For Subscribers

Get the complete article now!

TWST: I assume then that you’re not looking for the housing market to be particularly strong in the first half of 2001, or even into 2002.

Mr. Percoco: I think it’s important to keep in mind that over the past three years, builders have started nearly 3.9 million single family units. That pace was only eclipsed by the late 1970s, when many baby boomers were buying their first homes. The booming housing market of the late 1970s was followed by a bust that resulted from a spike in energy prices and interest rates. In the early 1980s, single-family housing starts fell almost 50% from peak levels. Given the substantial satisfaction of pent-up demand, a risk of a sharp housing downturn certainly exists in 2001. A substantial amount of housing demand over the past decade has been due to the shift of renters to owners. The home ownership rate has increased from 63.8% in 1994 to 67.7% today. Each percentage point increase represents about 1 million households. This shift has accounted for about 30%-40% of the demand for single-family housing since 1994. Some people think that the home ownership rate can go higher, but it probably cannot go much higher from here.

TWST: Which sector do you think is likely to be more vulnerable, existing home sales or new home sales?

Mr. Percoco: New home sales are probably more vulnerable, because they are the swing factor in overall demand. But the ultimate impact depends on what happens to the economy going forward and how quickly home builders can adjust. If the number of foreclosures picks up in a weak economy, they will compete primarily with sales of new homes. However, a lot of the homes that have been built over the past 10 years will probably not hold their value very well in a high energy cost environment.

TWST: You highlighted the Kaufman & Broad (NYSE:KBH) subsidiary. What is your thinking on the US business for Kaufman & Broad, KB Home?

Mr. Percoco: Despite the company’s efforts, I think California will be a tough market. In addition, KB Home is exposed to some of the more volatile markets, such as Las Vegas and Phoenix, but it is also among the market leaders in Texas and Colorado, which should fare relatively well longer term. The company is also highly leveraged, following several major acquisitions over the past five years.

TWST: You touched earlier on your expectations for consolidation. What form do you expect to see consolidation take?

Mr. Percoco: I think that it’s more likely that there will be acquisitions by large builders of small builders. Foreign companies may also acquire a few large US builders over time. The biggest builders will gain market share through acquisitions of other public builders, but also because many smaller builders will go out of business.

TWST: One last question then, just to sum up, what would your overall message be to investors looking at the housing sector in 2001?

Mr. Percoco: There is a high risk of a sharp pullback in the housing market. Investing higher in the capital structure may offer greater downside protection and eventually greater upside potential, but most investors should avoid the sector for now.