Even though we’re only half way through the year, some are already calling the game in favor of home builders. According to a recent article that appeared in HousingWire, home builders will win real estate this year.
To this, I say, “maybe.”
The publication shared a story about Pennsylvania-based Toll Brothers and Florida-headquartered Lennar, two of the nation’s largest homebuilders, going together on the acquisition of 173 acres of land in California, which had formerly been an old field. Together they plan to build 1,200 homes on land that the seller assures them will not be built over “abandoned oil wells.”
Five years ago a story like this would have been met with righteous anger. We know this because a few years back when shale gas drillers moved into Pennsylvania, consumers rose up and filed suit. The Grand Jury’s report to the court ultimately held that the state Department of Environmental Protection failed to protect the public’s health.
It turns out that when you punch a hole down through the bedrock in search of oil or natural gas, you run the risk of polluting the aquifer that provides drinking water to area homeowners.
But we didn’t hear those concerns in California. And that’s the first reason home builders might be the big winners in 2021. Lack of housing inventory is pushing these concerns into the background…for now.
But there’s another reason that homebuilders might win real estate by year end and that has to do with lumber prices. After surging to record highs this year, lumber prices finally started dropping in June. When they fell, they fell hard.
As soon as the vaccine started to roll out across the country, the do-it-yourselfers who had been buying every board foot they could find at Home Depot suddenly were able to get out of the house and back to real life. As a result, the composite index compiled by Random Lengths fell by 50%. Lumber futures tanked by more than 40% in June.
This is great news for builders because the cost of a new home never falls as fast in the wake of falling lumber prices as it rose when material costs increased. In the short term, we expect builders to see significantly higher profit margins. That will normalize over time, but probably not before the end of the year as many new homes are already in production.
On the other hand
But even with all of this, there are still some risks for home builders. First, the end of COVID may impact demand for new homes in some areas. When everyone was working from home without the need to drive into the office, they were free to live wherever they wanted. This prompted more to look outside of city limits and increased demand in new neighborhoods.
But now that more companies are starting to call their employees back to the office that could change. Builders that invested in large tracts of land may be facing increased risk if demand for homes further from corporate offices falls off.
Secondly, builders have higher profit margins on larger, more expensive homes, but the highest demand is still for smaller homes suitable for first-time home buyers. Unfortunately, the margin builders earn on those homes is not nearly as high. They can continue to build bigger homes, but the risk is that they will be harder to sell.
But whether lenders win or not in 2021, the lenders who can work with them to provide mortgage financing probably can’t lose.
The real winners could be the lenders
There are many challenges for lenders intent on working with home builders. For one, many builders have captive relationships with lenders or own their own mortgage division. For another, independent mortgage bankers will have much more difficulty working with builders than depositories. But there are plenty of community banks and credit unions who could make great partners for home builders, to say nothing of the nation’s largest banks.
To be successful, the lender needs to have a focus on construction lending and not just mortgage lending, as that’s where the relationship starts. It might start even sooner than that with a commercial loan to purchase the tract of land for the subdivision.
This means getting in with the builder early and being an active participant in the development from the very beginning. It’s a long term play, but institutions that can do it will also be big winners by the time 2021 is over.
By Joe Camerieri, EVP, Client Account Management at Mortgage Cadence
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