Saturday, July 15, 2006

Two Tiered Housing

Almost every article written lately, looks at the housing market inventory problem, as if it was grouped all together. Lets separate it into two different groups; newly built contractor housing and consumer owned housing.

Forget about the cost of the house, and reflect, upon the idea that contractors have been building houses and making a living at it for centuries.

Our house was built by a contractor in 1994 for $191,000 2,400 sq ft. The contractor made a profit. The same house built up the street this year by a contractor sold for about $650,000 and the contractor again made a profit. The only difference between then and now, is that there are more contractors building houses.

Notice, as the used housing market appreciates, the builders inventory also appreciates with no real investment. Figure the return on investment between 15% on up to 50% for the contractor (no real figures here, a rate of 15% is better than giving it to a bank, and a return of 50% or better would explain the sudden increase in building contractors.) I've been in two limited partnerships that returned 50% on condo construction.

Look at the homeowner that gets ready to sell. In a rising market, no problem. In a dropping market, there is realtor fees and competition from newly built houses. The owners selling price is set in stone. His whole future can depend on the outcome of the sale of the house.

Contrast this with a machine that is invested with money that spits out houses, and returns a tidy profit.

The contractor can probably take $150,000 loss in San Marco's on each piece of inventory and still break even and continue on in the world of house building or he could go broke (the investors would take it in the shorts).

As long as the homeowners hold out for a better price, the contractor does not have to mark his inventory lower to move it. At the same time, while looking for raw land to develop, he can demand and get lower land acquisition prices per parcel for new construction.

At this point the contractor is making money at the homeowners expense. More used inventory accumulates.

Now lets look at two different markets. Denver Colorado and San Marcos California. In San Marcos, the housing prices have tripled. In Denver, they have done nothing. Both areas show an oversupply of used housing on the market. Here is where the hair begins to stand up on you neck. This machine that makes houses and the financial institutions that feed it, have created something that is destined to fail in the near future. We are producing housing capacity that is not needed, but it is still very profitable to produce. This is the truest definition of "miss-allocation of resources," AKA "A Bubble." A basic ingredient of any "mind expanding, wallet reducing" recession or depression.

Something will stop this cycle, but at the present, its not clear what its going to be. Stock markets world wide seem to be pointed for a downward plunge. This could lead to a credit contraction that could bring the home construction industry to a halt.

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