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Rebuilding the housing sector

By Mark Green

Cover shutterstock_2612125Kentucky’s housing sector is showing signs of recovery after a five-year recession, with home sales, prices and new construction all rising solidly the past six to 12 months, especially in the larger markets.

The mood in the housing industry is improving with the nice increase in construction numbers. However, the current upturn began from the deepest hole in decades, and it will be 2015 or 2016 or even 2017 before Kentucky home construction activity grows back to what is considered “normal,” according to industry and economic experts.

The four- to five-year period after the financial bust in late 2008 was “an absolute housing depression,” said Brian Miller, executive director of the Northern Kentucky Association of Homebuilders. “So many people have never lived through something like this.”

Rejuvenation of the housing industry should mean that an economy technically in recovery since late 2009 will also finally generate jobs a noticeable number of jobs.

Home construction permits are up 33 percent year to date across the state through August. That’s long-awaited good news for Kentucky’s public and private sectors alike because housing activity affects so many areas of the economy. It creates jobs across the entire economy and is a major generator of tax dollars for local, state and federal governments.

U.S. housing metrics are quite positive, too, with building permit issuance up 20 percent this year, according to the National Association of Home Builders.

Housing’s recovery “will be the rising tide that raises all ships,” said Greg Harkenrider, deputy executive director for financial analysis in the Governor’s Office for Economic Analysis. “I think everybody right now is looking at housing.”

The collective mood is definitely improving and homebuilders are hiring, but they are doing so slowly because it is only the most cautious operators who are still in business today, said David Crowe, chief economist and senior vice president at the National Association of Home Builders. Chastened by five lean and difficult years, they remain gun shy of investing in “spec” homes – those built on a speculation basis before a buyer is lined up.

Housing builds private wealth, public revenues

Housing sector activity, said Crowe, represents 17 percent of the overall economy, which is just more than a sixth of U.S. GDP. The sector’s overheated collapse in late 2008 is credited with producing the worst economic conditions since the Great Depression. A housing recovery would mean growth, jobs and wealth creation.

constructionEmployment levels and tax revenues rise and fall with housing activity, Crowe explained. According to NAHB measures, each house built generates three jobs and a total of $90,000 in local, state and federal taxes.

This means that as Kentucky’s annual home building permits spiraled down from an overstimulated peak of 17,900 in 2005 to only 4,800 in 2011, the state lost 39,300 jobs. And so many of those who lost work left housing construction altogether as the slump worsened that the sector’s worries lately are shifting to concern about potential skilled labor shortages.

NAHB cannot estimate how the tax dollars divide among political entities because states and localities have different tax structures, Crowe said. By way of example, however, if local and state government each received a third of the $90,000 tax pie every new home creates, the revenue loss for various Kentucky government entities would total $786 million.

A housing revival will mean increases in state sales and withholding tax collections, Harkenrider said. Local government will see increases in occupational tax payments primarily and in property taxes secondarily, he said, with higher demand for construction workers generating higher wages and additional tax revenue.

“That’s good because construction workers, like any workers, their wages become somebody else’s income,” Harkenrider said, referencing the consumer spending multiplier effect. “What we need is housing to improve such that ancillary products can lead us out of what has been a very flat recovery.”

Kentucky benefits further from new housing construction because new homes require furniture, appliances, flooring and more, all products that are produced in a manufacturing state.

Headwinds versus animal spirits

There are potential headwinds that could slow a housing recovery, such as rising interest rates, more difficult mortgage lending standards and environmental regulations like new stormwater control requirements. One 3.5-acre residential development in Florence that Miller is familiar with incurred $360,000 in stormwater compliance costs, which must be tacked onto the cost of the new homes there, he said.

Cover Story Graph“About 25 percent of the cost of a new home is the cost of regulation,” Miller said, “and two-thirds of that is land development regulation.”

Home prices and sales volumes in the Lexington and Louisville markets are rising. Through July, the Greater Louisville Association of Realtors reported a 19 percent increase in closings with 4 percent higher average prices. The Lexington Bluegrass Association of Realtors reported 24 percent more closings compared to January through July 2012 and a 3 percent higher median price.

RELATED: Bluegrass area home sales top $1 billion so far this year


Home sales are rising now and expected to continue doing so even though consumers are more price-sensitive today. Take-home pay for many consumers has decreased the past several years, Harkenrider said, as a result of price increases for health insurance, food and other goods while wages remained nearly flat.

Rising home prices are viewed both as a headwind that could slow sales and an incentive to buy now before home costs climb.

Regardless of these headwinds, consumers increasingly are ready to spend, according to Harkenrider, who concurs with expectations that housing will continue its recovery the next few years. Demand for homes as well as autos is increasing, in his view, in part because of rising economic “animal spirits” as John Maynard Keynes labeled it. Kentuckians, like their fellow Americans, have resisted buying the comforts they’d like to have for four or five years.

“You can get them to hold off purchases for awhile, but eventually … they get antsy, and they say, ‘I’m tired of waiting. I’m going to buy that car or I’m going to build that house. I’m not going to live forever,” Harkenrider said. “They say, ‘After all, I work hard and I deserve it.’ ”

Meanwhile, he said, consumers can see also that the market has passed its bottom and prices and interest rates remain near historic lows. Waiting further will only bring higher costs, unlike the past several years.

Housing prices dropped for four years as supply remained out of balance with demand; several years of overbuilding were followed by several more years of repossessed homes returning to the market from buyers who’d gotten mortgage loans they couldn’t afford. Compounding the imbalance, new household formation stalled because young adult, typical first-home buyers could not find jobs or lost those they had and by necessity stayed in their parents’ homes.

A true housing sector rebound would help sustain itself by creating the new jobs that will lead to further household formation. Additionally, rising prices create a wealth effect among homeowners who see their equity and net worth numbers increase, which stimulates consumer spending.

“If you read the national economic forecasts and hear the national prognosticators,” Harkenrider said, “they look at aggregate demand. The key to consumption right now is autos and housing.”

Rural areas more stable, less active

Indications that the housing sector was beginning to improve began appearing in mid-2012. There was a surge first in home remodeling activity, said Bob Weiss, executive vice president of the Kentucky Association of Home Builders. Kentucky home builders started to increase production a year ago, he said, but upswings in construction activity are taking place mostly in urban areas.

In fact, bankers in rural areas of Kentucky are seeing very little change in mortgage lending, said Bob Ross, executive director of the Bluegrass Bankers Association, a trade group for community banks in the state.

“My understanding is that right now banks are not doing much home lending because there is not much demand for it out in the state,” Ross said.

Kentucky’s rural markets have been much less volatile than the nation as a whole, which is increasingly urban. Rural areas did typically did not overbuild and felt much less of the effects of the housing bubble and crash.

Bankers in Kentucky’s smaller communities are not seeing a distinct housing upswing, except for a few pockets of activity, said Paul Goodpasture, the new president of Bluegrass Bankers Association. He is executive vice president and chief operating officer of Citizens Bank in Morehead.

Goodpasture’s home market is one of those pockets of housing activity, which he attributes mostly to growth in the student population of Morehead State University.

However, Morehead and Rowan County are also a center for wood products production, Goodpasture said, and that sector is a leading indicator for the broader housing industry. Bankers listen when their wood products customers tell them their business is changing.

“When we started entering this recessionary period five to six years ago, they started telling us … we don’t know what’s happening but our sales are way down,” Goodpasture said. “Last summer we started hearing, ‘Hey, things might be starting to look a little better. We’re starting to see some demand for certain types of wood.’ ”

Bankers are picking up other positive signs.

“Local retailers in the appliance-type business,” he said, “are not talking doom and gloom like they were two and three years ago.”

Banks have fewer troubled loans, delinquencies and foreclosures, Goodpasture said. Citizens Bank has seen an 11 percent growth in lending year to date in 2013 compared to 2012, and at least half of that is from home loans. He said he expects Kentucky bank to remain cautious in their lending standards as they seek to grow earnings that have suffered during the downturn.

“The key right now for banks in general is, as things continue to improve, we need to make sure on the banking side we stay true to our fundamentals in terms of credit writing,” Goodpasture said.

What is ‘normal’ housing activity?

Lending fundamentals are one reason there is some disagreement on what level of housing might return to as the economy recovers.

Expectations do differ on what “normal” housing activity will be going forward. The consensus is that normal construction and home sales levels are those of about a decade ago in roughly 2002 and 2003, when Kentucky had 11,000 to 12,000 starts annually and the national figure was at about 1.3 million. This was before the housing “bubble” from 2004 stretching into fall 2008, when loose mortgage lending practices overinflated prices and demand and spiked construction to nearly 18,000 in Kentucky and almost 1.8 million nationally – and brought on an economic when the lack of true value behind mortgage-backed investment instruments became apparent.

No one expects or wants to see a return to the “bubble” period activity levels that created a housing depression with the lowest relative housing activity in 50 years, when industry statistics keeping began. “Normal” and stable housing activity is the hoped for outcome.

The question, of course, is what is “normal”?

Lending specialists at Republic Bank, which launched a national mortgage warehouse lending operation two years ago, are among those who disagree with the notion that the market will rise again to 2002 to 2004 housing activity levels over the next two to four years. They believe rising interest rates and new bank regulations will slow housing down.

“I am cautiously optimistic,” said Juan Montano, managing director of finance for Republic Bank. He oversees Republic’s mortgage warehouse lending line of business, which provides resources to customers writing mortgages in all 50 states.

Republic has seen a 35 percent increase year to date in the number of housing units purchased, Montano said, and the bank’s housing lending business mix has shifted significantly from refinancing toward purchases. In 2012, the housing lending mix was 70 percent refinance and 30 percent purchase; that has shifted in 2013 to 45 percent refinance and 55 percent purchase, he said.

For July, purchases represented 65 percent of Republic’s housing lending, Montano said, but he does not expect purchase loans to continue building into a larger share of the mix,

“What you’re seeing now is going to be a normal purchase volume,” he said. “It’s going to be stable.”

Montano considers National Association of Home Builders forecasts that Kentucky construction activity will increase 75 percent from where it is now too optimistic.

“I hope they’re right,” he said.

However, he believes rising interest rates in combination with new, more stringent qualified mortgage standards due out in January 2014 will prevent interested buyers from getting financing.

Kentucky recovers more slowly than U.S.

At the national level, housing construction is “about 60 percent back to where it should be” while Kentucky is around 50 percent of the way back, said NAHB economist Crowe, who happens to be a Kentuckian – he has degrees from Bellarmine University and a Ph.D from the University of Kentucky Gatton School of Business and Economics.

A new home is constructed in the Polo Fields subdivision in Louisville, Ky. More than 1,700 new homes have been constructed in Louisville this year, as of August 2013. (Staff photo)
A new home is constructed in the Polo Fields subdivision in Louisville, Ky. More than 1,700 new homes have been constructed in Louisville this year, as of August 2013. (Staff photo)

“We’re expecting you to get a little over 6,000 housing starts this year,” Crowe said. “At the worst, you were doing only about 30 percent of what we consider normal production levels. In 2013, we expect you to have moved up to 57 percent of normal.”

NAHC expects the nation to grow back to “normal” home construction activity levels by 2016, he said, with Kentucky another year or two behind.

The national association tracks the mood of homebuilders each month and that assessment moved above 50 and into positive territory four months ago, Crowe said. The September index figure was 58.

By comparison, the index topped out at 72 in June 2005 then fell to its all-time low of 8 in January 2009.

“It was a pretty drastic crash,” Crowe said. The previous index low had been 20 in January 1991.

Strength in $250,000 to $400,000 range

Major Kentucky home builders and executives in the state and regional associations say they do expect industry growth to follow NAHB forecasts for a return to the pre-boom construction levels of a decade ago – providing there are no major economic surprises in the meantime.

“It’s much stronger and continues to improve,” said Ray Ball, president of Lexington-based Ball Homes, the top builder in the Bluegrass and one of the top builders in the Louisville and Knoxville, Tenn., markets.

Ball Homes did notice the market slow some when mortgage interest rates increased a percentage point in early summer after Federal Reserve officials hinted at tapering off their economic stimulus efforts.

“The rate of improvement has slowed some, but our business is going quite well,” Ball said. “There’s a lot of variables in play, but we expect … continued growth over the next couple of years back to pre-boom time years.”

That’s faster than Kentucky as a whole, but Ball has less competition today than it did a decade ago.

“What we’re seeing real strength in is in the $250,000 to $350,000 to about $400,000 home,” Ball said. “That’s a much higher price point than what we would’ve thought.”

He attributes this to current buyers having waited longer to purchase their first home and to buyers acting more deliberatively to purchase homes they plan to stay in longer.

Bob Hawksley, president and chief operating officer for Fischer Homes based in Northern Kentucky, said his company is seeing activity focused in what he called “the move-up market” rather than first-time buyers who still are having difficulty meeting today’s down-payment and lending qualification standards.

Changes in the lending environment have “hammered” first-time buyers, Hawksley said, but that market is starting to come back slowly.

He, too, referenced the potential for rising interest rates and general uncertainties such as a late summer threat of U.S. military action in Syria to weigh on potential buyers’ minds. However, interest rates remain “extraordinarily low” even after recent increases, and the housing market seems to have mostly worked through its oversupply problems.

Less capacity to recover quickly

Overall economic and demographic conditions “are clearly in favor of seeing an increase in homebuilding activity,” Hawksley said.

He foresees a return to normal housing industry activity “in about 2015 to 2016,” and doubts there is sufficient industry capability to ramp up sooner even if demand and financing improve at a faster rate.

Fischer, which builds primarily in the Greater Cincinnati market but also Dayton, Columbus, Indianapolis and Atlanta, has hired 69 employees in the past year and now has 300, not counting its trade partners and subcontractors.

“Over the last six to seven years we saw probably 75 percent of the builders go out of business. That’s substantial,” Hawksley said. Subcontractors went out of business with them.

“We’re limited in some degree in our capacity to rebuild. You can’t just snap your fingers and double production.”

Builders lately are finding that there is more demand for subcontractors, and that it take a little longer to get them onto a job site, said Weiss, of the Kentucky Association of Home Builders.

“Houses are where jobs go to sleep at night,” Crowe said, citing an old industry adage. “In communities there’s often a focus on expanding the employment base, but that’s only possible if you have a house for that job to live in.”

Mark Green is editorial director of The Lane Report. He can be reached at [email protected].