Is another housing bubble about to burst? Are record-setting home prices poised for a sharp decline? Is demand still outstripping supply or have conditions changed?
The outlook for the building is sending some mixed signals. Read the news and headlines using words like “cooling,” “down,” and “signs of a down” to describe recent homebuilding trends. Mortgage rates are rising, but home sales remain extraordinarily strong. As we said, mixed signals, causing builders to ask one question above all others: What do we do next?
Changing market conditions are a risk for any entrepreneur, but especially for builders who take a big bet every time they start a new project. With high upfront costs, significant supply chain delays and tight profit margins, most builders can’t afford to be screwed by a sudden change in the housing market. That’s why the most successful homebuilders constantly assess market risks and adjust their strategic goals accordingly.
A changing market poses one of the most volatile and potentially devastating risks for a homebuilder. The right time and the business can achieve record profits. Get things wrong and the costs can be catastrophic.
Fortunately, home building doesn’t have to be a guessing game. Builders can make strategic moves positioned to generate a good return on investment by following these three steps to assess market risks.
1. Monitor market conditions
Rising interest rates, changing demand, high prices, inflation at a 40-year high and the state of the current housing cycle—these are just a few of the constantly changing factors that affect builders. Conducting a detailed market analysis is an important step in any construction project. However, when it comes to homebuilder risk management, one point analysis is not enough. Builders must constantly monitor market conditions to stay ahead of a changing risk landscape.
This means tracking key market and economic indicators such as:
- Interest rate – Current home prices have many potential buyers out of the market. Rising mortgage rates will also drive other buyers out of the market. The Federal Reserve sends warning signals before making an interest rate move. Current projections show small increases occurring over the next few quarters.
- Licensing and sale of new homes – Total housing permits issued in the United States and home sales are a less important indicator than data by geographic area. Follow the trends of the places of urban interest. For example, while April and May saw slight declines, hot markets exist across the country where demand significantly outstrips supply, the ideal scenario for a homebuilder. Macro trends can mask micro-opportunities for builders focused on the wrong information.
- Price indices – Housing prices also differ geographically. The pandemic created a migration of people leaving the big cities and moving to the suburbs. The overall decline in house prices does indicate an economic recession that can slow down construction. However, a better tool for builders is to review home prices by zip code to find current and future growth markets for investment.
- NAHB Housing Market Index – The HMI is based on a monthly survey of NAHB members that takes the pulse of the single-family home market based on an assessment of current market conditions. On a scale of zero to 100, the higher the score, the more positive the outlook. May’s preliminary national score stands at 69, down eight points from April. However, the HMI regional score for the Northeast, South, and West regions shows higher scores in the mid-70s.
Assessing the market locally and nationally by monitoring interest rates and other economic trends can help determine when to build and the right number of homes.
2. Create a risk assessment table
When monitoring the housing market for potential problems, a mechanism is needed to assess and prioritize risks as they arise. You can calculate your risk level using a simple formula:
Risk level = Probability X Impact
You must first assign a numerical value to both the likelihood of the risk occurring and the impact it would have on your business. For example:
Probability
- Very likely (4): Occurs more than once a year
- Likely (3): Occurs about once a year
- Unlikely (2): Occurs every 10 years or
- Very Unlikely (1): Only occurred once
impact
- Severe (4): Financial losses greater than $50,000
- High (3): Financial losses between $10,000 and $50,000
- Moderate (2): Financial losses between $1,000 and $10,000
- Low (1): Financial losses less than $1,000
These are sample numbers. Replace them with values that align with your company’s business. As you assess each risk, plug the scores into the formula to get an overall risk rating. A risk with a high score requires immediate corrective action. A low rating requires limited or deprioritized action. This can be a powerful quantitative tool to help guide strategic decision making.
3. Conduct periodic risk assessment meetings
A study on construction risk management found that nine out of 10 builders cited increased collaboration as the key to mitigating future risks. The report found a distinct link between regular team meetings and formal brainstorming with improved project outcomes. Benefits include increased reliability in overall project performance, reduced construction costs, improved project scheduling, and improved safety.
“The most effective risk assessment strategies, according to the study, are regular meetings with the entire project team focused on risk and the development of a plan to manage the risk,” reports Dodge Data & Analytics, which conducted the study. “Both practices help increase the reliability of project performance, maintain project quality, and improve project safety.”
Because housing markets can be volatile and construction risks are a constantly moving target, regular meetings help your team stay on top of changes in market conditions that could affect your risk level. your company Bringing a variety of voices and perspectives to the table has the added benefit of allowing you to draw on multiple areas of expertise when assessing your company’s risk landscape.
One form of collaboration that can make a significant difference in risk assessment and management is a partnership with a third-party home builder’s warranty provider. By mitigating the risks associated with construction defects while improving reputation management for homebuilders through expert homeowner complaint handling, a home warranty company like PWSC can alleviate a large portion of the needs of risk management of a company. This frees up builders to focus on other important factors, such as assessing the risks of the ever-changing market and where to start with the next home.
By Lindsay Tingler, PCF Construction Practice Leader
