I’ve been preparing for a conference this week held by the investment bank DeSilva & Phillips. The concept is intriguing: the principals, Reed Phillips and Roland DeSilva, have invited eight CEOs of mid-market media companies to talk about the transformations in their business to an audience of about 100 members of the private equity and media banking community.
Ironically, the context for transformation is crisis, as the publishing segment of the media sector has been under extreme duress during the recession. While this duress has taken a toll on the capital structure of media companies, it has also forced business to focus, identify where their customers are and develop more flexible and web-centered business practices.
In preparing for my presentation, I’m forced to answer two basic questions: what is attractive about our company, Network Communications, Inc., and what is attractive about our market.
When you are positioned squarely against the housing market it’s easy to fall in to the trap that your market is a problem.
Perhaps the best way to disabuse people of that notion is to show them two charts.
The first looks at home prices since 1970. It is the simplest way of capturing the impact of the housing bubble. For a short period of time,home prices soared irrationally. What we know now is that the loans made against those soaring house prices helped fuel a fever in lending to the entire building market — resale, new homes, multi-family and commercial — that created an unimaginable glut of capacity just when demand was going to decline.
When we take a long view of prices, it is easy to conclude that the market has fallen back close to the norm, and that with a little more correction, the housing market will be where it need to be.
The drama of the price drop over-simplifies the dynamic impact the housing market has on the economy. The best way to measure that impact is to look at the effect of housing on Gross Domestic Product over time.
The second chart captures all components of housing as a percentage of GDP since 1970 and plots the ratio against the logarithmic trend. This analysis shows that housing as a percentage of GDP is significantly below its trend over the past couple of years.
Closer analysis of the number shows that the driver for reduced production in the housing sector is the overhang of excess capacity, coupled with conservatism in the lending markets.
The most volatile component of the housing sector is residential fixed investment, which includes the cost of building new homes and multi-family units, improving existing homes and paying commissions on the sales of homes.
From 1995 to 2005, residential fixed investment increased $319 billion to more than $700 billion.
Between 2005 and 2010, residential fixed investment declined $424 billion.
Historically, residential fixed investment has been about 5% of GDP. Currently it is at 2.7%. At the normalized rate, residential fixed investment would be around $650 billion, or 85% higher than current levels and 15-20% below the peak.
Has anything happened to change the long-term structural dynamics around residential investment? Not really. There are more efficient building techniques, and the overall size of structures is likely to diminish, but the demand for residential fixed investment is driven by the population’s housing need. Population grows, existing housing stock ages, bylining costs come down, and new capital pours in as part of a virtuous cycle.
The current challenge of the housing market is that the alignment between supply and demand still is not set. Demand is suppressed because of the weak employment market and frozen lending channels; supply is too strong because of the overhang of building during the housing boom.
Each quarter the housing market regulates a little bit more, and a recovery in the housing market is not that far away.
At that point, it will be clear that housing is a good market opportunity, with steady growth characteristics that will distinguish it during a particularly challenging decade for our transforming economy.
