The Chicken or the Egg

The Chicken or the Egg

What came first, increased land prices, or builders securing land positions for future growth?  It is an interesting question.  Common sense dictates that you should buy low and sell high.  Land should be purchased in a down market and held for market improvement.  However, no one likes to catch falling knives and few builders tend to buy sufficiently long term land positions as a core objective.

So, how do we then account for the current land purchase frenzy in an improving market?  It is actually a simple matter of limited supply and short term planning.  Each year, builders set projections for the next few years, constantly modifying projections on a quarterly (if not monthly) basis.  Now, the builder who has a crystal ball has yet to be born, which tends to result in planning decisions based on current conditions, not future conditions. 

As markets improve, builders are forced to increase staffing to support sales and construction growth.  In turn, they push forward increased projections to align with this heightened staffing and anticipated continued market strength.  Now, knowing that you require at least a 6-12 month lead time in land position to accommodate future needs, everyone starts rolling the same dice at the same time to increase land holdings to both satisfy future projections as well as to justify larger staffing levels, causing land prices to rise.

Then, to support these higher land values, builders start increasing home prices under the premise that markets are heating up so that home buyers are willing to pay more for a home.  Never mind the fact that inflation is flat and salaries may not be increasing.  This often has the unintended consequence of slowing down the sales market as pricing accelerates past the point of current affordability, resulting in short term dips in the heated land values that helped raise home prices to begin with.

This somewhat artificial growth in land values will tend to continue until the next true down cycle occurs, at which point builders start reducing their land positions so they do not get caught over-leveraged on land, causing land prices to either flatten out or decline.  The disappointing fact here is that this is exactly the point that builders should be loading up on land and preparing for the next upturn in the market.

Unfortunately, it seems that those that do not learn from history are doomed to repeat it.  With investment horizons for builders, lenders and non-opportunistic equity investors typically hovering in the three to four year time horizon, I see no end to this strategy of buying high and hoping for higher.  Chicken or egg?  It seems we have a history of continually eating the chickens and then wondering where the eggs have gone.

Until next time…

Keep kicking the dirt!

Jeff Gersh is President of Gersh Consulting Services, a real estate advisory firm, headquartered in Orlando, FL.  He may be reached at jsgersh@gmail.com or 407-468-9328