The housing market's real test

Winter's chill is gone, but the market for home construction is still shuddering from the ongoing shakeout in demand and mortgages.

By Jim Buchta, Star Tribune

April 21, 2007 in the Star Tribune

The ground is thawing, but will the market for new construction remain on ice?

Spring is the time of year when Twin Cities-area home builders itch to put holes in the ground that will become someone's American Dream. But consumers aren't feeling so springy leading into the housing market's prime selling season.

"And lo and behold, the subprime market comes forward and just causes another issue that descends on the housing market and raises questions that we don't need," said Michael Noonan, division president with Toll Brothers Inc. "I'd love a period without news about housing."

Though the subdivisions of suburbia and the condo towers of Minneapolis seem a long way from the subprime mortgage debacle on Wall Street, the still unfolding shock to the housing market is bringing new doubt -- and challenges.

"It has sent a shudder through the housing and mortgage industries," said Noonan, who is also president of the Builders Association of the Twin Cities.

Buyers with shaky or no credit are having more trouble qualifying for mortgages as lenders rein in relaxed credit standards and exotic mortgages. And Wall Street is restricting the flow of mortgage money to companies that specialize in providing mortgages to risky and unconventional borrowers.

The pullback's timing could be particularly difficult for builders because many of the borrowers who no longer qualify for a mortgage are first-time buyers whose purchases ripple upward, creating demand for high-end houses, condominiums and townhouses.

And some are business owners with difficult-to-document incomes who will no longer be able to qualify for what's known as a "no-doc" or stated-income mortgage.

Builders have been focusing on reducing their inventories of unsold homes so far this year, rather than breaking a lot of new ground.

During March, Twin Cities builders were issued 330 permits to build 443 units, according to data from the Builders Association of the Twin Cities. That's a 53.6 percent decline in new units over the same period last year.

So far this year, the number of planned units in the Twin Cities is off 35.2 percent compared with the same period last year.

Noonan said Toll Brothers isn't saddled with deals that can't be financed because of the subprime situation because most of its buyers don't fit in that category. The company builds luxury suburban housing and puts its borrowers thorough a rigorous prequalification process.

The same is true at K. Hovnanian, for example, which has its own mortgage company and can vet borrowers before making a commitment. Art Plante, Minnesota division president, said that a few of the deals in the company's pipeline have fallen apart in recent weeks because of what's happening in the subprime market. Still, Plante knows that the health of the entire market is at stake.

"It's a big concern in the market as a whole," he said.

The first-quarter numbers show how difficult the market is proving for many builders.

Toll Brothers, one of the nation's largest luxury home builders, posted a 67 percent drop in fiscal first-quarter profit. Lennar Corp., a Miami-based home builder that was this region's top-ranked builder by gross revenue during 2006, said that its quarterly profits dropped 73 percent.

"Soft market conditions have been exacerbated by the well-publicized problems in the subprime lending market," said Stuart Miller, Lennar's president and CEO.

Home builders could face another challenge down the road if access to credit to fund their land purchases and to finance business operations gets tighter. Already there's evidence some are struggling.

According to the Federal Deposit Insurance Corporation, the amount of noncurrent real estate construction and development loans increased by $1 billion, or 15.5 percent, during the fourth quarter of 2006. That increase represented nearly a quarter of the $4.2 billion increase in all noncurrent loans and leases during that period.

"When you have something that shakes the confidence of the finance markets, that's a concern for us," Noonan said. "If access to financing or capital becomes more and more difficult, we'll have a greater challenge selling homes."

Amy Crews Cutts, deputy chief economist for mortgage funder Freddie Mac, said that although this slowdown and all the mortgage drama that has surrounded it has been painful, it was inevitable and necessary to bring the market into balance and to prevent excess price inflation or the kind of overbuilding that happened in the early 1980s.

Because builders have responded so quickly, she believes the market has hit bottom in terms of the number of transactions, though not necessarily in terms of prices.

"That said, I don't think the upward slope will be very strong," she said. "It's a bad thing if you are a homebuilder or investor in homebuilding, but it's a fabulous thing if you care about the health of the overall housing market."

Jim Buchta • 612-673-7376 • jbuchta@startribune.com

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