Why Global Real Estate Developers Are Eyeing the U.S.

Earlier this year, one of China's biggest real estate developers, China Vanke Co., announced its entry into the U.S. housing market — a partnership with New York-based Tishman Speyer Properties to build luxury condos in San Francisco. What do developers from China — and elsewhere — see in the U.S. market, which has experienced a considerable downturn since the bursting of the real estate bubble in 2008?

According to speakers at a March 27 real estate forum at Wharton — which was produced in collaboration with top Chinese real estate firm E-House and included senior real estate executives from China and the U.S. as well as Wharton faculty — changing demographics, pent-up demand and limited supply suggest that more housing is needed in the U.S., and savvy consumers are looking for new options in housing and lifestyle.

Stephen Kim, managing director of equity research homebuilding and building products for Barclay's Capital, shared his views on the market during a presentation at the forum. His talk was followed by a panel including Peter Brumme, vice president and general manager of Builders Digital Experience (BDX), a provider of digital marketing services for homebuilders, and Frederick N. Cooper, senior vice president of finance, international development and investor relations at luxury homebuilder Toll Brothers. The panel was moderated by Peter Linneman, Wharton emeritus real estate professor and founding principal of Linneman Associates.

Kim used a series of statistics and charts to make a compelling case for optimism for homebuilders. He first spoke about a significant change in statistics on housing starts — any unit that is beginning construction – noting that up until around 1980, the number of homes being built for rent versus sale was roughly the same. By 2005, there were almost three times as many homes being built for sale as for rent, with housing starts reaching a record 2.069 million that year.

By 2009 — following the bubble — housing starts had fallen by almost 75%, to 554,000, though the ratio of homes for rent versus sale had largely normalized. Currently, housing starts in aggregate are running at slightly over 900,000 per year. "That is a very repressed level," said Kim. "Our outlook is a very optimistic one, as we expect that figure to rise to 1.6 million by 2015."

A Growing Need

A key driver of demand for housing is household formation, with a household being defined as any individual or group of individuals who are living independently. For many years, the ratio of household formation to population growth was stable, but the ratio changed dramatically in 2008-2009. "Housing starts and household formation declined, but population growth in this country did not," Kim noted. "One of the distinctive aspects of the U.S. is that we have a net birth ratio — the number of births less the number of deaths — which is the highest among all developed nations. The population has been consistently growing, and as a result, we need more houses."

According to Kim, the U.S. can expect to see about 1.3 million households newly formed each year for the next decade, making housing starts at an annual rate of around 900,000 inadequate. Also, demand will further increase because of the disproportionately high number of shared households resulting from people being unable to support a household because of the recession, and the fact that home ownership is at unprecedented lows for every age group expect those 65 and older.

"As people in the U.S. get older, they are more likely to head a household. It really isn't until past the age of 75 that they begin to go into institutionalized care, nursing homes and things like that," observed Kim. "With the baby boomers not even close to 75 – they're in their early 60s down to their late 40s — we have a significant period of time where we're going to see some very, very strong household formations and household growth."

The final factor driving housing starts that Kim spoke about was demolitions. The U.S. removes houses at a rate of about 250,000 per year, which includes damage from such events as hurricanes. "We have about 125 million houses in this country, and if you are demolishing 250,000 of them a year, it implies that the average home being built today will be around still in 500 years," he said. "Clearly, the demolition rate is too low, and you're going to see an increase in that rate over the next few years."

Customization — and Confusion

How rising demand will be met and what homebuyers are looking for was the focus of the subsequent panel discussion, which explored trends in home ownership.

Toll Brothers is the largest luxury homebuilding company in the U.S., with prices ranging from US$350,000 to several million dollars. Typically, the homes are ready for families to move into. Cooper spoke of some of the changes in the market that Toll Brothers is seeing. The company started out building/selling single-family homes but is now building everything from attached homes to high-rises in New York City. Recently, there has been increased demand for "active adult housing" targeted at people 55 and older.

"These homes and communities are for people who are still very healthy but are ready to live a little different lifestyle — whom we call 'empty nesters,'" he said. "This type of senior housing is becoming much more of a big business in the U.S. as baby boomers continue to be a larger portion of the population. Many people, particularly in the South, are looking to move into a planned community with amenities."

Linneman observed how the housing industry has had a similar evolution as the car industry — with selling first focused largely on a very small number of basic products at various price points that had few distinguishing characteristics. As customers' buying power increased and tastes evolved, companies have been able to profit by allowing them to customize their purchases. This, in turn, has influenced how companies reach and sell to their customer base.

The amount of customization that builders facilitate for homebuyers has created both opportunity and confusion, according to Brumme of BDX. BDX, a joint venture between BHI and Moving, which in turn owns Realtor.com in the U.S., focuses on providing marketing, advertising, listing and sales services to homebuilders. Listings are distributed to hundreds of other sites, including sites for homebuilder associations and newspapers. "The hardest thing for people to do in some of the larger metro areas is choose a home," Brumme said. "In Houston alone, we have more than 9,000 plans on our site of homes than can be built by hundreds of builders. We've been trying to create some type of intelligent mapping to make the process easier, developing content that allows people to visualize the home that they're going to build." BDX's technology allows prospective buyers to see not just what their dream home will look like, but what the customization will cost.

The advances in this kind of technology have also proven to be beneficial to homebuilders. In the past, they relied on model homes to showcase their capabilities. Because of the expense of these homes, builders could only construct a few, showcasing a narrow range of options, which in turn limited customers' ability to imagine themselves in a particular home.

"If someone walks through a model home that has a white kitchen and they hate white, they are going to walk out and feel like they don't like the house, because they don't have a sense of what can be changed and how it would look if all those things they didn't like were changed — countertops, cabinetry, colors," said Brumme. "Now, a company can build a single model home and we can show what it would look like decorated in 20 different ways, and people can see them all and get a feeling of what type of home they would like to live in. Then, the chances of them buying a new home increases."

Virtual Experience for Home Shoppers

Home shopping has in fact become not just a more visual but a more virtual experience, according to Cooper, who said that Internet traffic to Toll Brothers' sites has increased dramatically over the last few years. "At Toll Brothers, we recognize how important it is to have something that works really well on a tablet [computer], because we know people are shopping on their tablets."

Linneman questioned how long people are likely to spend on a site. "How much of this can they really tolerate?" he asked. According to Cooper, the average amount of time someone spends in an online viewing session is about seven or eight minutes. "That's why being able to provide lots of imagery that people can flip through quickly is really important," Cooper said. He added that people typically make repeated online visits.

The increase in Internet traffic has not led to a corresponding increase in visits to actual home sites, according to Cooper. "We measure every possible data point and we've noticed in the past few years that physical traffic — people actually showing up in our communities — has stayed very flat. However, the conversion rate for those visitors to actually buy a home is much, much higher."

He attributes this to the fact the people are able to do so much research on the Internet. "Customers are much better educated when they walk in the door and much more ready to buy," he said. "They understand our process — you pick a home, you add rooms, customize the home physically and create new features. He pointed out that the average customer adds US$100,000 or more to the base price of the home through customization.

What motivates people to buy a particular home could be something extremely specific – and can be hard to predict, according to Brumme. "What we found in our research is that people pick homes for very weird reasons. Somebody will pick a very simple home because they like the railing that's over the front door, or they don't pick a house because they don't like color of the garage door."

In terms of specific features that are driving sales, Cooper said people are not as motivated by the green options that are being offered as much as they are by more "visible lifestyle features," such as bigger kitchens, elaborate media rooms and sophisticated sound systems. This type of consumption is not what his company expected. "Coming out of the downturn, we would have thought that Americans would pull back a little bit, but it doesn't seem that way," Cooper noted. "The buyers that we get still want to expand as much as they can and put 18%-20% in value added options into their homes."

Another factor that is influencing people's buying patterns is low mortgage rates.

"The affordability in the U.S. right now is very attractive because most people buying a home have a mortgage, and the interest rates are very, very low," Cooper pointed out. "I would say in general people are spending between 25%-35% on an annual basis of their income on servicing their mortgage, home insurance, and the other components [of home ownership]."

Linneman observed that historically, about one-third of homeowners in the U.S. have no mortgage or pay it off very quickly, with the typical homeowner carrying a mortgage of about 65%-80% of the home's initial value. He cautioned people to recognize the "aberration" of the housing bubble, pointing out that in 2005, the typical mortgage was 96% of the home's initial value. "What people forget is that wasn't true before that little window, and it's not true after."

In response to a question from Linneman about entering the Chinese market, both Brumme and Cooper acknowledged that the size of the potential market is attractive, but said their companies are disinclined to pursue opportunities in China right now. "There's still so much mining to be done in North America," said Brumme.

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