Shifts in Land Deals Reveal Direction of U.S. Economy

Land sales often reveal an interesting aspect of the U.S. economy. Activity surrounding land transactions can portend where the real estate industry may be headed. In the case of the most recent economic recession that started in February 2020, land sales highlight the shift away from commercial office and retail development, while showcasing a renewed interest in residential development.

The shift is caused, in part, by the fact that commercial real estate development typically slows during a recession. Developers are reluctant to incur the holding costs of land parcels if there is not an expected demand for new product. But that doesn’t mean other factors aren’t driving land sales for residential development, despite the ongoing pandemic and economic disruption.

Uncertainty in the office and retail markets have also contributed to slowdown in land sales for development in these property sectors. Yet, land sales for residential development have accelerated in line with the increased demand for housing in many markets. The current economic downturn is not led by real estate and housing, unlike the 2008 recession.

The uptick in land sales for residential development is notable, since the coronavirus outbreak. Builders are acquiring land at a swift pace, with most states experiencing a higher percentage of their total land sales earmarked for residential development compared to the prior year.

2020 Development Compared to Last Year

Private developers that build on a smaller scale have continued to buy land and push projects forward the past year, except for a momentary pause at the outset of the COVID-19 shutdowns last march. It was full steam ahead for many regional builders, after the regained confidence in April. They recognized demand was unexpectedly strong. That could be attributed to a market that was buttressed by low interest rates, peak millennial home-buyer age, and changes in housing location preferences due to the COVID economy. These private developers adopted a strategy of taking sites piece by piece, encompassing 5 to 20 acres at a time, and funding the next plots of land with proceeds from pre-sale contracts and property sales.

Research showed larger builders adopted different strategies to cope with the impacts of the pandemic. The country’s largest homebuilders pulled back on land purchases and laid off workers in March and April due to the high risk in holding large land parcels for hundreds of homes.

For instance, Hovnanian cut $20 million in costs through furloughs, layoffs, other measures, while delaying land purchases, land development activity, and working on unsold homes to preserve cash. Pulte cut $100 million in cost through layoffs, furloughs, salary reductions, and quickly modified sales, construction and administrative processes in response to a demand slowdown in March.

Meanwhile D.R. Horton instituted a near-term hiring freeze, and laid people in some markets, while limiting land acquisition and development spending and adjusting product offerings, incentives, home pricing, as well as sales pace. The company temporarily stopped purchasing raw land, tightened finished lot purchases, and adjusted the timing of takedown schedules to match current demand levels.

Other builders such as Green Brick Partners, and Lennar also altered their land acquisition strategies, due to the economic uncertainties of the pandemic.

Low Inventory + COVID Driving Demand.

One of the unexpected upshots that occurred during the pandemic was the market experienced strong buyer traffic. In fact, significant interest in new construction led to record sales rates and a depletion of already-low inventory levels. Supply dropped to just a month or two in many markets, compared to 5 to 6 months for a balanced market.

The supply of new homes for sale in the United States is currently down 33% year- over-year while existing home supply is down 26% from the prior year, both following a 2% decline in 2019. Demand was strong in Boise, ID (+13%); Spokane, WA (+12%); Indianapolis, IN (+11%); and Phoenix, AZ (+10%).

The lack of supply and ensuing demand resulted in increased competition for land among builders, who are attempting to ramp production up quickly. The U.S. has experienced a marked increase in building permits and starts. And homebuilder sentiment in July jumped 14 points to 72, returning to pre-pandemic levels, despite a recessionary economy.

Builder sentiment experienced the biggest bump in the Northeast (+22 points) and Midwest (+18 points), primarily due to pent-up demand that had been sidelined by spring lockdowns. Builder confidence in the South and West also increased (+10 and +14 points, respectively).

Suburban Shift

While migration to the suburbs is not a new trend, it became more pronounced in summer 2020 after months of sheltering-in-place created a desire for more space, and the likelihood that more people will work remotely. As a result, it is expected that this trend to suburban markets where single family home demand is greatest to continue as the work- from-home lifestyle becomes standard in the near-term and employees adjust to COVID-related flexible work models.

New home demand is rising in lower density markets, including small metro areas, rural markets, and large metro exurbs adding to the increased demand for land. Record-low interest rates should continue to support mortgage applications for new homes (+54% in June and +39% in July year-over-year).

Conclusion

Demand for land with residential development potential is expected to continue rising from the incremental boost caused by home buying preference shifts resulting from the coronavirus pandemic. Developers are exhibiting a willingness to build a variety of residential product: single-family homes, multifamily apartments, and townhomes, to accommodate buyer preferences.

Commercial land sales for residential development accelerated this year to satisfy a new spike in housing demand, after a pause in residential development activity in March and April 2020. As a result, there is an increase in land sales for residential development at a time in the economic cycle when commercial land sales would typically slow. This is an anomalistic trend compared to commercial real estate land activity during prior recessions. 2021 promises to be an interesting year to track land sales for development while revealing growth areas.