By Craig Webb, President, Webb Analytics
When one of housing's biggest optimists changes his outlook, attention must be paid. Stephen Kim, senior managing director and head of Evercore ISI's Housing Research Team, had declared in September 2020 that housing had entered a Golden Age. But that changed on June 20.
“The impact to affordability [from mortgage rate hikes] on top of a rapidly deteriorating consumer outlook makes it increasingly likely that a cycle of fear will churn its way through the housing complex over the next six months," Kim wrote in a new report. His updated forecast calls for an 11% decline in housing starts this year from 2021 and a 12% drop in existing home sales, followed by drops in both categories of another 1% in 2023 and finally a return to growth in 2024.
With his reset, Kim joins the herd of economists and housing experts who say the COVID era's pell-mell growth is slowing. The return of 6% mortgages has made houses much less affordable: sales of existing homes fell 3.4% to a seasonally adjusted annual rate of 5.41 million in May and are 8.6% lower than a year ago. There are a record number of homes under construction--largely because of supply-chain hangups--but housing starts fell in May to a 13-month low, while the annual rate of building permit issuances dropped 5.5% from April.
Those numbers don't reflect the impact of the Federal Reserve's increase in its key lending rate of 0.75 percentage point on June 15--the biggest single rate hike since 1994. That's likely to increase rates on credit cards and business loans and have an impact on mortgage rates. And over this all looms the threat of stagflation--a period in which the economy limps along while prices keep rising. The last time this happened, according to The Wall Street Journal, stock price indexes went nowhere for 16 years while inflation ate away at profits. It took a recession induced by Fed Chairman Paul Volcker to snap the nation out of its lethargy and onto a decades-long path of growth.
How do you manage amid stagflation? Nobody has a magic formula, but experts tend to recommend doing these things:
* Focus Extra-Hard on Profit Margins
"No margin, no mission" is a saying that applies to business any time, but it's particularly important now given what we've been through since early 2020. When prices rise to scary heights and customers still are clamoring for every stick you can find, the resulting numbers look so good that it's easy to overlook that sales by unit might have dropped and the gross margins on the products have shrunk. Operating costs are going up, too. In general, worry more about the bottom line of your profit statement than what's on top.
* Limit Personnel Cost Increases
Respondents to this year's Construction Supply 150 survey who hadn't added branches or acquired other companies--in other words, that stayed relatively stable--said their payroll has risen nearly 20% since COVID began. Sales commissions no doubt figure in that increase, but so have permanent pay raises and perhaps bigger bills for health insurance and such. Those latter costs won't go down if sales decline. To avoid being left high and dry, work toward building a financial culture that rewards people for doing good work and for being there in good times. Give bonuses for catching errors or improving collections rates. Encourage workers to save some of the company profit-sharing from go-go years to help tide them over when the business cycle inevitably turns. And set a maximum for the percentage of revenue that goes toward personnel costs. If sales dip but personnel costs don't, and you then cross that line, you'll know layoffs are needed for the company's sake.
* Avoid the Inevitable Rise in Lending Rates ...
Anyone who has had to pay off a big credit-card debt knows how disheartening it is to see the interest charge on the balance eat up so much of what you're putting in. Business loans haven't smacked of such usury, but as rates on them rise in the coming stagflation, you'll get the same feeling of taking two steps forward and then being dragged one step back. Especially in high-inflation times, being out of debt is better than being a borrower.
* ... and Wean Customers Off of Paying with Credit Cards
It's getting far more common for small businesses to give discounts if people pay with cash rather than with credit cards. First, recalculate your recommended sales prices based on what it would cost you if you had to take less because the payment was with a card. Then find a number that's below what you're charging but slightly above what you'd get if the customer used the card. Not everyone will go alone with us, but you should get a few folks change over and thus boost your gross margin. And by the way: Given how many people want to pay online these days, offer the same benefit if they pay online via bank transfer rather than with a card.
* Keep Becoming More Efficient
You could say COVID was a blessing in how it persuaded dealers to dramatically speed up their use of technology. Companies that used to rely solely on mailed invoices now take in payments over the computer (which means they'll avoid coming postage rate hikes). Offering BOPIS--Buy Online, Pick Up in Store--paved the way toward more advanced e-commerce. Less noticeable, but also significant, is the rise in dealers' interest in improving operations. Reorganizing the yard for efficiency, adding warehouse management systems, and adding apps that tell customers when deliveries will arrive all help cut costs. During the coming stagflationary period, the dealers who improve operations the most are going to emerge with a powerful advantage once the housing cycle changes again.