Archive for September, 2010

"When is a buyers market not a buyers market?"

Posted September 27, 2010 By Fletcher Groves

“When is a buyers market not a buyers market?”, asked the intrepid, results-based consultant.

She surveyed the collection of blank stares in the RB Builders conference room for a few seconds. Not waiting for an answer that was not going to come anyway, she answered the question herself:

“When there are no buyers.”

“That’s what you call a conundrum”, announced a superintendent.

“Like, possibly finding yourself between a rock and a hard place?”, asked the CEO.

“That would be an analogy”, the superintendent replied.

Conundrum, indeed.

One of the best economic and finance weblog sites is Calculated Risk ( It would be safe to say that CR has forgotten more about economics than I ever knew. One of the topics CR spends a lot of time on these days is the housing market. Actually, you can trace the importance of the subject on CR to before 2007, when the market was beginning to show signs of stress.

At an 11.6 month supply (August), CR says that the current inventory of existing homes is very high by historical standards, and that is going to cause home prices to fall even further than they already have fallen. I think CR is right, and I do not know what can be done to change that outcome, but, at the same time, I do not think the inventory of existing homes, measured as the number of months supply, is the core problem.

The current high-level supply of existing homes is the visible symptom of a much deeper problem, which is demand. The months supply of homes – whether new or existing – is a relative measure, not an absolute measure. It is current supply in relation to current demand. As CR explains, last month (August), there were 4 million existing homes on the market, and the seasonally-adjusted rate of existing home sales was 4.1 million – as he says, almost a 12 month supply. But, is that because of the high inventory or the paltry rate of sales?

As illustrated in a Calculated Risk graph in a post on March 23, 2007:

From 1983 until 1992, and again from 1996 until 2003, the inventory of existing homes for sale was in a narrow range of between 1.8 million and 2.2 million; during the period 1993 through 1995, the inventory hovered around 1.5 million existing homes for sale. That is a 20 year period in which the inventory of existing homes for sale was between 1.5 million and 2.2 million. The current inventory level, which is double the historic level, is a recent phenomena.

During the period of 1991 through 2003, even into 2004, the months supply of existing homes moved steadily lower, because the rate of sales steadily increased against this relatively static inventory of homes. In fact, sales of existing homes went from about 3.1 million homes per year in 1991, to about 6.8 million in 2004.

And, then, it changed. Here was the approximate annual picture for existing homes in 2005-2007, from the same CR chart:

2005 Inventory 2.7 million
2005 Sales 7.1 million
2005 Months Supply 4.6 months

2006 Inventory 3.5 million
2006 Sales 6.5 million
2006 Months Supply 6.5 months

2007 Inventory 4.5 million
2007 Sales 5.7 million
2007 Months Supply 9.5 months

It is no coincidence that, since 2005, inventory has moved inversely to the rate of sales.

Last month, David McCain (MPKA) and I were discussing this subject, and we both concluded that supply in the absence of demand is irrelevant. Which brings us to the implication for homebuilders.

Sales of new homes last month (in August, 2010) were estimated at 288,000 (and, yes, there is a lag between sales and completions, so it does not coincide precisely with existing home sales). At the same time, there was an estimated 206,000 completed-but-unsold new homes, which equates to an 8.6 month supply (high, but down from an all-time high of 12.9 months in January 2009). But – by historic standards – 288,000 new home sales is table stakes, amounting to perhaps 20% to 30% of the normal demand projections supported by demographics. At that level, there is no way new home completions, sales, or closings are contributing to the overall increase in the inventory of homes available for sale; it is doubtful that it even replenishes the stock of existing houses.

The problem is demand.

Except that, demand is not the real problem, either. Like the inventory of homes, it is both a cause and an effect, a symptom of one thing, but an outcome of something else. Go through a checklist of the factors that negatively impact demand, the factors that negatively influence the individual homebuying decisions of millions of Americans:

The decline of real personal incomes? Check. The loss of jobs? Check. The lack of consumer confidence? Check.

Those are the big factors. But, what about other factors:

The consolidation of households? Check. The availability and terms of mortgage financing, including serious-for-a-change LTV requirements? Check. The forecast short-term downward movement of home values? Check. 11 million homeowners who, according to the Wall Street Journal, are currently underwater on their mortgages, who will be joined by another 2.5 million if existing home prices decline by just another 5%? Check. The resulting lack of equity to transfer to the purchase of another house? Check. Credit scores, for many prospective homebuyers, that have been hammered a couple of hundred basis points? Check. Despite the de-leveraging, the lingering hangover from too much personal borrowing? Check. The prospect of higher income and capital gains taxes. Check. The possible discontinuation of the mortgage interest deduction? Check.

There is more:

The share of government spending as a percentage of GDP? The percentage of federal debt as a percentage of GDP? Check, all at record peace-time levels. An economy that – if it growing at all – is growing at one-third the rate that it should be growing? Check. The diminished prospect for U.S. global competitive standing? Check. Keynesian Socialist Idiots in charge of Congress and the White House? Check.

All of the above in some combination – and seemingly unending continuation – of a perfect storm? Double check. Too much for lower prices, mortgage interest rates at historic lows, and homebuyer tax credits to resolve. And – ominously for the builders, largely publicly-held, that banked on it – too much for a loss carryback provision to weather.

Generally-speaking, prices do not have much elasticity, unless supply and demand collude. So, there cannot be a real sellers market unless there is both high demand and a marked shortage of available homes. And, there cannot be a real buyers market unless there is both weak demand and a glut of available houses. If there was only an oversupply of new or existing homes, prices would not move much, and there would be no buyers market.

But, as CR points out, we do have a glut of available homes. And, we have weak demand. So, we must have a buyers market.

Until it gets so bad that there are no buyers.

I have been through every economic (and housing) recession since 1974. Whether that makes me wise, or simply a relic, I am not sure. I do know this recession is not only worse than anything I have experienced, it is much more complex. We live in a world of cause and effect. This time, the chain of cause and effect is longer and more complex.

Which is why we are going to rue the day we decided that government was smart enough to make so many decisions, decided we were smart to use government deficit spending as a stimulus, and decided we were smart enough to target so many incentives. We are going to rue the day when we decided not to allow market forces to sort this out. We are going to rue the day that we decided to let people that had never run a business decide how all businesses should be run.

It would have been painful. Companies would have failed. But, it would likely be over by now. Instead, we are four years into this mess, and we still cannot see the end.

Conundrum, indeed.

NOTE: I ran this post by Bill McBride at Calculated Risk, before I posted it to Escape from Averageness. Bill had three observations, if I can paraphrase them.

First, he observed that when he started Calculated Risk in January 2005, the first topics were the housing bubble, obvious speculation, leverage, loose lending standards, non-traditional mortgage loans, etc, and how the housing bubble would eventually burst, leading the economy into recession. Bill said, back then housing was almost all he wrote about.

Second, he guessed that he is one of the “Keynesian Socialist Idiots”, except he thinks only a portion of what was done was “Keynesian” (he says the housing tax credit was anti-Keynesian). Bill would have argued for much more stimulus spending aimed directly at jobs. He thinks more spending should still occur.

Third, he said that we need to look at supply, demand, and price. He said that, at some price – except for a few areas with shrinking populations, like Detroit – the housing market would clear and the excess inventory would be absorbed. He said, lower prices would spur demand, but the economy (and the housing market) would still need jobs and incomes.

Bill said that they are all tied together.

Selling Footballs to the NFL

Posted September 15, 2010 By Fletcher Groves

This week, I had a call from a former executive of one of my clients, a bright, young guy, who, at this point in his career, is still an operator, more of a manager than a senior executive. Resourceful. Determined. Good leadership attributes. Has a bright future.

He wanted to talk about sales, which I thought was kind of interesting, in part, because the consulting practice at SAI only deals indirectly with sales, but mostly because I did not think this guy could sell footballs to the NFL.

But, here is his story:

He left our client in late 2009, and took a position with a fund-backed real estate company that buys and builds out distressed residential communities. This company’s business model calls for standalone communities, essentially the management of single projects of finite duration. Early on, he personally managed sales in this community, with the help of two commissioned sales agents. They opened for sales in November. Initial sales were slightly below the budget of three sales per month, but quickly slowed.

By the end of May, the community only had nine sales; six sales behind budget, five months into the budget year. But – that understated the current situation. In the preceding three months (March, April, May), they had only sold five homes, four below budget. Traffic counts had improved, doubled, in fact, but the conversion rate (percent) had fallen from the 10% to 16% range to the 3% to 6% range.

In the next three months (June, July, August), they sold 16 homes, one above budget for the three month period. Compared with the previous three months, sales were up 150%, traffic was up 100%, and the conversion percentage rose from 4.7% to 7.7%, a 65% improvement.

And, he wanted to tell me why.

He talked with me about the rigorous problem-solving approach he had used to look at the symptoms of the problem and get to the root cause, an extension of the PDCA-Kaizen tools he had learned with our client. I listened to it. I listened to all of it. And, then I told him to go back and challenge these conclusions with a healthy dose of legitimate reservation. He came back with a couple of qualifiers, but essentially the same conclusion.

And, that conclusion will surprise many of you.

First, the qualifiers that were added. One, the increase in traffic coincided with the start of a new, heavier sales and marketing campaign that turned out to be effective. Two, at the beginning of June, he promoted one of his sales agents to sales manager, a move which seemed to better organize and solidify the sales team.

The important decision, however, was to take one specific element of a team-based performance compensation he had learned at our client, and apply it to his situation, to resolving the specific constraint that he faced, namely, insufficient sales. He and the new sales manager looked at the problem, argued about the differences in how they saw the situation, and debated different approaches. And – then – they made the following changes:

First – to give necessary attention to the increased traffic, which stemmed from the success of the marketing campaign, they hired two more sales agents, bringing the count to three. Not in the budget, but they did it anyway.

Second – they took the commission/draw arrangement for the three sales agents, and converted it to a base salary with a team-based commission arrangement, so that sales agents receive a $45,000 salary and share equally in a one-percent (1%) commission pool on all sales, versus the previous straight two-percent (2%) individual commission and $35,000 reimbursed draw (the sales manager has a slightly higher base salary and a slightly lower commission that is not part of the commission pool).

Third – they instituted a new flat monthly $1,000 cash bonus, for every sales agent, paid in any month where the team sold more than five homes (remember, the budget was three sales per month).

So far, so good. The results speak for themselves, but here is what this manager said:

“In addition to the results, the culture of the team has elevated to that of a pre-recession environment. The team is excited to come to work. They work together. Every day, they discuss where they are in relation to their targets and work together to constantly strategize how they are going to reach their goal as a team.

“I underestimated the impact this [compensation change] would have on the culture of the work environment.

“By the way – in case anyone says they cannot afford this – the overall three-year proforma reflected a two-percent (2%) sales commission paid to in-house sales agents. When you project that entire expense over the life of the project, and compare it to this fixed salary with just the one-percent (1%) pooled commission, we actually reduced the overall line item in the proforma by $179,000. We spent less. We paid out less. But, with the base salary – which relieved a lot of pressure in this difficult economic time – and with the new and improved team environment, we overwhelmingly changed the culture and made it a better place to work.”

My own observations: First – given the time periods when this occurred – it had nothing to do with the homebuyer tax credit. Second – this broke a lot of rules. Third – and foremost – this was a lesson about the effectiveness of changing a paradigm for how to compensate sales agents, and about using that change to break the external (market) constraint that limited the ability of this project to make money.

Okay, Fletch. It is just one project, and kind of a small one, at that.

But – in a larger, more important sense – is this not also a wakeup call? A call to rigorously challenge the status quo? A lesson to challenge the accepted way of doing everything? A warning not to settle for “industry best practices”? A call to not be afraid of being different, in the quest for being exceptional? An encouragement to resolve conflicts, challenge assumptions, break constraints, and solve problems, not compromise on the solution?

A call to stop settling for being average?

Does the world really need more average homebuilding companies?

I think not.

"I remember where I was . . . I remember who I was with."

Posted September 10, 2010 By Fletcher Groves

On Tuesday morning, September 11, 2001, I was in the offices of Fidelity Homes, in Venice, Florida, just starting a process mapping engagement that would give this start-up builder a state-of-the-art set of business processes. SAI’s involvement was part of a large pro bono effort, sponsored by Professional Builder, that included a number of top consultants servicing the homebuilding industry.

I was the Process Architect for Fidelity Homes.

Sitting across the table were David Hunihan and Todd Menke, two young builders, eager to take their experience in homebuilding and pursue a National Housing Quality award. To this day, I think these guys represent the entrepreneurial spirit and personal courage that makes this country and this industry great.

We had barely started, when David was pulled away by a telephone call. It was his wife, asking if he was aware of what was going on in New York City. As the events continued to unfold, in New York City, in Washington DC, in western Pennsylvania, we eventually found that it was impossible to concentrate on mapping processes, and it did not seem all that important, anyway. We cancelled everything for the rest of the day, and, separately and in our own ways, watched and processed what was happening.

Bill Lurz, then a senior editor at Professional Builder, joined us the following day. We finished the project two days later, and I drove back to my family in Ponte Vedra Beach through a tropical storm. The hugs had more conviction than usual.

The articles were written for Professional Builder.

I will not much impose my views on all of you, as to what I consider to be the remaining, unfinished business of this country. Time has not changed my feelings one iota. Suffice to say, we were attacked because of who we were, and because of who we remain. Suffice to say, evil is the enemy of good, and it has a face.

In the years that have followed, careers have changed. But, I will never forget where I was, or who I was with.