Rate resilience: Strategies for builders navigating high interest

Zach Wojtowicz:

What’s up, everybody? Welcome to “The Building Code.” I’m Zach Wojtowicz and today I’m flying solo. Charley couldn’t be here. He sends his well wishes. It’s unfortunate because today we’re getting into things that Charley loves, like the economy and interest rates and data. That’s what happens when you get too big time, can’t make all the recordings, but that’s okay. We’re going to be just fine without him.

Today, we have Nikolas Scoolis. He’s the manager of economic research at Zonda. Zonda is a market research firm that aggregates data and really kind of tells us about what’s happening. We’re going to talk a little bit about the interest rates. We’ve covered different topics like this a time or two, we’ve had economists on, we’ve had market researchers on. Here’s another one. I really love these episodes, so without further ado let’s get Nick on here and let’s dive into what’s happening out in the market.

Hey, Nick. Welcome to “The Building Code.” It’s great to see you today. It’s your first time on “The Building Code.” How are you doing today?

Nikolas Scoolis:

I’m doing great. Excited to be here. Thank you for having me.

Zach Wojtowicz:

I love it. Well, we really appreciate it. I’m really excited to talk a little deeper about a hot topic in retail or, excuse me, retail, residential construction and real estate, not retail, about high interest rates. I recently just purchased a home, and I’m telling you, that interest rate hurts a little more than my old 3%, so a little bit of personal impact there for myself. Before we dive into that topic, though, we always like to ask our guests tell us about yourself. How’d you end up at Zonda? What’s your expertise?

Nikolas Scoolis:

For sure. Well, prior to Zonda I was in another commercial real estate data firm. I’ve been at Zonda for about five or six years now working in economics department with our chief economist, Ali Wolf, who some people may know, and we do all sorts of analysis, insights, long form, short form, both public and private projects for large public home builders as well as private ones. Yeah. It’s been exciting.

Zach Wojtowicz:

Love it. Would you tell us a little bit about Zonda maybe for those that aren’t as familiar about kind of what Zonda is representing?

Nikolas Scoolis:

Yeah, for sure. Zonda is the nation’s largest new home housing data provider. In addition to being a data provider, we also do advisory consulting work, so we inform and advise as well as kind of leverage our proprietary data into insights. We like to say that we’re building the future of housing. We have national coverage. Our research covers over 60% of the new home market. For reference, when the census is putting together the new home sales figures, they’re only surveying about 10% of the market, so our coverage is really substantial and expansive. We are fully covering almost a hundred metro areas, which includes more than 440 counties.

Zach Wojtowicz:

Wow.

Nikolas Scoolis:

A lot of data. Yeah. A lot of data that we collect internally and that we are very proud and lucky to have.

Zach Wojtowicz:

Yeah. Are you primarily collecting that data through surveys or what kind of … Are you getting requests for those data pulls? What is the aggregation of what you’re collecting?

Nikolas Scoolis:

Yeah. We have a full-fledged research team that actually calls and collects data from online sources on projects or subdivisions across the entire country. They’re doing this really by hand, but then to supplement that we also run surveys with builder presidents to kind of get the more sentiment and more of the emotional stuff, how builders are feeling, what they’re maybe seeing where the data … People like to say numbers don’t lie, but sometimes data does lie in terms of how it feels to people, which we might get into a little bit later, but … Yeah. We have sources on both ends of the spectrum.

Zach Wojtowicz:

Mm-hmm. Really interesting. Yeah, there’s the old saying, “Lies, damned lies, statistics.” Does that kind of ring true or are you kind of like, “I’m here to stop the stereotype if it’s good data science?”

Nikolas Scoolis:

I’m a big numbers guy, but… I’m a big numbers guy, so whenever I am building data models in the models, whatever they put out, sometimes people will tell us, “Oh, well, that’s not right.” Well, I’m like, “It’s right, but it’s maybe not how it feels to you.” There’s always a little bit of difference.

Zach Wojtowicz:

Yeah. You’re resisting the urge to hit them with your statistical analysis and your p-values and be like, “No, we have pretty high confidence intervals, sir.”

Nikolas Scoolis:

Yeah. I’m very certain this number is right, but it is what it is to some people sometimes.

Zach Wojtowicz:

I love it. Well, I’m really excited to talk to you a little bit about the high interest rates. Well, not excited to talk about high interest rates. Obviously, there’s impacts there, but really excited to dig into some of those numbers and what you’re seeing and really educate our listeners to something that is probably affecting their businesses, and you can tell me. Give us just the current landscape of what interest rates is happening and how it’s impacting the housing market.

Nikolas Scoolis:

Yeah, for sure. Kind of when going into this picture, we’ve kind of set up 2019 as a backstop comparison year because when you think back to 2019, if you can remember a time before COVID existed, 2019 was considered basically a strong housing market by historical standards, not running red-hot, just chugging along, good numbers, so we like to use that kind of as our baseline. Basically, since then due to the pandemic and due to price appreciation that we saw with COVID unlocking basically where people live, how they live, what they look for in a house price appreciation institution exploded because rates were down. Basically, you could get a jumbo loan for 2.5%. Since then, prices exploded and then rates all of a sudden kind of, if you were unsuspecting, jumped up, and they went up past 7.5%. Those prices paired with that price appreciation basically saw what a home could have been purchased for in 2019 to, say, late 2022, 2023 increased the mortgage payment 60, 70%, even more in some places where the price appreciation was red-hot, maybe, say, like Austin and some of the southeast markets in Florida. Those were almost increasing over almost 100% in that period. Same home, 100% more expensive.

Now, when we’re kind of focusing on today, rates have come down slightly. We’re still elevated maybe at 6.5% or whatever it is as of today. So, 6.5% historically isn’t that high, but when you’re comparing it to people who locked in a 2.5, 3% mortgage, that jump is really, really substantial. The mortgage payment alone when you’re not factoring in house appreciation, that number may be up 50% for the same home on a … 50% on a $500,000 loan. Now, we’re kind of seeing the housing market split into two different markets on new and existing side as well as differences by price point and differences based on regional differences across the country. It’s a pretty interesting time.

Zach Wojtowicz:

Yeah, most definitely. Our customer base is kind of a mix of new construction, remodeler, so nobody is for the most part unable to escape the reality is that even on a short-term project where you’re taking out a personal loan that’s $60-$70,000, you’re paying more on those interest rates, and then, obviously, new construction, they get kind of different products in order to offer their customers, but they’re certainly seeing the effects. I’d like to kind of focus on the new construction side a little bit. When you say the market is splitting, what is happening on that new construction side?

Nikolas Scoolis:

Yeah, for sure. Kind of historically, the new and existing side have basically mirrored each other. The trends that happened in one side of the market where happening in the other side of the market, but because, and as you mentioned that you just recently bought a home and switched from that 3% to the 6%, we’re seeing a lot of people just being unwilling or unable to give up those low mortgage rates because the increase in payment is so much.

What builders have been able to do is both twofold. One, they can build smaller homes, and they can kind of shrink the top-line price, which they’re still packing in price appreciation in a per square footage basis, but the top-line number is more attainable for a lot of people, or they’re able to offer things like incentives, builder rate buydowns or other things that kind of close the gap on that affordability crunch that people are feeling. That’s why we’ve been able to see sales numbers on the new home side that are on a seasonal adjusted annualized rate of high sixes, low sevens, which are historically very good numbers, whereas the existing home side just was at the lowest full-year sales total in the last 15 years. We have two markets operating on different levels of success.

Zach Wojtowicz:

Mm-hmm. That’s really interesting because when I think about some of our customers who do both, it’s kind of probably affecting the way that they run their different revenue streams. A lot of the builders that I’ve interacted with turned to remodeling during COVID because it was something that helped kind of bolster the fact that there was a material shortage, they couldn’t do longer projects, and now it’s like you have this situation where new homes are really hot again and people are probably going to do that and then … What do you see for that remodeler market?

Nikolas Scoolis:

Yeah. Quickly on the new home market, this kind of goes back to what the numbers say versus how it feels is we’re seeing these sales numbers that are really strong, in some places historically very strong, the absorption rates people are being able to get, but then we’ll hear it from builders and it’s like, “What we have to do to close that sale either in incentives doesn’t really feel like the market’s running hot.” That’s kind of the numbers are saying the market’s really strong, but because of the outlay on incentives or whatever it may be it doesn’t really feel the same way.

On the remodeling side, pretty interesting. I would expect that due to the quote-unquote, “lock-in effect” of people having these low mortgages, instead of maybe moving they’re putting more money into their remodeling and staying put in this one place because they either refinanced or purchased a new home and instead of saying, “Okay, we’re going to go pay 50% more on a mortgage.” We’re just going to put money that we’ve been saving over the last few years into remodeling our home. We have people who operate specifically in remodeling and based on the demographics and also of the age of existing housing stock, he calls it the quote-unquote, “golden age of remodeling”, and I think this kind of adds a little fuel to that fire as well.

Zach Wojtowicz:

Yeah, makes a lot of sense. It’s really interesting. I am curious just based off what Zonda provides from a real estate standpoint, is home builders specifically … How does high interest rates impact them compared to maybe other people and verticals in the economy that you’re studying? Because all lending is impacted by these interest rates.

Nikolas Scoolis:

Yeah, for sure. Builders undoubtedly are impacted by high interest rates because they have to be able to make the sales, and often when they’re underwriting their developments it’s years out where interest rates are maybe doing something completely different. What the big builders have in terms of an advantage is they’re buying loans ahead of time, but they’re able to offer these buydowns, but that isn’t necessarily a permanent long-term solution. They’re offering buydowns between 5 and 6%, which for a lot of people is kind of a threshold that’s more affordable. When the number gets into a 5.5, that makes the number doable for a lot of people, but it’s not something that they can just necessarily do forever. There’s kind of a short-term gap that they’re able to close, but if rates stay elevated for years and years and years maybe that becomes a lot harder.

Zach Wojtowicz:

Yeah. Construction is such an inherently risky business even just from the pre-construction process, the investments you’re making to be able to even finance these on top of the production itself before you can actually deliver the product. It’s just interesting how it all interconnects. You could be great on the actual production, but if you aren’t staying ahead of your funnel or developing in the right areas, these economic forces can have a huge impact on the bottom line of your business long term. It’s no surprise that a lot of construction companies can’t survive these types of market forces. What are some of the strategies that home builders can employ to try and mitigate the realities of what happens outside of their control when things like high interest rates or material costs that we saw through COVID?

Nikolas Scoolis:

It’s kind of interesting that we’re seeing this currently. This is almost the opposite of what you just asked, but we’re seeing a lot of builders kind of offer more quick move-in homes, which are homes that are available to be moved in the next few months. Because of the resale side having basically no supply, those are kind of stepping up that inventory, which both apparently is a little bit risky should the market slow, there’s more costs that they’ve invested, but instead of having longer lead times for buyers that maybe, say, they want to put down a contract on a home that isn’t completed yet, that turnaround is shorter, so if mortgage rates do fluctuate in the long term, they can kind of move that buyer in, close that home in that shorter process rather than saying, “OK, we’re going to build this home nine months from now. We don’t know what mortgage rates are.” We’re seeing increase in QMIs, which are both a risky strategy, but it’s one that’s been pretty successful for a lot of builders recently for that two-folded reason. You’re operating as the resale market but also shorter closing times and getting people moved in.

Zach Wojtowicz:

I’m also curious in your research, do you look at the subsegments within the new home construction, the spec builders versus the production builders? Is there any … If not, I just thought I’d ask because you’re an expert, so I assume you’ve probably started looking at those things. Have you? I guess I’ll start there. Do you look at those levels of variances within the new home construction space?

Nikolas Scoolis:

Yeah. I mean, it’s not necessarily in isolation of a builder that only does specs versus a builder that only does public, but, like I said, the QMIs are one of the biggest things we’re watching because historically it’s a risky thing to do, but because of the imbalance on the resale side it kind of takes away some of the risks, so to say. Currently in terms of new home inventory of what’s available for sale, the new home side is making up 30% of all homes that are available for sale. Traditionally, that’s about 15%, so it’s almost doubled from what the historical average is. The public builders, again, also do have a very big advantage because of the scale. They’re able to maybe have their margin shrink and still make money on the bigger size investments, so that’s something to very much watch for. Public builders have the cash, they have the economies of scale to do it, but they also have the public reporting, and they have to drive sales further so there’s also that inherent responsibility.

Zach Wojtowicz:

That’s really interesting as far as the big public builders are just going to be a little more insulated. We’ve had different economists come in and talk about that, that the big guys will have advantages and then there’s other circumstances where the little guys will have their own advantages. What are you guys seeing just from the future of these interest rates? Looking at what the Fed’s going to do is not an easy question to answer, but are you guys expecting in your own models that the interest rates are going to stay kind of at this new normal or is it something that as the adjustments happen that we can expect then changes downstream in the new home market and how does that change kind of the variables?

Nikolas Scoolis:

Yeah, for sure. I think it’s a two-part answer because I don’t think the sub-3% mortgages are coming back anytime soon barring economic catastrophe because that really was just a perfect storm of a situation where it was a black swan event that no one could predict, no one has ever dealt with before, so the Fed was taking every instance they possibly could to try to avoid a depression, which I think was the right response at the time based on what they had to go on because I think you think back with hindsight, it’s a lot easier, “Oh, they should have done this or done on this.” They were operating in a situation that was basically lose-lose for them. We did avoid a depression, but the inflation that came with it was a consequence.

So, I don’t think we’re going to see rates that low barring catastrophe. However, I think it’s pretty confident to say that we should see rates declining in the second half of this year. How substantially is kind of a wait and see because the Fed … This fed is very, very data-driven, and they’ve been that way throughout their whole process. They want to see inflation come down, they want to see closer to the 2% target. The 2% target isn’t set in stone what it needs to be, but there needs to be kind of disinflation, it needs to be slowing, and the recent numbers have been a little bit hot.

On top of that, the job market continues to post a lot of gains despite kind of a lot of headlines showing cuts in the tech sector and things like that, so they’re going to want to see the slowing of the economy. The Fed met today as we’re … Right before we’re recording, they just actually announced that they’re pausing again, but they’re still as a group expecting three cuts throughout the rest of the year. Should that strategy maintain, I think we could see rates either down in the low sixes, high fives by the end of the year, which, again, that kind of threshold of 5.5% [inaudible 00:19:15] for a lot of buyers, but that is assuming that prices don’t start running away again because it’s all intertwined in that affordability calculation.

Zach Wojtowicz:

Yeah. That makes a ton of sense. That is an interesting area as well. We talked at the beginning here kind of discussing the reality of people are holding onto their homes because of the affordability. Let’s say they do drop the rates even a percentage. What is the impact then on the existing housing market in comparison to the new housing market? What would be the … Let’s play the game theory out of like, “If this happens, then here.” I’m just curious for your perspective. I don’t get to talk to experts in economics every day.

Nikolas Scoolis:

Yeah, for sure. That is also a very good point because from a builder’s perspective, you’re still kind of loving this no competition environment. They’re the only game in town. But at the end of the day, they need people to not only be converting from renters to buyers, they need existing homeowners to convert to new homeowners, so yeah. As rates do come down, I think it becomes much more palatable in that 5 and 6% that we could see people starting to start to give up their mortgage, but more importantly the demographics for home sellers is so strong right now because we have the baby boomers who are continuing to retire.

What demographically baby boomers like to do and most older generations like to do is move where their kids are having kids and be in closer proximity. That is either moving markets completely or just even downsizing their homes to something that they can retire in place in or age in place in. That’s a big driver of home sales. Millennials are still the largest living generation, having historically low homeownership rate for where they are in their age cycle, so they are driving home sales. As rates do come down, I think you can expect existing sales to pick up maybe not super substantially, but you’ll just see it continually going exponentially up as rates come down because demand is so much, but that’s also why we’re seeing prices on the existing side continue to go forward even though sales are at the lowest point they’ve been in in half a … Or a decade and a half.

Zach Wojtowicz:

Mm-hmm. Mm-hmm. That makes a ton of sense. Well, we’ve covered a lot today. It’s a topic, obviously, that we get a lot of interest in information, so I really appreciate you sharing your insight. If our listeners are out there, want to learn more about this research or read for themselves, is there a place that they could go in order to kind of consume more and kind of get kind of these insights on demand?

Nikolas Scoolis:

Yeah. Our website is zondahome.com. My name is Nick Scoolis. I’m the economic research … Sorry, I’m the manager of economic research at Zonda. We provide some public-facing blogs, some private-facing blogs with our kind of research, and there are other marketing events that can provide more information on new home construction, rental construction, all sorts of things.

Zach Wojtowicz:

Love it. Love it. Well, thanks again so much for being here today. For our listeners out there, we’ll be sure to link to Zonda’s website in the show notes. Nikolas, it was a pleasure having you on and hope we can again when we’re talking about when the interest rates drop and can see if some of these things play out.

Nikolas Scoolis:

Yeah, that’d be great.

Zach Wojtowicz:

All right. Thank you so much.

Nikolas Scoolis:

That’d be great.

Zach Wojtowicz:

We just talked to Nick over at Zonda who’s a market analyst and really got into some really detailed topics around the high interest rates. Hopefully you’re listening to this and you’re hearing positive signs if we’re talking about new home construction starts there at historic levels. If I could ask him again if we had a little more time, I’d love to know kind of where that is. It’s interesting to think about the long-term consequences of how the forces that be ultimately make decisions to help control the long-term health of the economy and how that affects you, our listeners, who are running construction businesses.

It’s interesting as well to talk about some of the strategies that you can do to try and buy down your mortgages or offer different products temporarily while also looking at additional revenue streams. I thought Nick did a great job making things that seem really complicated actually into very simple terms, and I think there’s room to be positive about where these interest rates are going and that if you’re in new construction, you shouldn’t see a lot of drop-off in your top-line revenue because you’re able to go to your businesses and compare against existing houses that are appreciating in value, but they’re older and not as attractive as a new home construction. I mentioned my own housing. When I was buying a house, my wife and I, we looked at that. We looked at old homes versus new construction, and it’s difficult to choose. Depending on what you’re looking for as a consumer, there’s reasons to wait, which has then led to the remodeling.

Overall, if you want to learn more, go check out Zonda at zondahome.com where you can read some of those public-facing blogs, some really interesting notes. We hope you enjoyed this information today. Nick, thanks again for coming on. It was great to have you. Please like, review, subscribe on all our social channels, check us out, leave us a comment, we’d love to hear from you. I’m Zach Wojtowicz. I’m speaking for Charley. This is “The Building Code.” We’ll catch you next time.