“The ache for home lives in all of us, the safe place where we can go as we are and not be questioned.” ~Maya Angelou
In Chapter 22 – Land Ownership, we discussed the commoditization of land on our planet. The land can be owned by an individual, a company, or a government. Land is typically taken from native people by a conquering government. Sometimes this is done by force, and sometimes this is done simply by squatting. These methods are how much of the middle and west U.S. was colonized. It wasn’t until the Homestead Act of 1862 did the American government come up with real guidelines of what land ownership entailed. In most developed countries, the government piece-and-parcels the land out to its citizens. The most common usage of this commoditized land is to build homes. In this chapter, we’re going to focus on the home building industry.
The majority of home building activity is done by large public companies and small, but highly resourced, private companies. There are hundreds of small, privately financed companies and, in 2006, the ten biggest homebuilders represented 35% of new houses being built. Both types of companies get loans, buy huge amounts of land, and then build properties on the land. Individual home owners go through a similar process of securing a loan to buy a home. It’s fascinating to me that all this is done primarily through the transfer of debt with little actual cash trading hands.
Typically, changes in local employment availability will determine the local home building industry. Wealth distribution typically determines the size and quality of the homes in each area. I say typically, because a cliché, but true, saying when it comes to building a home is “location, location, location.” This means that home buyers may place equal weight on a specific location as some buyers would put on tangible considerations like schools, crime rates, value, etc. These ideal locations and places with superior tangible considerations means home buyers will sometimes suffer long commutes. Los Angeles continues to rank #1 in the worst commutes in both distance and quality.
Commutes can also be impacted by local population density. For example, friends that live in the Texas, live in neighborhoods where homes come with one acre per home. My previous home in Bossier City, Louisiana has more tightly packed neighborhoods with a small backyard and above average sized backyard. In Washington D.C./Virginia, where I currently live, there are townhomes which are physically connected to each other. There are almost no front yards and the back yards are as big as a large closet. The city seems to have more people than available housing.
When cities start running out of available housing, the prices will start to rise quickly. I’m paying three times as much for the same size house in Virginia than I was in Louisiana, despite the Virginia house being 60-years older. This, of course, is supply and demand. Housing prices are impacted by changes with supply and demand, sometimes independent of each other. For example, in California, the demand can be high irrespective to the available supply which drives up the prices of similar houses. Some cities are in unfavorable locations and have an adequate supply, but the demand is missing which lowers the price of housing. For example, the mayor Akron, Ohio, says “We have a city of 200,000, with the capacity for 300,000.”
Individuals build homes as well. Instead of a conventional home loan, individuals receive construction loans. Once the house is built, these are converted to traditional loans. There’s quite a bit of conflicting data available on whether it’s cheaper to build your own home versus buying it from a home builder. Conventional advice suggests that the more customization or niche demands you have (i.e., off the grid requirements or ornate finishing) the more building your own home becomes cheaper. If you’re fine with the homogenous design and features offered by a home builder, then you’ll more than likely save money buying the house.
In 2014, 50,000 individuals built their own homes.  To me, it’s not important how many people built their own homes. I do think it’s important to focus on how the home building industry is founded largely around debt. If you’re a frequent reader of this website, you know that the entire Financial Genome is built on the belief that the whole system is real (and legitimate), and it’s enforced by a government. If either of these two conditions cease to exist, or are weakened in any way, the entire system gets put at risk. I’ll save apocalyptic planning and the lack of a government for another chapter, so we’ll keep the enforcement by our government intact. In 2008, we got a glimpse of what happens when people get insight into how complicated and crazy our system truly is, and what happens when our beliefs are challenged.
For most people, the dream of owning a home is simple, and we assume the system that supports the dream is also simple. A company buys land from the local, state, and federal government. A company builds a house on that land and sells it to you. You buy the house and have achieved the “American dream”. This is how it would work in an all-cash system which we don’t have. We have something less secure, and the USA saw it unfold in 2008.
We’ll stay out of the political and ideological arguments in this chapter, but I believe the start of the 2008 financial collapse actually started in 1995 when President Bill Clinton changed the Community Reinvestment Act which forced banks to lend to more low-income families. This started a slow departure from what banks were willing to risk when they issued loans, the risk people were willing to take in getting loans, and finally, what practices the government were willing to enforce.
To force banks to loan to low-income families, the government provided default protection to many banks. This made banks more comfortable with taking risk and issuing loans. With interest rates dropping, people felt they could take more risk with a mortgage, despite the rapidly rising housing prices. People were focused more on the monthly mortgage payment and less on the purchase price of the home. Banks saw this as an opportunity and provided alternate mortgage types to keep the focus on the monthly mortgage payments such as Adjustable Rate Mortgages and even Interest Only mortgages. The euphoria was so great that banks starting loaning money to people with barely any income.
Banks realized that the government only provided insurance on a small percentage of the loans, so other banks provided more insurance to help banks loan more money. The insurance premiums were low because the insurance policies invested in mortgages that were bundled and traded like stocks. These insurance policies became so popular that the insurance companies started to need their own insurance policies. Resultingly, banks started providing re-insurance policies that were cheap because they too were invested in these securitized mortgage bundles. The government enforced it all and also invested in the securitized mortgage bundles. In less than two years, the bubble popped in 2008.
The home building industry came to a screeching halt. Home building companies and the banks that primarily dealt with home financing went bankrupt and either disappeared or were bought out by bigger banks. That was an oversimplified version of what actually happened, but the basics are all there. It changed the whole fabric of America…or did it?
In 2019, we’re facing similar issues. There are slight variations that may protect us this time such as increased down payment requirements. A 20% down payment used to be the standard for home buying. This protected the buyer, the bank, and the home builder by providing more cash (and liquidity) into the system. Banks are required to have greater cash reserves when they loan to home builders and home buyers now. The government is slightly more awake this time.
The home building industry is interesting. For the most part, it’s an industry built entirely on loans with barely an cash transferring in the system. If you’re thinking about purchasing a home in the next five years, it’s important to evaluate the home building industry for trends. One of my favorite sayings in personal finance class was, “A house is only worth what someone is willing to pay for it.” This was important to me because many people fall into a trap of thinking a house has an intrinsic value to it and your mind anchors on that imaginary price. Also, the saying should be changed to “…willing and able to pay for it.” If the economy is in a recession, there may not be someone able to buy a house and get the loan for it.
Over the next couple of weeks, I will be working to create a feed of important reports that Wall Street and economists normally read. I’ll update this chapter when that feature is available.