ULI Fall 2009 Meeting Highlights

Just returned from the ULI Fall meeting in San Francisco. The event was well attended by approximately 6000 real estate professionals. Speakers included a wide range of experts such as Ivy Zelman (a leading research consultant on homebuilding), Ron Terwilliger (retiring Chairman of Trammell Crow Residential) and Bill Emmott (Editor in Chief at The Economist). If I had to summarize what I heard in two words it would be “jobs creation” as the key to a sustainable recovery. Here are the quick takeaways:

The Economy

• Non-performing loans continue to rise, trailed by a similar amount of loans “at risk” due to slow/no payment.
• Inflation will rise from 1% to as high as 3-5% in the next five years.
• Of the thousands of ULI professionals surveyed during the Fall meeting, 65% feel the recovery will be a “broken W”... meaning a long trend line of improvement on the back side.
• Some of the positive rebound we’re seeing could be due to recovery from an over-correction of the markets, stemming from last year’s panic. Companies rushed into cutbacks in starts, staffing and budgets to counter the situation and quite possibly– cut too deep.

Unemployment

• We’ve lost 8mm jobs over the last two years. It is critical to the recovery that we have a public policy that fosters jobs creation. Buy-side programs like Cash for Clunkers and the current tax credits for home purchases, while helpful, will not sustain a recovery over the haul; reducing unemployment will.
• A significant portion of the unemployed will not be re-hired into the same roles. Instead, new roles are likely to emerge over the next three years that may not exist today.
• It will be late 2013 to early 2014 before full employment recovery occurs.
• The good news: we still have over 100 million people who are employed and need places to live. While they may be more cautious now with their buying decisions, it doesn’t replace the fact they still have needs. For several years now the American consumer has lived beyond his means and now must pay the bill. The days of consumers buying on a lark or without making comparisons are long gone– which most experts agree is not necessarily a bad thing.
• Recommendation: train your salespeople to diligently counsel buyers, arming them with convincing data on why it is in their interests to buy now vs. later. Salespeople should be experts on every facet of homeownership, tax credits available and mortgage programs.

Residential leads the Recovery

• Housing was the first sector to take the hit and will be the first out to lead a recovery. Extension and expansion of tax credits certainly helps, but once again “jobs” are the key to sustaining a long term housing recovery.
• Equally important is the ability for builders to obtain AD&C financing, especially for the local and regional builders. The public builders left standing have far greater resources and can afford to sell at near break-even margins in order to ride out the downturn. This places significant pressure on the smaller private builders, who absorb higher costs across the board but are unable to recover those costs through higher pricing.
• Expect the public builders to aggressively buy-up the majority of finished lot inventory in major markets– even if they already have ample land on their balance sheet. Strategy will be to sit on any raw land on the books and hold for long term recovery while building out newly purchase finished lot inventory. This too will put additional pressure on local and regional builders who lack similar resources.
• In spite of the bleak economic news, demand for housing will remain. Expect a 13% increase in housing starts in 2010 and higher numbers in 2011 and 2012.
• Recommendation: Smaller builders need to demonstrate a unique selling proposition to the customer in order to counter price differentiation with the big builders. Higher grade amenities alone may not accomplish this due to appraisal difficulties (more on that later).

The Lender Side

• Government sponsored financing at both the consumer and banking level, has “bought” us some of the recovery.
• Moving forward, two options appear to exist: Option 1. The more government aid is utilized to bolster banks, the longer the recovery process will be– albeit with less pain. Option 2. The sooner foreclosures are dumped on the market the faster recovery will occur– accompanied by more immediate pain and bank closures.
• 5.6 million mortgages are in imminent foreclosure or "at risk", meaning 60 days past due. If all of them reach foreclosure, home ownership will drop to 63%. This is no longer a sub-prime issue, as 41% of these mortgages are prime, non-jumbo loans.
• In spite of the government sponsored modification program, only 9% of delinquent loans reach that process.
• Bank failures will increase as the Fed becomes more confident in the economy and therefore, less willing to extend support.
• As more banks fail, the FDIC will struggle to absorb the losses and will require additional governmental support.
• Problems with commercial real estate loans are just now beginning. (The graph one economist used to show the potential debt “at risk” was downright shocking; imagine a trend line that shoots straight up in one year– in this case, 2010.) This becomes a potential cancer on the balance sheets of banks; whether or not the cancer is curable will vary with each patient.
• Pension Funds and Insurance Companies are in better shape and should recover slowly over the coming year.
• Whatever the timeline is for recovery, some banks will opt-out of real estate lending altogether or, limit their loan portfolio to projects with shorter time lines for completion. Speculative projects or those early in the entitlement and planning process will have a much more difficult time getting funded– banks will foresee too much potential for problems before build-out.
• Recommendation: builders with should approach their lenders with multiple solutions in hand. Don’t wait on them to help you figure it out.
• Recommendation: offer to help lenders workout their other problem projects, either on a fee basis or as help-in-kind. This might also give you the inside track on short sell opportunities.
• Recommendation: of the deals considered for acquisition, avoid the ones requiring preliminary approvals or which required significant debt commitments. Look for the “A” projects further along in their life cycle so you can hit the ground running.

Appraisal Challenges

• New appraisal processes are stripping new home values of value-added features such as lot premiums. Instead, appraisals are being made on a strict price per square foot basis without much consideration for upgrades or lot premiums.
• Recommendation: Builders must rethink their pricing structure if their product or community relies on upgrades or lot premiums as a profit tool. Simply put, the new appraisal environment focuses heavily on straight price per square foot formulas.