords of single-family rental homes own only one home, per RentRange.

Detached Rentals in Masterplans We have noted that even actively selling masterplans, despite not building singlefamily homes for rent, have a significant number of singlefamily renters. Just go into Zillow and look for yourself.

The proactive developers are now looking to develop these neighborhoods and homes themselves, rather than letting others meet the demand.

Our research, which we confirmed with the CEOs of several of the institutional investors, shows that these renters live in detached

homes primarily because that is the preferred lifestyle. Most of them did not even consider renting an apartment. They prefer to live in a detached home and are renting either because of: 1. Necessity. They do not have the ability to qualify for a mortgage.

2. Flexibility. They choose to rent to maintain the flexibility to move.

3. Choice. They would rather spend what they earn today than save for a down payment.

Thus, single-family rental home competes more with the detached resale and new home market than with apartments.

Clearly, there is a subset of renters who will pay a premium to rent new, as evidenced by the 200K+ apartment units that are built and leased every year. If it works for apartment developers, why has there not been much attempt to build single-family homes for rent? Those days are now ending.

Seizing the Opportunity Here come the home builders, seizing the opportunity to build single-family detached homes to be sold to professional investors or to manage themselves. Consider the following: • Starwood Waypoint, an owner of 16,000+/rental homes, has worked with 12 builders to buy homes from them. While they have often bought the slowest selling floor plan or the last few homes in a community, they are now actively pursuing new subdivisions in areas where they currently operate. Their CEO recently told me that their business has shifted dramatically in the last few years, with only 25%+/- of their tenants now having gone through foreclosure, versus 50%+ a few years ago.

• The CEO of American Residential Properties shared at our recent client conference that their tenant profile has shifted as well, with new leases typically to young families with

more than enough income to buy but who are choosing to rent primarily to have the flexibility to move.

• Masterplan developers have taken notice. Bob Sharpe, the owner of Rancho Sahuarita in Tucson, surveyed his 5,500 home community and found that renters occupy 22% of the individually-owned homes. With 4,000 homes left to sell, why not build and rent homes to this group, many of whom will buy homes in the future?

• Lennar has been a pioneer in detached subdivisions for rent with their Frontera community in a suburb of Reno Nevada. Rents for 1,210- to 2,182-square-foot homes range from $1499 to $1999 per month, or $0.92 to $1.20 per square foot, per apartmentguide.com.

While Lennar also runs an apartment company, they acknowledged that the management complexities are very different. Lennar’s CEO recently noted that “it’s a pretty exciting opportunity for our company…and we’re probably going to launch another one or two as part of our evaluation as we go forward.”

Drop the Stigma There remains a stigma that renters are not as good for the neighborhood as owners. From personal experience in my own neighborhood, as well as Census data, I can testify that they certainly move more often—and that they have always been great neighbors and their homes have been very well maintained.

Conclusion Last year, approximately 25,000 detached homes were built for rent. We believe that number will increase significantly over the next several years.

We expect detached homes for rent to become an important segmentation opportunity for the top masterplans in the country, who will no longer ignore 10% of housing demand.

California’s

Housing Costs to Income Ratios

By Adam Artunian July 2015

California has always been expensive, and it is getting even more expensive as buyers from all over the world flock to the Golden State. Even considering today’s low mortgage rates, the ratio of monthly housing costs (which include mortgage, PMI, taxes, and insurance) to income is getting quite high in certain markets.

The housing costs to income ratio has recently surpassed the historical average in most major California markets, even with record low mortgage rates.

First-time home buyers are particularly sensitive to this ratio, as this buyer demographic is generally more payment sensitive than move-up or retiree segments.

The chart below shows the housing costs to income ratio since 1985 in the major California markets.

The ratio in the major Southern California coastal markets hovered around 35% during the mid-tolate1990s, when mortgage rates ranged from 7%–9%.

The ratio more than doubled over the following eight years, reaching 70%–85% at the market peak in 2007.

The current ratio for these markets is approximately 50%, which is above the historical average for these markets and equivalent to levels seen in 2003–2004.

The same trend can been seen in Northern California markets. Only Sacramento and the Inland Empire remain affordable, at 30% of the median household income.

Although affordability is currently only slightly worse than the historical average, elevated housing costs to income ratios in a rising interest rate environment exposes these markets to considerable risk if mortgage rates rise. This is especially true if wage growth remains somewhat stagnant.

Pro Forma Payments & Incomes We advise all of our clients to note the monthly housing costs and median incomes they are assuming in their pro forma spreadsheets. As rates and incomes change, this will help our clients identify when the target home buyer can afford more or less home than originally thought.

* We calculate the housing costs to income ratio by dividing the market’s median monthly housing costs by the median income. We consider housing costs as 95% LTV; PITI plus mortgage insurance payment assumes purchase of home at 80% of the median-priced existing home

Source: John Burns Real Estate Consulting, LLC

Don’t Let the

Drought Dry Up Your Sales

When shopping for a new home, buyers have a new concern to add to their list: For a copy of our paper on the California drought or consulting assistance, contact Dean Wehrli, our Northern California Consulting Senior Vice President with 16 years of market research consulting experience.

By Dean Wehrli | July 2015

• • • •

How are the schools?

Is the area nice?

Is there retail nearby?

Will I have water?

Maybe.

Water has become the issue du jour in California.

In the new home world, water is changing how we do business. Homes are becoming more water efficient and communities less water reliant. Here we tackle the issue of sales. Can the drought have a real impact on new home sales?

New Home Sales Pre- and Post-Water Story

Fortunately—or unfortunately, depending on your point of view—we have a recent test case to examine this. Mountain House is the 35th-largest masterplan in the country, located in the City of Tracy, just across the Alameda County line, and fueled by strong San Francisco Bay Area demand. Mountain House is an attractive community with excellent sales in the last few years.

many of these agents did not believe water was the overwhelming issue, the data speak otherwise.

Then the local media began reporting the Great Mountain House Water Scare of 2015. The local water agency that supplied Mountain House was going to be forced to cut back due to new state restrictions and could only guarantee water for Mountain House for another week. Cue imagery of dry taps and dead lawns.

Still, some damage, however temporary, has been done.

The thought is now in the heads’ of prospective home buyers—if I buy at Mountain House can I be sure I will have water? While most developers have a reasonably certain water supply, this psychology is concerning.

Such an event can happen anywhere in California, and even the hint of water insecurity could have an impact.

A prolonged event would undoubtedly slow pricing as well as sales.

The potential impact of this mini media buzz was obvious—would this story quash sales at Mountain House due to home buyer worries about water? This was not just green lawns and blue pools. It was bathing and drinking.

The table above displays Mountain House and City of Tracy net sales for the three weeks prior to this story and the three weeks after. Many buyers shopping Mountain House, we surmised, might conflate the two communities and believe a similar waterless fate hung over Tracy too in a kind of guilt-by-association effect. Lastly, we show data for River Islands, a new masterplan in nearby Lathrop that approximates the appeal of Mountain House and has sold more than 200 homes in the last year. The River Islands data are included to test whether or not any sales impact was due to normal seasonality.

The results are clear. Mountain House was hammered by the water scare. Sales dropped 70% in the immediate period after the water scare story, while sales in Tracy decreased almost as much. Meanwhile, sales at River Islands dropped only marginally, and most likely due to seasonality than due to water. Discussions with sales agents at a variety of these neighborhoods indicate that at both Mountain House and Tracy buyers expressed concerns about the water situation. Though

The good news is the impact seems to already be dissipating. The state has backed off some of its potential restrictions, and Mountain House developers have, at least for the near-term, secured a water supply. Pricing has remained stable.

So, what do we do?

• Lock down water rights. Fairfield, a community in the Bay Area, recently trumpeted its relatively plentiful water supply. Water should be one of the first due diligence questions.

• Train on water. Buyers will be suspicious if the water issue becomes particularly buzzworthy in your area. Train staff to be ready for water questions. While the drought is regional, access to water is very local.

• Market water. Understand that water is as important as price and schools and product. This means you can market your water rights—“We have water!” Since almost all new homes are more water efficient than resales, market lower water bills just like you would lower energy bills for energy-efficient homes. Maybe even “go on the offensive” by reminding buyers that new homes are far more water efficient than resale homes.

The longer the drought lasts, the greater the chance of further water insecurity. For a copy of our paper on the California drought or consulting assistance, contact Dean Wehrli, our Northern California Consulting Senior Vice President with 16 years of market research consulting experience.

Landlords Encouraging Renters to Move By

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Rents in the highest-quality apartments rose 4.4% last year, including an 8.0% jump in one West Coast portfolio. With a very high occupancy level (95.8%) and job growth exceeding construction levels in almost every major market in the country, landlords will continue to raise rents throughout the remainder of the year.

While the number of tenants leaving to buy homes remains low—only 14.7% of renters moving versus a norm of 17% since 2002—we believe more tenants will choose to become homeowners soon. The table and chart come from a report we prepare that compiles the results of the publicly traded apartment REITs. We find this to be the most pertinent rental market data for home sales because these represent hundreds of thousands of high-income renters.

In summary, $70+ per month rent hikes are a great kick in the pants to go buy a home if you have been thinking about buying a home anyway.

We expect the landlords to keep raising rents aggressively until they start to hurt their own occupancy numbers.