A tale of two cities for the homebuilding industry

The Charles Dickens classic novel, A Tale of Two Cities, is set in London and Paris before and during the French Revolution. With well over 200 million copies sold, it is the most printed original English book, and among the most famous works of fiction.  The opening passage from that book, “It was the best of times, the worst of times, the age of wisdom and the age of foolishness” is certainly valid today for real estate, residential development and homebuilding.

 I offer for your consideration a modern although abbreviated Tale of Two Cities, a story of residential development set in two American locales in 2010.  While certainly not places as famous as Paris or London, they are, I believe, representative of housing markets across the country and demonstrate what can and should be done (or alternatively not done) to deal with the realities of the homebuilding industry and the housing markets today.

 In the first city, one of the most challenged housing markets in the country, a high rise condominium developer found that values had decreased by 46% and were unlikely to recover for several years.  With substantial standing inventory remaining and unwilling to simply “walk away” from either his banking partner, with whom he had established a long-term and previously mutually beneficial relationship, or his buyers, who had invested in his vision, he created a strategy to maximize value.

 He thoroughly researched the market to determine realistic competitive housing values and the likely timetable necessary for a market recovery and then created a realistic program to maximize values.  Recognizing that his lending partner had at least an equal stake in the success of the development, he proactively reached out to his bank and presented the facts and his program as a basis for renegotiating the terms of his financing to provide the time necessary to implement the required strategy. 

There was little likelihood that sales would be made at an acceptable rate in the short term even with prices that had been correctly “marked to market”.  The natural potential buyers were unable to sell their existing homes at pricing that they found acceptable and there were no other viable markets to replace them.  In fact, it would probably be two to three years before the market had truly adjusted to the realities of the new housing values.  With the constant barrage of negative publicity regarding home foreclosures in general and, specifically, the extra challenges facing condominium purchasers, it was unlikely that consumer confidence would return either.  While the renegotiated financing provided adequate time for the market to return, a more than half empty condominium development would soon develop an aura of failure that would further challenge further sales and values and could not be permitted.  

The strategy created was both logical and viable – rent the vacant inventory for the interim;  a simple solution but one that required professional implementation to succeed.  If successful, it would provide income to cover the carrying costs until the market had recovered while both eliminating the perception of a “failed” development from the market and, more importantly, filling the residences with predisposed prospective purchasers who had become accustomed to living there. 

The existing purchasers had to be educated to the benefits of the program to gain their enthusiastic support.   The rental rates had to be sufficient, equivalent to the cost of ownership, so that the tenants were both qualified and financially predisposed to eventual purchase.  The rental program had to be independent of an ongoing and reinvigorated sales program so that the naturally occurring limited sales could still occur for the short term. 

This developer did it all correctly, starting with the recognition that research and strategy must be constantly updated to reflect changes in the market.  Sales have continued, the building is now 90%+ occupied and positioned to sell out when the market returns.  And this developer, operating in what is certainly not an optimal environment, made it an age of wisdom and the best of times.

In the second city, an average “middle of the country” market, home sales had slowed by 40% and prices had declined by 25%. The housing product was single family homes, certainly less challenged than condominiums, but the specifics of the development had provided their own challenges as the builder had failed to do any initial research and had created his “dream” of a development which unfortunately bore little resemblance to the reality of what the market wanted or could afford.  The homes were seriously overpriced for the market, failed to reflect the specifics of the development’s location and had noticeable design flaws.  After the first year of operation, no homes had been sold and the substantial speculative inventory was showing its age.

Instead of recognizing any problem, this homebuilder was apparently content to continue on his path to destruction until his lender stepped in and forced him to bring in outside assistance.  A complete market analysis was prepared together with a strategy to market the development and the program was implemented over the vocal objections of the builder.  Prices were adjusted to the market (in some cases with substantial reductions), enhancements were added, a new sales team was installed and the overall marketing was restructured.  And within the next year, thirty-seven homes were sold. 

The builder saw this “success” as a validation of his initial concept so he proceeded to begin design of another housing product and raised prices, Two months later he attempted to implement yet another price increase which he justified to his lender and sales team by circulating a news story summarizing the latest month’s MLS sales report which showed that for that specific month average prices had increased slightly over the prior month. 

Unfortunately, the builder did not perform anywhere near a thorough market analysis or he would have realized that he had incorrectly interpreted that single month’s data; proper analysis of the data utilizing the sales for the year to date actually showed the market was deteriorating further.  The inventory of unsold homes was increasing to well over a one year’s supply while both median and mean pricing reflected significant continuing declines in value.  Instead of showing any improvement whatsoever, the correct data indicated that the housing market was visibly deteriorating and, when adjusted for the fact that the tax credit had boosted sales in the early part of the year, that deterioration was significant.

The first price increase, implemented against the advice of his sales team, effectively killed sales.  Realtor® traffic, vital to success in this market, had previously been growing and generating a significant component of the sales but since declined by 75%.   And in the face of the second price increase the lender was forced to step in again, this time taking control of the property.

This builder did not do anything correctly and, as a result, is no longer involved in the community.  The age of foolishness does not work in the homebuilding business and resulted in the obvious and only possible conclusion of creating the worst of times for all parties involved.

It appears that Dickens was not only a great author but also prophetic about the housing industry for this truly is “the best of times, the worst of times, the age of wisdom and the age of foolishness” for homebuilding, depending upon the builder or developer’s course of action.  Every development, every community, every real estate investment must continually be reexamined on a “zero base budget” format, determining what is the best that can be done today under the current real world conditions and the most likely future occurrences.  Proper and thorough research and analysis will lead to the best strategy (the age of reason) and professional implementation will lead to success (the best of times) while ignoring reality and living in one’s dreams and wishes will create the opposite.  Let us hope that the homebuilding community chooses to make this “the spring of hope” and not the “winter of despair.”  But that’s just my opinion.

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