Homeward Bound

SPECIAL TO THE TIMES

Bruce Karatz is the chairman, president and chief executive of Los Angeles-based Kaufman & Broad Home Corp., the largest home builder in California and third-largest in the United States. The company is also active in Europe. Since taking charge in 1993, Karatz has focused on reducing the risks involved in the new-home business by creating a more efficient operation while growing the public company through acquisitions. Karatz, a frequent spokesman for one of the state's most influential industries, is known for his marketing savvy and for quickly spotting and capitalizing on changing trends in buyers' tastes. Karatz will appear as a member of a developer panel at the Los Angeles Times-sponsored Real Estate Outlook conference July 16 at the Century Plaza Hotel in Century City. He recently offered some of his views about the need for new-home construction, the relationship between the residential and commercial real estate markets, and other facets of the California housing market.

Question: Are we overbuilt, under-built or about right in terms of new housing for sale in Southern California?

Answer: California is back to the stage where we are having a substantial increase in population, both from internal growth and from in-migration, so there is a continuing need for more housing in general. There is a particular need in the coastal markets of California for housing which is more affordable for the greater percentage of the home-buying public. This is an issue that has always existed, but I think it's even more acute today.

Q: Why would it be more acute today?

A: Because communities have become more and more restrictive in the amount of development that they will permit. As restrictions pile on top of each other, the end result is less new development in the areas where the demand is greatest, and therefore prices tend to go up and out of the reach of first-time buyers or even first-time move-up buyers.

Q: Then you're saying we're under-built in housing stock for first-time buyers and, in some cases, for existing homeowners wanting to move up?

A: Yes, I believe so.

Q: Is there a relationship between the commercial and residential real estate markets?

A: When the economy is good and consumer confidence is high, there is usually a growth in employment, which drives both housing and commercial real estate markets, so to that extent they are interrelated. However, commercial usually depends on a specific submarket where there tends to be shortages or overbuilding. This is true much more so in the commercial markets than in housing. Another difference is that, as a general policy, many communities encourage commercial development but discourage residential development.

Q: Why the preference for commercial building rather than residential?

A: There is a view in a lot of communities that commercial development doesn't require the level of services that residential does, when in fact, in today's world, new residential development is paying more than its fair share in fees in exchange for the right to develop.

Q: Does the difficulty of getting approval for new-home construction mean that housing doesn't get overbuilt to the extent of office or retail space?

A: It has happened in the past that housing has been overbuilt, although not to the extent of some of the commercial overbuilding. I think the housing market today is operated on a much more prudent basis than it was in the past. There is much, much less speculative building going on in the residential sector. While there are always exceptions, generally speaking there has not been the kind of overbuilding in residential for the past 10 years that we saw in the previous cycle.

Q: Where do you see the building in California in the future?

A: [Construction] is going to increase significantly in the Inland markets like San Bernardino and Riverside counties, and in the central part of the state from Bakersfield on north. Clearly, those areas will see significant housing growth because the communities are more receptive to the growth and land is available to meet the demand. Also, there are more and more jobs being created in those areas because it is less expensive for companies to establish themselves in those places and because businesses often want to locate where there is affordable housing for their workers.

Q: What about problem spots in terms of adequate housing supply?

A: The Bay Area is the opposite of the inland areas I mentioned. The Bay Area's biggest challenge is providing affordable housing if it wants to continue to grow its business employment. There have been a number of studies showing there is an enormous shortage of new housing being developed in the close-in Bay Area to support some of the projections businesses have for their growth in employment. The conclusion, then, is that because of the housing shortage, employment growth probably will not be as great as some of those projections.

Q: How is this boom different from the last one?

A: The factors driving housing demand today are different from those of the 1980s. Today there is very little speculative buying in the new-housing market. The market today is driven by lifestyle changes. People are looking for ways to house themselves and their families in an environment that is superior to what they have in an apartment. It's a financial decision. People understand that rents go up every year while mortgage payments usually don't, and that most mortgage payments for many years consist primarily of interest payments, which are tax-deductible. So it makes good business sense to buy.

Q: But that scenario depends a lot on interest rates remaining low.

A: Absolutely. Low interest rates allow more and more people to afford a home. There is no question that today's historic low interest rates cause people to conclude that net mortgage cost per month is similar to or less than they're paying in rent. That is driving a lot of purchases.

Q: When the next recession arrives, what will it mean for the housing market?

A: No one knows what is happening on a macroeconomic level. No one really knows what is going to happen six months from now. We cannot be overly consumed with that kind of discussion because it is beyond our control. The issue is to operate our business in the here and now, executing as best we can, day in and day out. We don't see anything out there that is likely to cause significant increases in interest rates in the near future, so we don't see any reason to substantially alter the way we're doing business. If we did see something, we might take a less aggressive path than we're on now. Particularly in the markets we're operating in, there is still a huge unmet demand for new housing, and we're just beginning to benefit from it. The presumption is that if there is an economic downturn, we'll simply build fewer homes. Of course, we're not just a Southern California home builder, so the conditions here may vary from those in other areas of the country or even from France, so that's another factor enabling us to withstand a downturn.

Q: Even with California's sustained economic recovery, the number of new homes being built each year in the state is only about half of what it was at the peak of the last cycle. Will we ever again see 160,000 new homes built per year?

A: I don't think it's un-achievable. I don't see it in the next few years, but it's not something I would rule out.

Q: Your firm is one of those involved in the consolidation of the home-building industry. Yet, even as the third-largest home builder in the country, you're only building 14,000 or 15,000 homes per year. That's a tiny fraction of the more than 800,000 new homes built every year in the United States. How much more of a market share do you think you or any other home builder can capture?

A: In the past, there was a view that when a home builder's volume exceeded 10,000 homes per year, there was a risk that controls would be inadequate to handle a volume that large. We are considered by many as a big behemoth, and yet we're only at a very small percentage of the overall market in the United States. There still remain lots and lots of opportunities, in our view, to achieve significant growth on the top line. I believe it is possible to have a business building well in excess of 20,000 homes per year that is well-run, predictable, consistent and capable of delivering quality homes. I believe it is possible to grow and to remain efficient.

Q: Do you expect some of that growth to come from acquisitions?

A: Undoubtedly.

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