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The Bottom For Housing Starts?

August 16, 2010 | About:
Josh Zachariah

Josh Zachariah

38 followers
Warren Buffett commented on CNBC a couple months ago saying we should expect to see an up-tick in house prices in about a year, at least for regions not overproduced. Though it should be read with caution as he acknowledges he didn't appreciate the size of the housing bubble years ago and made some mistimed investments in companies like U.S. Gysum. In any case he's generally more right than wrong and current trends may actually favor his projection.

The price of housing, like all assets are governed by supply and demand so that's a good place to start when examining housing. Below is the annual figure for new housing construction from the U.S. Census

Figures in thousands


1991 1,013.9


1992 1,199.7


1993 1,287.6


1994 1,457.0


1995 1,354.1


1996 1,476.8


1997 1,474.0


1998 1,616.9


1999 1,640.9


2000 1,568.7


2001 1,602.7


2002 1,704.9


2003 1,847.7


2004 1,955.8


2005 2,068.3


2006 1,800.9


2007 1,355.0


2008 905.5


2009 554.0




The steep drop off is unparalleled in the last 40 years of housing starts, but the boom was equally so. Buffett had noted that in 2005 when housing starts were about 2 million household formations, the demand side, were running about 1.2 million. More houses were being created than people could fill. Fast forward to 2008 and we're left with excess inventory resulting from foreclosures.

There still exists a large inventory of houses and even a "shadow inventory" of delinquent mortgagors that haven't been put into foreclosure by Freddie Mac and Fannie Mae. Inventory levels will need to drop to normal levels before prices can ascend. Both Buffett and Robert Shiller noted that unemployment weighs heavier on house prices than does higher interest rates. Buffett doesn't see a rise in interest rates having a significant negative impact on housing, but unemployment does remain elevated and shows little signs of abating.

So how good does Buffett feel about housing? Good enough to not sell any of his shares in U.S. Gypsum, a maker of sheet-rock. He sold shares in Johnson and Johnson, Ingersoll-Rand, and Proctor and Gamble in the past year. U.S. Gypsum is a unique investment for Buffett because it is quite commoditized and it doesn't appear to have the "moat" like many of his other investments have. The company claims to operate as the low-cost producer and they do hold patents on the name Sheetrock which they are credited with inventing. But many other drywall producers exist, Chinese firms as well.

The company recently unveiled a lightweight version of sheetrock which is about 30% lighter than present models. The company claims heavy sheetrock is the single largest concern of contractors and this new model maintains a pound for pound durability which is stronger than heavier versions. However, the company is seemingly producing more red ink than sheetrock at the moment. It has been operating at a net loss since 2008 and has mothballed facilities until demand picks up. The new lighter model is unlikely to bail them out from current trends, but it should pad earnings in future years.

Josh Zachariah
Disclosure: Shares held of USG

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.8/5 (10 votes)

Comments

batbeer2
Batbeer2 premium member - 4 years ago
and even a "shadow inventory" of delinquent mortgagors that haven't been put into foreclosure by Freddie Mac and Fannie Mae.

There is also a "shadow demand".... young poeple staying with their parents a year or more longer.Extending their studies, working, saving before starting out, etc...

These poeple will eventually want to start new households.

As an aside, Buffett was very explicit about his expectations for housing in the latest shareholder letter. http://www.gurufocus.com/forum/read.php?2,82726,86850#msg-86850
grandpagates
Grandpagates - 4 years ago
I an unable to recreate Buffett's calculation that housing supply and demand would equalize around March of 2011, as described in his 2009 letter to shareholders, which is alluded to above.

If household formation was 1.2 million a year, then the overbuilding began around 1994 (see census figures above) and consists of approximately 3.8 homes by my math. It woud then appear to take 3 years no building to wipe out this oversupply (1.2 million times 3 years). But the census bureau says there has been building.

Therefore, I cannot reproduce Buffett's reassuring mathematical calculation, and the future of Western civilization hangs in the balance

batbeer2
Batbeer2 premium member - 4 years ago
Your calculation relies on the assumption that in recent years, the rate of destruction declined as rapidly as the rate of construction.

I think it's a safe bet that the rate of destruction, like the rate of construction, was at decade highs round 2005 (I'll call this the destruction boom) I don't think it's safe to assume it's now at decade lows. If not..... you get some interesting non-linear effects.

Don't get me wrong, I'm not saying a house is torn down for every house that's built the rates are not equal. However, I think there's a good chance the rate of destruction unlike the rate of construction has remained at 2005 levels. It's that gap that matters, not the rate of construction alone.
AlbertaSunwapta
AlbertaSunwapta - 4 years ago
some thoughts:

- As for new construction I see, one, most if not all future household formation being met by existing supply and two, investment demand for new construction or facilitating new construction not materializing again for many, many years. (i.e. the pricing of existing housing stock should under-price replacement for a few more years.)

-Companies that have bought up foreclosed properties and rented them out will certainly be willing to flip much of their asset base upon any decent uptick in prices.

- I imagine the supply of serviced lots must be at an all time high so I don't see much housing demolition for a while either. Building on these cheap or free serviced lots may provide some demand.

- I think the renovation and commercial markets will be the only real bright spots for a while.

- Government interference in the form of regulation and incentives to improve insulation levels might help. Of course, all their (or your) free money will also help.

grandpagates
Grandpagates - 4 years ago


Okay. Mystery solved. WEB is saying that the housing recovery will be years off:

Ben Stein: "How about in housing?"

WEB: "That recovery is still a long way off. That market got way out of equilibrium, and it's going to take a long while for it to get fixed."

There are many good points in this interview and it is worth reading:

http://money.cnn.com/2010/10/18/pf/investing/buffett_ben_stein.fortune/index.htm

Gold and silver investors are hounding me to join them whole saying that stocks are scary, and this article gives me ammo to just say no.

I think WEB likes Fortune magazine becuase they never seem to try to want to twist what he says.

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