Implications of Hovnanian's move
Among the lessons I learned as a real estate lender was “The first loss is often the best loss”. Hovnanian is doing what they must in this business environment, namely eliminate costly inventory and re-align the company to operate in the current real estate climate.
The carrying cost of inventory is extraordinary. With inventory on the books, the interest clock ticks eating cash. And to add insult to injury, the value of the underlying inventory continues to erode, due to the market forces and the increasing staleness of the product. Knowing when the market will “stabilize” is left to the crystal balls, and waiting for it is a suicidal operating strategy for most businesses. The only prudent move is to take the hit now, clear out the inventory and get the business on the correct operational footing. It will hurt, as evidenced by the losses reported and the decimation of the stock prices of the building companies. But the industry will emerge from this and continue.
Other builders will follow Hovnanian’s lead. Many have tried less drastic attempts to move product through “upgrades” or subsidizing other buyer’s costs. But the market has turned too dramatically for these marginal approaches to work. The great unknown is if the massive amounts of inventory that currently exist can be absorbed by this move. Contracts will be an initial indicator, but the truth will be in the actual closings- how much inventory actually is sold.
This marks an opening of the floodgates. Now, there will be real pressure on the builders and the banks to “mark to market” their inventory and loans respectively. The new wave of hits to balance sheets and income statements will be pronounced. Although this move is called a sale, the selling price of a home affects values of the surrounding area. Although some might attempt to call this a “quick sale” and therefore a discounted price, there is a threshold that once crossed, establishes value. A single unit might be sold at a discount, several units sold constitutes the market.
Lastly, this does not bode well for the resale market. The appraisers “laws of substitution and comparability” require this segment of the market will be affected by the moves in the new home market. The segregation of these as two distinct markets is misleading. To sell an existing home in this environment will require competing with this aggressive price cutting from the builders. Very savvy marketing and extremely realistic and sharp pricing are the only things that will move existing houses. As re-sellers have been slow to react to the current realities of the market, expect the velocity of sales in this segment of the market to slow in response to the builder’s moves.
The carrying cost of inventory is extraordinary. With inventory on the books, the interest clock ticks eating cash. And to add insult to injury, the value of the underlying inventory continues to erode, due to the market forces and the increasing staleness of the product. Knowing when the market will “stabilize” is left to the crystal balls, and waiting for it is a suicidal operating strategy for most businesses. The only prudent move is to take the hit now, clear out the inventory and get the business on the correct operational footing. It will hurt, as evidenced by the losses reported and the decimation of the stock prices of the building companies. But the industry will emerge from this and continue.
Other builders will follow Hovnanian’s lead. Many have tried less drastic attempts to move product through “upgrades” or subsidizing other buyer’s costs. But the market has turned too dramatically for these marginal approaches to work. The great unknown is if the massive amounts of inventory that currently exist can be absorbed by this move. Contracts will be an initial indicator, but the truth will be in the actual closings- how much inventory actually is sold.
This marks an opening of the floodgates. Now, there will be real pressure on the builders and the banks to “mark to market” their inventory and loans respectively. The new wave of hits to balance sheets and income statements will be pronounced. Although this move is called a sale, the selling price of a home affects values of the surrounding area. Although some might attempt to call this a “quick sale” and therefore a discounted price, there is a threshold that once crossed, establishes value. A single unit might be sold at a discount, several units sold constitutes the market.
Lastly, this does not bode well for the resale market. The appraisers “laws of substitution and comparability” require this segment of the market will be affected by the moves in the new home market. The segregation of these as two distinct markets is misleading. To sell an existing home in this environment will require competing with this aggressive price cutting from the builders. Very savvy marketing and extremely realistic and sharp pricing are the only things that will move existing houses. As re-sellers have been slow to react to the current realities of the market, expect the velocity of sales in this segment of the market to slow in response to the builder’s moves.
David Levin
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