MARKET INTELLIGENCE WEBINAR: APRIL, 2022

Abridged Webinar Transcript

Jack Mannon: Hello everyone. This is Jack Mannon, Director of Marketing and Communications for Builder's First Source. Thank you everyone for joining us today. Without further ado, I'm going to kick it over here to Mike Farmer, President of Commercial Operations for Builders First Source.

Mike Farmer: Thank you, Jack. I'd like to welcome everybody to the Builder's First Source and Zonda Market Intelligence Webinar for April. I'd like to start off by thanking our vendor partners, manufacturers, and importantly, our builders, for a great partnership over the last year. We're starting off with another very interesting year in 2022, and we couldn't do it without all the partnerships, communication, and support for each other. I really appreciate everybody's effort and continuing to work together to help keep our country building today. I'd like to thank our partner, James Hardy, and sponsor for today's event and turn it over to Mike Patrick, who is the National Strategic Account Manager for James Hardy.

Mike Patrick: Thank you. Hello everybody. It's an honor to speak to you today. Going ahead of Ali Wolf is like being the opening act for The Rolling Stones. Don't worry, I'm just going to keep this about 120 seconds, then we'll get onto the talent you've joined for. As a consumer-focused brand built on beauty and durability, we have an abundance of resources dedicated to understanding the consumer, which is your home buyer. What they desire, what they aspire towards in their home design, through extensive research.

There's a clear determination that architectural styles are evolving. Here's just a couple of examples. According to an AIA home design trend survey, since 2006 the popularity of contemporary design homes has grown by over 50%. The other trend driving this shift is the increased demand for mixed materials and different texture options on the designs of homes. We are seeing this from starter homes up through custom homes, depending on the market. It's a trend that's here to stay.

The big shift we see are homeowners really demanding a mix of both modern and traditional elements throughout their house. This is the definition of transitional architecture. The most common example would be the modern farmhouse. That is incredibly popular.

And then–I'm sure you are familiar with -- based on our market research, transitional design continues to take a larger share from traditional design homes. The most common way to achieve this look on the exterior is to use mixed materials and textures to add more architectural lines. The question becomes as a builder, “How do I meet this potential need without disruptions or complications with my current trade labor and existing supply partners, such as Builder's First Source?”

We think the answer is a Hardy Architectural Panel, which was a winner of Best in Show Award at the 2022 International Builders Show. This integrated solution of panels and trims enables unique combinations of contemporary textures and architectural lines with the durability and installation efficiencies you expect from James Hardie. And we have a significant investment and production capacity that will come to fruition in 2022 and beyond, to better support the demand for our products.

You're seeing investments and new product innovation. This will continue to be a part of that investment as well. The shiplap joining system simplifies installation and provides sophisticated lines to yield contemporary design aspects. Examples of the finishes would be Fine Mountain Sand, and soon to come, Sea Grass and Sculpted Clay, which all complement each other and add to our existing wood-look materials to build a dream home your consumer or home buyer desires.

I know that was quick but thank you for your time. For more information, please go to our website, to view the Hardy architectural collection and discover the full range of product options to make your dream home a reality.

Mike Farmer: Thank you very much, Mike. And thank you and the James Hardy team for your sponsorship for today's call. Next up, I'd like to introduce Steve Lavalley, Vice President of Forest Products and Transportation.

Steve Lavalley: Thank you. And thanks again, Mike from James Hardy, not only for this call, and to BFS. Most on this call are well-aware of the exceptionally vulnerable commodity environment of the last couple of years. On the screen here, I'm presenting a couple of visuals to show what's happened over the last handful of years. I think many people on the call are well-aware of this, but what it really goes into it is, why is the supply and demand so tight?

But we can see here on this slide, the lumber consumption represented by the red line. The black line is lumber production. The same with OSP at the bottom. We've seen the trend over the last handful of years where the consumption has grown faster than the pace of production. There are many variables involved, but we've ended up in a scenario here where the supply and demand balance are exceptionally tight. Lumber and OSB are not the only product in this place, but certainly it's created an exceptionally valuable commodity environment. We may look at it and ask, when do we think this dynamic may change? When do we believe there's a little bit of production to come online?

But also, as demand increases, I'm not sure how this balance really changes. And one of the two questions … we need to ask ourselves the question. Two things needed to happen to resolve this imbalance is going to be either supply needs to increase, or demand needs to decrease.

Hopefully, Ali can shed some light on what she thinks going forward. The questions could be, is this a stage of volatility? Is this the new normal?

Well, I think it's going to be a little bit too early to really say if this was normal or not. Hopefully, we all agree this extreme volatility is painful on the business.

We do think there are some increases in supply coming. There could be some headwinds on demand, but that's a little premature. I think to expect continued volatility, certainly in the near term to mid-term until one of these two things changes.

Going back to the word normal, and we think about what normal looks like. We also need to consider the tendency of markets to gravitate towards the cost of production over time and forest product tomorrow. We all need to challenge our historical assumptions around this breakeven level. We can all draw our conclusions as to what normal may have been in the past, but moving forward, also think of all the inflationary pressures currently unforced.

We get fuel costs. We get transportation disruptions, logistical challenges, wages, labor rates, inflation of raw material. Often in places we rarely think of … all these things are tremendous inflationary pressures on the cost of production. And we start to think about what normal is.

The one thing I'll leave everybody on the call with is to expect this cost of production level to be higher than it was historically where it settles in. I don't know if we all know exactly where this inflationary spiral is going to end up, but safe to say it's higher than what it was in the past.

Scott Doyle: Good afternoon, everyone. Excited to be speaking with you here today. Again, I’d like to thank James Hardy for putting this on. On our slide, we have some good news out there and some bad news. Unfortunately, the bad news is we continue to see transportation challenges all throughout the industry. We've already been short around 70,000 drivers to this point, but now experts are starting to say we're probably going to be closer to around 100,000 or over 100,000 by the end of 2022. We can see pressure starting to mount when companies like Walmart are starting to throw around amounts of up to $110,000 for drivers in their first year.

It's imperative to get them into the door to keep all the supply moving. We're now starting to see another added layer of complexity with fuel surcharge, as the recent fuel costs have really started to skyrocket as well. There's obviously no surprise and shortage of material.

We continue to see a large amount of pricing pressure, due to anything from shortage of raw materials and core materials going into the products, as well as the transportation going into it. Just as the Walmart example, we're starting to see a lot more call for rising [prices] out in the field and it's getting harder and harder to fill all those positions. You know, with those increased transportation costs and all those factors going in, I think we're going to continue to see that for some time now. For me, the good news though, we are going to start to see added production from suppliers in the second half.

One of those is going to be coming from our partners at James Hardy. We should start to see their production coming. Probably end of this year, which will be helpful. And the decking side of the equation is going to bring on some added production as well. It should help there. And we should also see some in sheeting.

Mike Farmer: Great. Thank you, really appreciate the update and information there. Now I have the honor of introducing Ali Wolf, Chief Economist, Zonda.

Ali Wolf:Thank you, Mike. And I am excited to be back with you. There is so much going on and I know we're all just trying to wrap our heads around this. We have about 35 minutes and we're going to get through a lot of different content. But just as Mike mentioned, I am Ali Wolf, Chief Economist, Zonda. If you're not familiar with Zonda, we are a housing data and consultancy firm. We check the entire building life cycle from raw land, all the way up to the closing out of new home communities.

We collect our data through different measures. We use satellite imagery. We have our advisory team, that's going to office visits. We have five hundred people in our research department calling new home communities across the country seeing what you'll see today. And we're driving the communities as well.

But while our proprietary data is on the new home side, of course, we must look at what's happening in the existing home market. What's happening with policy. What's happening internationally. And we’re going to discuss a lot of those different trends. Like I said, in the next 35 minutes we'll go through five, six. We’ll start high level.

Look at what's happening in the economy.

Talk about housing, talk about the buyers. Talk about the market challenge we're running into today. And finally, we'll finish with our forecasts and final thoughts. Now at the economic backdrop. I want to start on just one slide. We're going to spend a little bit of time on this because some of these topics, I'm not going to hit on more, but we know this is part of the fluid backdrop we have.

And the first is of course, we have the war in Ukraine. And we never want to talk about what is happening in Ukraine without acknowledging the human life of it. But also, what does this mean for the economy and for the housing market? And you'll hear me mention this a couple of times throughout today's presentation.

Another part of the backdrop is the volatility. When you look at the stock market, we have good days. We have bad days, and we always will. But the volatility has seemed to pick up since the beginning of this year. A little bit later, when we talk about the buyers, we'll talk about what the stock markets, what the current trends look like and what that could mean for overall home shoppers’ inflation.

We're now at a 41 year high after the data came out yesterday. And the challenge with inflation right now is a lot of analysts believed the overall level of inflation was going to come down as you start to see some relief on the supply chain. That’s still the expectation, but we know the geopolitical challenges. What's happening with Russia and Ukraine is making it a little bit more difficult to forecast inflation and pushing out some of the timeframes of what was originally expected.

Now, one of the categories that influences things is of course oil prices.

We are nowhere near the record high of oil prices. And in the past couple of weeks, we've come down from the recent high in oil prices. But what we've been through recently is oil shock, where we had the fastest jumping oil prices on record. Last I looked, this morning, we were a little bit over a hundred dollars a barrel. What we know about the oil prices is that has gone up. Some other imports into the US have become more expensive. And then obviously. I agree, one is well-aware of what's happening with the gas tank, and we just must watch how high oil prices go.

And how long do they stay? Another part of the backdrop is we have already seen about three weeks ago. Now the Federal Reserve raised the short-term interest rates by twenty-five basis points. Note I said short term, different than mortgage rates, but we also have seen that recent spike. And you'll hear me mention rates a few different times throughout today's presentation, providing context to it, and then talking about what it means ultimately for the housing market. For now, we still have steady demand.

Companies are still trying to hire.

We still have the homes that are market [price] selling very quickly. But again, we'll talk about how we should be thinking about affordability and planning. I think one of the reasons we are still seeing some of housing demand carrying on, even with 5% interest rates, is the idea our labor market is exceptionally strong. When you look nationally, we have 60% more job postings today compared to where we were before the pandemic. Companies are still trying to hire. And our national unemployment rate right now is 3.6%. What is important when we look at the labor numbers is to look at the high-income. And the reason I say this is when you're looking at housing demand, obviously, we're going to have buyers in all these different categories. But to me, the high-income job sector is one of those key components to track. Where are we seeing the most strength supportive of a strong overall housing? The percent you're looking at, we're comparing the high-income jobs by market compared to where they were in 2019.

We like 2019, because back then was the lowest unemployment rate we had had in 40 years. If you're at a hundred percent, you've recovered all those high-income jobs, all the markets I'm showing you here, are markets that have not only recovered those jobs but have grown since. Look at Austin, almost 120%.

We know the same thing for Dallas, Raleigh, Jacksonville, Tampa, Nashville. You're going to start seeing these markets show up on the top of a lot of the lists. We know there's been migration there, second headquarters, companies just moving there and contributing to the overall labor market and some of the strengths in the housing market.

Generally speaking, though, we know in the economy, people want jobs. And you heard Scott talk about the rising wages with Walmart. We're seeing wage growth, across the sectors. When you look at wage growth, there's a lot of different ways to track this. I like the employment cost index.

This shows wages are up 4% compared to last year. Growth is the highest it's been in 20 years. We now have this back. Where we know there are a lot of people working. We know companies would like to grow more. They're just running into not having enough available labor.

We're seeing wages go up. We know people are willing and able to spend their money. We're seeing that across the economy. We continue to run into these supply chain problems, not just in housing, but across the economy. We have this supply and demand imbalance persisting. That we saw again yesterday, the new inflation data came out with the headline being consumer price index up 8.5%.

The economy is really good.

That's higher than where we were the month before when we're looking at inflation. If you don't remember, what we should be doing is averaging. We're at 8.5% and an important takeaway from the economic backdrop is the economy is so good. You can look at so many different measures and it will tell you the economy is strong, but we're at a point that it’s so strong it's getting a little bit unhealthy and we're trying to get it back to just this healthier pace of growth.

And that's why the Federal Reserve has been active in making a lot of change. Let's step back. When we were meeting last year on this webinar, we were thinking the Federal Reserve will raise rates. The Federal Reserve believed they were going to raise rates three to four times this year, and then they came out this year. And we've already seen the 1.25 basis point increase. Then the Federal Reserve says, “Hey, by the way, we think we're going to do six additional rate increases.” And while a lot of people thought we were going to be doing 25 basis points, we may even be doing 50 basis points. Some believe we will see a couple of those 50 basis point increases front-loaded right now. Just to try to get some of overall inflation under control, but there are a few things I want you to know about. The first thing is just because the Federal Reserve says they're going to do six increases does not mean they have to. If the market starts to slow, if they start to get to healthier growth, they may not go forward with all of them.

The second thing, if you're looking at GDP data, job data, car sale data, even housing data, it starts to slow. You must keep in the mind that's intentional and 8%, 8.5% inflation level is not good. Federal Reserve is intentionally trying to slow the economy to get us back to a better place.

Now here's the discussion point. What can happen – and many of you are familiar with these terms -- is the Federal Reserve could have a hard landing or a soft landing. A hard landing is a recession. Now the Federal Reserve does not want to cause a recession. Absolutely not. But what we'll talk about when we get to the housing section is in an economy so dynamic and moving so quickly, trying to make decisions based on a couple of months of dated data can sometimes get you in trouble.

And, the Federal Reserve is going to have to raise rates. Watch the data. The data is going to be lagged, and then oops, they may accidentally push it to. Again, not their intention. They would love to execute a soft landing. This means inflation comes down. This means the financial markets don't freak out. And then we can just get back to a healthier path.

Now, as we're looking at this, you may be asking yourself, well, you said the Federal Reserve raised interest rates twenty-five basis points. Why is it then mortgage rates are up over a hundred percent? And the answer is what the fed raising rates can tell you to expect mortgage rates to go up. The relationship between the two is not very strong. All you really can tell is if one goes up, the other goes up. It doesn't tell you timing or extent. And the reason the Federal Reserve are influencing the mindset of investors. Investors are looking at “Where should I place my money?”

And they're aware there should be seven in total rate increases this year. We're going to start going through quantitative tightening. And what's happening in Ukraine is pushing inflation levels up when that's the case. The ten-year treasury has been on the rise and as the ten-year treasury goes up, there's a near perfect relationship between a rising tenure and the rising 30-year fixed rate mortgage, which is why there is important distinction to understand what's happening in the economy because that can directly impact what's happening to us here in the housing market.

We see the price increases again.

Let's shift the discussion there. When we look at mortgage rates, one of the things I track every single day is the 10-year treasury. And this morning, the good news is it's come down a little bit from where we were at those high levels. Hopefully we're going to get new data tomorrow on mortgage rates. It'll be around 5%.

I've got a quote from a lender. I'm just doing research and yesterday he said 5%, but we're still expecting more volatility. And what we see on the mortgage rate environment is we have some people deterred by these rising mortgage rates. We'll talk about prices a little bit later. People are saying, “Rates are going up; prices are going up. The market is still frustrating. I don't want to be involved there stepping aside by choice.”

I got a message from a lady yesterday who said she was quoted a 6% interest rate ... the highest I had ever heard, but she was under contract. She was picked for a resale. They quoted her 6%. She had to dropout. Some people are needing to drop out by force because of how high the rates are. But for other consumers, we know they're motivated by this: I don't want the monthly payment to go much higher. I want to lock-in. Maybe some people already have a rate locked and they're trying to just find something secure they can have lower.

And what we know -- and this goes back to the challenges with real-time data -- is we've seen a mix of both where activity is still strong. It has shown signs of weakness. The most recent data we have is through March. Obviously, we've seen some changes since the beginning of this month, but as we look at what we saw for March, we're looking at the average sale.

Now, let me tell you why we're looking at this. I could show you total existing home sales or total new home sales, but in a moment, I'm going to show you inventory. And if I show you sales numbers, we're going to see some of the sales numbers are down. And that's a bit misleading because they're down because inventory has only gotten tighter over the past year.

What I like about the average sales rate is this: Saying we don't care how many homes are on the market. If you're a builder and you're selling homes, how well are you selling? With the caveat. The fact that through March, ninety% of builders were still capping sales. This still isn't your perfect measure of the market.

But this is a better market measure of overall demand. March data is purple; March of 2019 is yellow. You can see all the markets are still outperforming where they were compared to pre-pandemic levels. And some of these markets are Riverside, Las Vegas, Phoenix, Orlando, Jacksonville.

These are some of our big migrations, right? LA is a market some people have left, but it's also a market under-supplied and constrained for so long that available homes are still selling. Now, like I said, I don't want to look at the total sales number, because if you look at new home community count anywhere where there are five or more units for sale, the data continues to go lower. Meaning more builders are still selling out of communities quicker than they can replace them. We'll talk about that a little bit later with land and land development, and when we expect that to turn around, but we know that's happening on the new home side and we know it's also happening on the active listings side a little bit.

Bottom is showing you the active listings for 2022. Now part of this is a bit skewed by the fact we still have a high percent of homes pending within a couple of weeks. And if they go pending within a couple of weeks, they don't get captured in the active listings data. This shows the market's a little bit tighter than it is.

Inventory is tight on the resale side, partly because people have refinanced and they're choosing to stay put, and partly because some people would love to move right now, but they're just afraid if they list their home and they sell them, where are they going to go? And again, that goes back to how can new home market step in and supply some of these homes, given the constraints we have.

And we'll talk about that in our forecast section, but I think we can all acknowledge it is a very frustrating time to be a buyer, especially when we continue to see the level of home price growth. We talked earlier about basically 120% of the high-income jobs recovered in Austin. Then you can start to say, okay, well, it makes sense.

There's 50% home price growth across the market compared to last year, as you look down this list, Austin, Raleigh, Phoenix, Tampa, Dallas. Again, these are the markets we talked earlier about. High-income and linking them. That data's for the resale side, we go into our Zonda database.

We track all of the actively selling new home communities. We can look at what are we seeing in terms of new home price appreciation. And as you look at this, you can tell the percentage growth is smaller than what you're seeing on the resale side. And that's because the new home market is susceptible to mix shift.

What homes are on the market? What product is changing? Where are the locations changing? That's going to impact the overall price. To adjust for this. I mentioned earlier we also have our division president survey. We know 97% of builders we talked to in March had raised prices month over month, 60% of which raised prices $10,000 or more.

We see the price increases again. This is through March, partly because of pricing power and the fact there isn't inventory, and you still have long interest lists. And partly because land costs are expensive, the labor costs are more expensive, the material costs we’ve seen some relief, and there’s a little bit more relief. But if you look at the year-over-year change, material costs are still a lot higher than where they were last year when we're looking at this.

Maybe some people are falling off on the margin. Interest rates are making some people nervous, pushing some people into the market. We know supply is still extremely tight, prices are still going up. And then the important question is, who are the drivers of the strength and how are those drivers holding up?

And, if you've been on really any of my presentations over the past couple of years, I'm going to show you a slide you have seen, and you will continue to see from me. This matrix, we created at the beginning of the pandemic. Remember why we did this? This was 2020, and we're like, what is going on? Geez, the market is strong, let's sit back and acknowledge. Who's buying? First time buyers move up. Luxury. Second home, all those different categories. Why are they buying? And last year, all these different categories would have checks over them.

Yes, work from home. Yes, demographics. Yes, great homes. Today, what I would say is four of these still have a very solid checks. We still have some of the demographics we'll talk about. We still have home equity. And I think the fear of missing out has only grown since then. The work from home, check. Yes, we still have people working from home. Yes, they're still looking to buy. There was a rush of people pulled forward when the work-from-home was impacting them every day, and the stay-at-home orders were in place across the country. And there were a couple of categories I would say are still checks in today's market but become a bit of a question mark.

At what point does some of these tailwinds start to be headwinds? We have the stock market strength. Yes. There's volatility. We have prices that continue to rise in a rising rate environment. We're watching people get back to normal every day.

But let's take some of those categories and let's dig in. We're talking about rising mortgage rates and there are some shoppers incredibly sensitive to mortgage rates, and we'll show the math behind that. There are some shoppers, just not sensitive because they have other factors driving their purchase.

And in some cases, you have people buying off their wealth. And yes, we've seen the S&P 500 come down from recent highs. I think some people feel just a little bit more uncomfortable because it's not as strong or the portfolio isn't as strong as it was a few months ago. Looking at some of the longer-term trends, what kind of wealth have people accumulated? Accumulated like the S&P 500 over the past five years, still up, or almost 90%?

We see the strength in stock people are willing to tap. It’s not as big of a deal if you must take on the higher mortgage rate. And then you have the equity, the average home equity compared to last year. And I want you to keep in the back of your mind, California, one of the highest over the past year and Texas.

Let's think about equity, who does this impact? Well, if you're a first-time buyer, this stinks, because you haven't been able to enjoy the renovated prices. If you're a buyer trying to move-up within the same market, you’ve seen a bit of competitive advantage, but it's not that big of a deal.

If you are taking out a cash-out refinance, which we know has been increasing, this is important. If you're moving down, this becomes important. If you're moving further inland from the central business district, this becomes important. And if you're moving from one market to another, this is when it gets impactful.

Demographics are about as good as it gets.

Some of these wealth shoppers don't care as much about interest rates as some other buyers. Let's look at the migration. I love this data. It comes out once a year and by the time it comes out, it's already dated, but it's the best data we have to track where people are moving to.

This comes from the census. The 2021 data is only through July 2021. When it's out, it's dated, but you can track this over time. And this is showing you markets in the country with a population of a million. Have more people moving in and moving out, you can look down the list. That's your top ten.

And then the markets are listed below would round out your top fifteen. Again, you see Austin at the top. Now we've said number one for migration, number one for high-income job growth and number one for home price appreciation. But you think about the buyers in a market like Austin. We've run the numbers.

What is a like for like home? A 2,000 or 2,400 square foot home in Austin is $550,000. In the Bay Area, it's $1.5 million. Again, if you can tap the equity, if you're coming in and Austin still looks cheap, despite 50% home price growth -- and consecutive at that -- you can see how. And the market's still can run. The fact it is still running, despite having some of those headwinds, then you look at demographics and people that study the market are enthusiastic about demographics -- and they should be -- because right now, demographics are about as good as it gets.

When you thought about forecasting, many of us were saying, “Look at 2020, it's going to be a good year.” Even before that, just based on these numbers alone, the largest share of the largest living generation is between 29 and 32 years old, completely corresponds with when people typically start to get married, have kids buy homes.

The larger cluster of them start -- obviously, people have different choices of when those decisions are made -- but when you look at millennials, we had this interesting thing happen in the data I’m going to show you. For millennials. I have done a survey every year for the past six years.

And one of the things we wanted to know when we started collecting the data is if you're a millennial and you own a home, what size home do you want? And we wanted to use this to say, “You can build a smaller home.” Millennials are fine taking a smaller home because they're trying to just get onto the homeownership.

We closed the survey in February of this year. Forty-four percent of millennials own a home under two thousand square feet. Let me give you context before the pandemic. That was 70%. Now, before you go and say, “Wow, I think something went wrong with your data collection this time around,” I know that's such a severe change. One of the important things is that when we talked about millennials, I'm thinking back to 2015, 2016. We were saying, “When we’re willing, I am going to buy homes.” Where are they going to buy homes? And then we were at a point going into the pandemic, the millennials were the largest buyer in the market.

What this data is capturing is not that millennials are just buying larger homes. We don't just have first-time buying millennials. The pandemic really pushed to move up millennials. Now we're capturing who is buying in entry-level home. That's getting included here, but also the fact we've had people that have moved further out and have gone larger for their home size. They've bought a move up home. They’ve moved from a high-cost area to a low-cost area, and they've increased their square footage there. But this brings up a really important point. And as we look at millennials and we're enthusiastic about this group, I think some are in the move up category.

They're part of the wealth accumulation. They fall into some of the earlier positive factors I was talking about in the market, but then you also have a lot of the millennials are first-time buyers most sensitive to affordability. They're trying to get into the market today. And they're really running into a lot of challenges, which is where I want to take the discussion to what I'm watching most closely.

When we do our monthly division president survey, again, this is through March. We had builders saying, “We raise prices 25, 30, $40,000 month over month. And the home still should sell within a few days.” We know one in four builders aren't having any challenges in today's market.

But we also know there’s still some hesitancy from buyers, but most notably we've seen a shift where builders are saying they had people already pre-qualified, and because of the higher interest rates, they can no longer qualify, or buyers are coming in and they're enthusiastic, but they can't get qualified in the first place.

And the top two quotes I have shown here, I think are important to digest. Which is we significantly raised base prices and seem to have hit the wall with the buyer, or demand is good, but losing more people due to pricing. One fourth of the builders say everything is fine. They're really catering to this group on the right.

If you're a relocation buyer, we provided some of the math behind that. If you're a wealth buyer, if you're a move up buyer, if you're an investor, this market works for you. It's frustrating. Prices are going up. There are still some bidding wars. If you're a local buyer trying to compete with someone from Washington state, if you're a lower income buyer, if you're a first-time buyer, if you're just buying off your paycheck versus your wealth, this market is very difficult to navigate, and you're always going to have winners and losers in the housing market.

But the spread between these two has really grown. And to me, it's provided some risk to the model. Now we'll talk about what we're seeing on the ground and some possible solutions to this, but I just want to go back to the discussion of mortgage rates. Yes, they're up. Yes. Some people in. Yes, some people out. But let's provide some numbers behind it. Now, if you were someone who was trying to buy a $450,000 home at a 3% interest rate and you were capped out, that was the highest you could go for payments. Interest rates went from 3% to 4%. The same payment for that buyer is a home at 400,000, not $450,000.

Then you look at 5% interest rate, the same payment. You go from $450,000 to a $350,000 house. And not everyone is capped where they can't put another penny towards housing, but we also are acknowledging the reality for some consumers. A1% chance. And interest rate translates to a 13.2% change in home price.

People may have to start compromising at this point. Do they move further away? Do they take a less good school district? Do they take an attached home? Do they compromise on something brand new? They have to have a home in the resell market. Maybe takes a little bit of work. There are some compromises that need to go, especially we're in an environment that has the compounded effect I've been presenting on for a while. And I started warning about it too soon, but I kept saying I'm really nervous interest rates are going to go up and home prices continue to go up. Let's look at the math. I'm going to use Houston, just because it's the top market on this list.

At the beginning of this year, 55% of households in Houston could afford the median price new home. Then we saw interest rates go up, home prices go up. You saw some of those buyers drop out where we are today. As you went from 55% of households that could afford the median price new home to 45%. Now, before you ask, there is no number I can tell you … if Houston gets to 40% … all the market stops …there's no number.

Look at Miami at the bottom of this table, 14%. Some markets can continue to do well with a completely different affordability number. And as both of those are going up, we are losing. At first, we started losing buyers on the margin. Then you start cutting a bit deeper. To me, this begs the question of how we get to a point the housing market is healthy, so that we can cater to all different buyer groups.

We can continue to see moment moving forward. And I ask myself, what are builders planning to bring to the market? And we supplemented this with my question going out to the builders. And what we found is 70% of builders said their new communities will be the same square footage of the communities on the ground.

Today, you have about 20% of builders -- a little bit under that --saying they're going to increase their square footage. We think partly because they’re catering to a higher price point, their buyers are asking for more space. And partly because it would be a bigger plan. Because they're limited by zoning restrictions. Then you have, again, a little bit under, 13% or 14% saying their total square footage is going to decrease.

And I'm going to go into this. But one of the common threads we saw is the addition of more attached product to try to capture a wider range overall. When we're looking at the market, I want to go back to detached. Consumer research shows customers say they want a single family detached home.

That's why we see it as generally the larger share of the market. We still have 78% of new homes being built today detached. Why do I bring this up though? Is if you look at it by market, look at San Antonio, Austin, Houston, Lakeland, Sacramento, Columbus, Phoenix. These are some areas with a lot of positive migration that is detached. And to me, this is the silver lining in a lot of the discussion, which is there is still the ability to make some changes to the product. Obviously, it's difficult to do. You must work with the cities.

I know there are so many things in the way of this, but to me in some markets, like LA, the design solutions, they're trying to get even more creative. And some of these markets like San Antonio, the creativity hasn't really had to hit. And I think that's still something to change.

Now, as we look at this, we have some builders that will just say, “There is absolutely nothing we can do in our market. It's too late for entry level. Our prices have gone up. Land, labor, materials. It's not going to work.” But then as we look at some of the other comments, there were things like, “We're going to look at higher density, single-family detached.”

We know consumers liked detached. We're going to focus on density. And do some different level of finishes. There still different moves to adjust for how the market is evolving.

What I think becomes important is -- as you're shifting the product -- looking at some consumer research. Again, this is from our millennial survey, and we asked, “What are the highest priorities?”

The number one answer for millennials is a large kitchen. The number one answer for the boomers is a large kitchen, a nice kitchen. You have the barbell of demographics saying don’t skip on the area I want to socialize in, that I spend a lot of time in. That really matters to me. You see another component is office room, which is tricky because obviously we're trying to talk square footage and price.

We have an equal share of the millennials say they either want a big backyard or just give me a functional, a good backyard, somewhere I can socialize and enjoy, but I don't have to have it huge, especially if it's going to impact the overall pricing. Let’s go to the final section here.

Expect to see more homes coming to the market over the next 24 months.

We have about four minutes left to go through forecast and final thoughts. And I want to start by acknowledging that we know more building can help and the supply shortage we've talked about earlier. But it's very easy to say, “build more homes.” It's very difficult to get more homes built, especially when we're looking at constraints across the board.

When we're looking at forecasting out starts, we like to start with lots. We think lots become very important to determine if it's even feasible to get more homes. Total upcoming lots from our database. That's any of those that with equipment on site going through excavation or have road work. Up 26% compared to last year in the fourth quarter, fourth quarter being the most recent data available.

When you look at total upcoming lots, you can distribute them by timeframe. Six percent of the Watts were in the streets in phase, in the fourth quarter, which means they became available to builders via a vacant developed lot last quarter in the first quarter. We started to see more. Lots started to see more vertical building.

Then we have 25% of the streets paved, which means this quarter we're in right now, we're going to see more of those BTLs coming to the market –70% -- and excavation. Available to the builder at the end of this year, available likely to the consumer towards the end of next year. We see distribution matches up in most top markets across the country where you see it skewing more heavily towards the excavation phase.

For us, this means we expect to see more homes coming to the market over the next 24 months. For this year, we are calling for 5% growth in starts. I found out recently we are on the high end of overall forecasts. For us, we're looking at the land and lot data to guide this, but also trying to pull back based on what we know. What the constraints are. If we don't see any relief on any of the different components, we obviously will be too high for this forecast.

But as we look at the challenges, we did try to consider the fact there are still government service problems. There are still land disruptions. Last year, this time only 40% of builders said they had a labor shortage. Now we have 90% of builders and 94% saying supply disruptions. I know there's some early rumblings there was relief. But we still have through March. All of the builders are saying this is an absolute headache.

And when you look at it by category, we asked the builders of these different groups, which one are you having? No shortage, some shortage, or a serious shortage? Some appliances, cabinet, HVAC. No surprise garage doors, windows and doors, HVAC, appliances, cabinets. We're looking at this, we're calling for 5.1% growth in starts.

Again, the risk is to the downside. We gave too high of a forecast. For sales, we're calling for 5.5% growth contingent on the fact we do see inventory go up a little bit. We know some homes built as spec last year become available to consumers this year, where that's pushing some of our numbers up.

We think sales caps go down as the year progresses and the demand picture looks softer. Look at the context though, when we're calling for 5% growth, which puts us still below where we were in 2010. Ultimately though, we're watching affordability. That can be the wild card where you have initial rush.

And then you see the market starts to pull. When we're looking at the market, I think we all can acknowledge there are challenges ahead we need to be paying attention to.

But I also think we in the industry need to remember, why home ownership? We need to communicate it with our clients, with our sales teams, remembering to ourselves. There is value in owning a home, especially in an environment where we have 8.5% inflation. A lot of people are looking at housing as inflation [increases] and hedge lock the largest share of [their] monthly budget.

And you can always refinance later if interest rates come down, but locking it now gives certainty, especially if someone can afford the overall monthly payment. For me, I'm not so eager to sell the homes to people just trying to enjoy the upside and pose some risk to the market.

But if you have someone coming in and they're having a kid and they want to have a good school district, and they're planning to stay there for a while, they're saying to themselves, and you don't want them timing. I can't tell you how many people I know waiting for the market to drop.

And then we continue to see the prices move the direction they are. Plus, we know going back to the inflation hedge and, and trying to lock in a payment. We know rents continue to rise. We didn't talk about it here, but when you look at rent growth, we still have rent growth. That's double digits, matching, sometimes a little bit slower, but still rising a lot compared to the for-sale market.

Just remember to educate consumers on down payment options. I can't tell you how often I hear people have no idea you can do a low down-payment option, or there’s some shame in a low down-payment option. Obviously, that's going to impact the monthly payment, which will be a question, but I think it’s important to keep reminding consumers of any kind of incentive to help people get their closing cost credits. We know that can go a long way for some consumers trying to get over the final push when they're nervous about mortgage rates and looking for a slightly better rate.

Mike Farmer: Thank you, Ali. Great presentation as usual. I really appreciate all your insights. I learn something new every time I listen to you.

Q&A

Q: Ali, will rising interest rates reduce the number of resale homes and contribute to the lack of total available inventory? Seems like existing homeowners wouldn't want to pay a higher interest rate to move.

Wolf: Yep. This is, this is important, Jack. I think one of the things many of you may have remembered from 2018 -- and some of the past times we had rising rates -- is there's this fear of what's called the lock-in effect. The lock-in effect is exactly what was laid out in the question, when? If rates go up and you're an existing homeowner, why do you want to sell your home and reset the rate? I think we absolutely should be paying attention to that. I think you could get to a point where people panic sell. They get afraid the market's slowing and you could see, especially investors, change the overall inventory environment. Absolutely rising interest rates slow some of the transaction. Who doesn't get impacted by the lock-in effect would be your first-time buyers? But again, that goes back to the discussion of trying to, or needing to, rely on more of our lower-income shoppers. We need to make sure we're positioned in a place to acknowledge that.

Q: What are some of the first indicators, [lot] visit? Watching that might signal a slowdown. Is it traffic inventory or affordability? And do you have any market specific examples currently?

Wolf: Yes, to all the above that was laid out. Traffic? Absolutely. We're watching traffic, but we’re watching conversions, too. People are coming, and then they're talking to their families, or they're talking to their mortgage lender, and it's not working. Conversion is one of the numbers we would track. Cancellations? Absolutely. We are tracking. Going back to the market example, we do a weekly update of the housing market in some markets across the country. And yesterday in new data for Denver, we did start to see a little bit of an increase in cancellations. Not alarm bells increasing, it was still below 2019 levels, but, but we all know cancellations were slow for so long. And just starting to see a little bit of a normalization there. We're tracking price cuts very regularly. And price cuts don't necessarily mean the market is coming down right away, but you're starting to see early signs to track every single day.

I track it on Redfin all the time. Days on market is an important one I'm looking at. And then ultimately incentives. What are your competitors doing? Are they at a point they're hitting resistance? There are a lot of different things to track in the market to give early signs.

Q: Ali, Which markets are the most vulnerable for an economics?

Wolf: I'm going to answer this without answering it. And the reason I'm saying that is we are in the process of working through this right now and what we are doing, and we have some initial data on it, but I don't want to say…

We know this home price appreciation level has been high and we know what feels frothy in some markets. Can we justify the level of home price appreciation? Because to me, if you can justify it with fundamentals, there's a little less risk than markets where you're looking at job growth.

You're looking at the job base, you're looking at migration and all of those numbers, average to below average, but the home price appreciation is far above average. To me, there's something misaligned here and the market will be due for a correction. I'm looking for the kind of confluence of all of those, but I'm not ready today to say which markets we have identified.

Q: Ali, do you expect a shift in home builder market share in the next day?

Wolf: Well, the scale of the national builders and institutional money in the build-for-rent category reduce the share of the small custom home builder. Unfortunately, yes. This has been an ongoing trend, but I think it's exaggerated.

Q: Steve, is there any forecast for when the market might catch up?

Lavalley: I don't know if there's necessarily a forecast. There's forecast for continued volatility because the rubber band is still stretched very tight. We'll see time periods we see some downturns, but the underlying demand is strong enough that we're going to bounce off these bottoms, when they happen.

Q: What do you think the likelihood is we're going to see a recession in the next 12 to 18 months?

Wolf: The risk of recession has most certainly increased compared to where we were. I would put the odds of a recession over the next 12 months, at 30%. And then you go higher as you go further out. What could cause a recession and or be related to a recession? We've seen the spike in oil prices, but a little bit coming down, that's good. You have the fed changing policy. And when the fed changes policy a hard landing is more often. We've seen changes in the bond market and the inverted yield curve, but we know what's happening with the yield curve. What happens in the economy? Sometimes people say the inverted yield curve causes recession, and I've had some conversations with banks that would support that based on what I've heard recently. Some people just say the bond yield curve is your early warning sign. I'm not saying it's a hundred percent guarantee. We do have three signs that point that direction. Just pay attention to the data as a trend.

Q: LVLs are the biggest issue right now. Do we see that bouncing from one product to the next, or do we see LVLs being the consistent?

Lavalley: I'm not the LVL guy, but it's difficult to tell. Certainly, LVL seems to be across many issues. Over the last couple of years, some of the worst. Then, we get to the second worst one and that one looks critical. We're going to be stuck in this spot here for a little while because there's constraints on how fast the mills can ramp up additional production … you have to look beyond 2022 … The next nine months are going to resolve the supply side of things, a small incremental change, but this is probably a 2023 scenario.

Mike Farmer: Thank you to our participants today and to our team here at BFS for all you do every day. Looking forward to continuing to make this a great year. Thank you very much.