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Hot or not? Sometimes analysts disagree on which housing markets are the hot spots and which one have cooled.

HOT or NOT? Sometimes analysts will disagree on which housing markets are the hot spots and which ones have cooled.

Cleveland is a hot housing market, according to one consultant, but big developers show no interest. It has a declining population, but an increase in the number of households.

Wichita is also hot, according to the same consultant, but nothing has happened except for a decline in housing starts and the lack of a surplus.

But an industry publication examining the same two markets found that housing starts in Cleveland declined 6 percent in 1988 from 1987, and that population growth is near nil. Even though building permits for residential units rose by about 3 percent last year, Cleveland was not among this publication's hot 20 markets, and Wichita was not even charted.

Why such a different perception of the same two markets?

The consultant, Kenneth Danter of Kenneth Danter & Company, Columbus, Ohio, analyzes markets to the smallest detail, including income, wealth, housing deficits and surpluses, population growth and household formation and mobility.

"There are good opportunities in the worst markets, and you can stub your toe in the best markets," Danter said.

The publication, U.S. Housing Markets (produced by Lomas Mortgage USA) bases its conclusions on per capita permits and does not include absorption. "The older cities are going to run quite low on our index," said Brian Bragg, editor of the publication. "By no stretch of the imagination could Cleveland be considered a growth market."

The publication said last year that the housing industry's national recession has broadened to include all areas of the country. Bragg said the assessment still holds in early 1990, with the exception of the oil patch states, "which had nowhere to go but up."

Its 10 hottest markets are Las Vegas, Ft. Myers-Cape Coral, West Palm Beach, Orlando, Riverside-San Bernadino, Daytona Beach, the Florida Space Coast, Seattle, Sacramento and Atlanta.

Danter's 10 hot markets are Boston, Chicago, Cleveland, Los Angeles-Long Beach, Newark, New York, Philadelphia, San Francisco, San Jose and Washington, D.C.

The disparities in these lists show the risky decisions that will face lenders and developers in the 1990s.

"Most developers go wherever the most building permits are, and that makes it a hot market for them," Danter said. Investors and lenders, however, need to compare housing starts with existing housing and other factors to determine whether or not new construction will outstrip the capacity of the market.

On the other hand, developers with deep pockets are buying large tracts of land in depressed markets at discount prices, said Wayne D. Ferguson, president of Lomas Realty USA. They hope to be positioned to profit from an eventual upturn.

Danter agreed that new construction opportunities still exist by filling a geographic, price or conceptual void. "Lenders are becoming a little more sophisticated in knowing this," he said.

A demographic study released in November 1989, by the National Association of Realtors found that new opportunities will be found in the strong housing demand by various groups such as trade-up couples, retiring baby boomers, non-traditional households and immigrants.

Danter's rationale

In an interview, Danter said his firm does analyses from the perspective of the investor, not the developer. As such, he preaches that markets are changing.

"There are a dozen different profiles of buyers and renters," he said, "and it is becoming more and more important to target each one. Not many of our developer clients have a handle on this."

Once these profiles are understood, Danter believes that developers will realize that people do not move because they need a new house, but because they want one.

Along with targeting a market, a developer should be following local housing demand. For Danter, a complete analysis of demand begins with housing starts and adds mobile home installations. From this number is subtracted an existing figure on household growth, based on census and other data.

If the resulting number is negative, it indicates a "hard" housing deficit, which is the best environment for a builder if positive, a housing surplus exists.

To further clarify the picture, the number of uninhabitable units and mobile households are then subtracted. If the housing demand had been negative but is now positive, a "soft" deficit exists in the market, and households are not moving out of existing housing.

A housing deficit might lead to two or three years of overbuilding while absorption continues and the pipeline is getting choked.

Why rent or own?

Danter said it takes two calculations, backed by a lot of phone survey work, to analyze the viability of single and multifamily projects. In the former, residents and owners are more willing to move, while apartment dwellers are more convenience-oriented.

Mobility within a market is another reason for single-family sales. Danter said that Philadelphia, for instance, has modest growth, but benefits from frequent corporate transfers. "Anytime you have someone move in, you have a household on the loose, and the potential for someone to want a new home," he said. Mobility is virtually unpredictable, he added, with no correlation to growth or employment.

One reason for mobility is to find affordable housing, said Stan Ross, co-managing partner of accountants Kenneth Leventhal & Company, Los Angeles. In California, people are moving east of Los Angeles to the Inland Empire and north of San Francisco to Sacramento. The same trend of outer suburban migration has long been occuring on the East Coast.

Ross said that affordability problems are spurring sales of condominiums. In some parts of California, a new unit priced under $200,000 will move because a whole group of buyers has been blocked out of single-family housing.

Developers need to understand how much households can step up rent and mortgage payments, according to Danter. For apartments, he said the maximum increase is $100 a month. But buyers may move up from $75,000 homes to the $150,000-$200,000 range.

Some housing stock is becoming vulnerable. New low-end, single-family construction is hard pressed to measure up to the top end of rental housing, he said. While there is no shortage of homes costing $50,000 to $70,000, anything less than the equivalent of a $600 apartment is a step down in terms of the quality of accommodations. These householders have been upgrading their other purchases and tend to "pile up" in the rental market until they are comfortable to buy. Careful lenders are looking at eight to twelve-year buildout periods for new single-family projects to be financed, he added.

As many renters enter their thirties, they begin to leave three-story walkup apartments in search of $150,000 single-family detached homes. This is the segment of the apartment market that will be most vulnerable, Danter said, projecting a 10 to 15 percent vacancy in the next eight to ten years.

A report for Salomon Brothers in 1988 by Kenneth Rosen confirmed this, predicting that long-term demographic demand for apartments is negative but shows wide variance across regions and metropolitan areas.

Ross said that multifamily starts in California outpace single-family detached homes by two to one. Furthermore, he said that a lot of these apartment projects do not make economic sense because their pro forma cash flows are insufficient to cover the debt service.

The reason they are being built, he said, is that resale prices for the entire project are beyond normal economic patterns. In other words, the owners expect an above-average profit when they sell the project. These developers and others are forecasting continued high demand for housing in the state, Ross said, ignoring that price escalation has leveled off.

Danter said that developers often think they have a red-hot product when what they have is a red-hot market. "It is not always easy to know what is a good product," he said. "It is only during bad times that we can identify a bad product."

The methodology for Danter's apartment studies include reams of "street-level data." His company tracks in its database the rents, absorptions and vacancies for 12 to 14 million apartment units.

Before it makes a recommendation, the firm may survey up to 15,000 existing units in a single market. This data permits the company to advise developers on the feasibility of specific projects, he said.

One of the trends in the rental market is a family orientation, he said, with appropriate amenities and floor plans. With the arrival of children, these households feel a loss of disposable income and a lower likelihood of buying a house.

At the other end of the spectrum is an increase in the number of older adults, swelling the rental pool by 300 percent in some markets. "Several clients are building single-story garden units with attached garages without ever using the word elderly," Danter said, "and these projects quickly will be 85 percent occupied."

For more complex forms of elderly housing, such as congregate care, Ross said that lenders must associate with a veteran developer because the concept is so management-intensive.

Risks and rewards

Developers perform some due diligence and shop their projects among lenders to establish their own comfort level, Danter said, but only 10 to 15 percent of all developers would buy a true market study if the lender did not ask.

Some developers will offer their own study, he said, which should be declined on the principle of a conflict of interest. Optimistic developers may offer a study that "leaps" from the data to the conclusion, instead of taking the smallest step possible.

Ross recommends that lenders rank how certain cities stack up in a particular segment of the real estate market, based on macroeconomic and microeconomic factors. Due diligence can then be performed on a developer and his specific project, he said.

Every lender focuses on certain items in a pro forma. One is land cost, which Danter said is less important if it can be translated into rent. Another is operating expenses, which can be justifiably high or low.

A third key item is the absorption rate of units in the project, which need to be realistic. Lower absorptions do not make a project a bad one, but estimates that are too optimistic are a typical feature of troubled projects. Another mark of a weak performer is failure to recognize the impact of renter turnover.

"Most troubled projects we work on come from lender overcomfort," Danter said. "They require less and less due diligence and it comes back to haunt them." Danter's firm helps turn these projects around by suggesting changes in the marketing strategy, rent, signage, amenities or perhaps the management itself.

The company will recommend similar changes in the proposal stage. "Our job is to give everybody comfort with the product [with a decision] or to kill it," he said. "Our information will kill a concept sometimes and may come up with a better alternative." It turns out that Cleveland experienced an increase in home building last year. "The area went from 5,800 starts in 1988 to 6,700 in 1989," Danter noted, "but we still have a good strong housing deficit."

Housing starts in Wichita declined slightly in 1989, he said, but the area is still a "contender."

Bragg of U.S. Housing Markets said that Cleveland has been a good housing market for a year or two in terms of new construction. But this new product has to compete with a lot of existing homes because Cleveland is an older city.

Which just goes to show that in real estate, "hot" is in the eyes of the developer that wants to build.

David Givens is a senior staff reporter for Real Estate Finance Today.
COPYRIGHT 1990 Mortgage Bankers Association of America
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Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Givens, David
Publication:Mortgage Banking
Date:Apr 1, 1990
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