Homebuilders' Impairment Potential
Changes to Homebuilder Assumptions May Create Inventory Impairments – But It’s Still Not at the Risk Level of 2006-2008
Behind the Numbers followed the homebuilding industry through the start of the boom in the early 2000s through the unwinding of the subprime bubble which led to the homebuilders taking massive write-offs to the value of their inventories. Now, all-time high home prices coupled with rising mortgage rates, increased labor and construction costs, and waning stimulus, have some investors calling residential real estate another bubble with the expectation of a wave of homebuilder impairments on the horizon. The SPDR Homebuilder ETF is down some 15% since the beginning of the year reflecting this concern.
We stop short of making macro calls on the economy or giving an outlook for home prices. We do not see another 2008 in the making given the unique circumstances impacting that period that are not in effect today. However, we do believe the risk is growing that the homebuilding industry may experience an increase in impairments in upcoming quarters regardless of what home prices do. This is due to the unique nature of how the homebuilders account for the value of their inventories which many investors do not understand. Many still believe that homebuilders only face inventory impairments if they walk away from purchase options on land. That is actually a minor part of a potential impairment. In reality and as seen in the past, impairments can exceed the current inventory balance on the books. The impairment is closely tied to changes in forecasted profitability. Higher costs, higher interest rates, and perhaps slowing price increases all play a major role in those forecasts. We will explore the mechanics of homebuilder inventory accounting and look at how it is likely to impact the big four homebuilders, PulteGroup (PHM), Lennar (LEN), D. R, Horton (DHI), and Toll Brothers (TOL).