Impact of Cycles on Housing Profitability

Aggressive Bidding for Land

At this point in the housing market cycle, aggressive bidding for land is commonplace. Without double-digit home price inflation, cost overruns can wipe out profits. In some recent cases, site development cost overruns have created substantial losses for aggressive homebuilders.

How many investors and homebuilders are taking a serious look at realistic forecasts of the future? Are they considering whether land acquisitions make sense without home price appreciation? Are they including an adequate budget for contingency factors in their costs?

Forward-Looking Strategies

Even mild real estate cycles can be very damaging, particularly when they take a company by surprise (a common occurrence at the end of every housing boom). But it is possible to take advantage of the cycles, with an ongoing, sophisticated, professional approach to planning for the future.

The late 1980s/early 1990s boom-bust cycle make a good case study. Using the clarity of 20-20 hindsight, an optimal strategy is readily apparent:

1. Stop making major land purchases in 1987
2. Land-bank only enough lots to last through 1989
3. At the tail-end of the boom (beginning early 1989) only take down small phases of lots, and only pay prices that reflect the current market (do not assume future price increases)
4. Create a war-chest of cash that allow vulture purchases of finished lots during the distressed market that follows
5. As the market rebounds, begin buying paper lots (raw entitled land)

Investors and homebuilders that followed this simple strategy during the last boom/bust cycle enjoyed spectacular profits during the mid-1990s. How did they anticipate the real estate cycle?

Anticipating Cycles

Buying a home is the single largest purchase decision most people will ever make. This makes it subject to wide swings in demand. Factors such as interest rates, affordability, consumer confidence, job creation and population migration can cause rapid changes in housing market conditions.

Despite the apparent staying power of this new knowledge-based economy, business cycles are likely to continue in the future in some form. As job growth and interest rates fluctuate, it is inevitable that the economics of buying land and selling homes will change for the better or for the worse. Investors and homebuilders who anticipate and capitalize on the cycles, rather than falling victim to them, will enjoy long-term prosperity.

Systematic Tracking of Cycles

Ongoing monitoring of business and real estate cycles at a regional level should consider the following:

- Interest rates

- Job growth rates

- Types of jobs added

- Movement of jobs between regions

- Regional competitiveness

- Consumer confidence

- Income growth

- Population growth

- Household formation rates

- Pent-up demand

- Apartment vacancy rates

- Apartment rent trends

- Home price appreciation

- Home equity levels

- Consumer debt levels

- Housing supply levels

- Entitled land levels

- Pipeline of new entitlements

- Development constraints

Anticipating the future requires a combination of business wisdom and well-organized data. Periodic strategy meetings to review key trends in housing market factors can go a long way towards giving investors and homebuilders a competitive edge. Becoming aware of subtle shifts can make you first to predict major shifts, which will lead to enhanced long-term profitability during changing economic and market environments.