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Un-building boom

November 9, 2001

Article by Sharon Simonson

This is the house that Jack didn't build.

Developers are abandoning, postponing or rethinking new housing subdivisions in Silicon Valley because they say the projects no longer make financial sense. At least 1,000 single-family homes and townhouses in various stages of development have been affected by the pullback so far.

Squeezed by falling housing prices and still-pricey development costs, principals for some of the largest homebuilders in the area say they no longer can afford the financial exposure of Bay Area housing development for the returns the market is producing.

Developers clearly are responding to a pronounced drop in housing demand, which, somewhat ironically, is set against a backdrop of some of the most dramatic financial inducements to buy in decades. The nation's mortgage interest rates are at their lowest in generations. There already have been significant declines in many Silicon Valley house prices. And there is an abundant inventory of homes for sale.

That people won't avail themselves of what is almost certainly a historic opportunity in Silicon Valley housing seems a strong indication of their fear of major financial commitment in these uncertain times.

Further, the pull-back is a tangible example of a rapidly decelerating Silicon Valley economy, and is the latest evidence that the area's economic picture continues to degenerate. The fall-off in new construction is sure to hurt contractors and workers in the building trades, and could contribute to the area's already rising unemployment.

The decline in new construction also is aggravating what most agree is a chronic housing shortage in Silicon Valley.
Left unattended, that shortage could further exacerbate the job loss in the valley, says Stuart Gabriel former Federal Reserve economist and director of the Lusk Center for Real Estate at the University of Southern California.

"Concern about housing affordability is much more than an altruistic concern," he says. "The jobs won't come or stay in California without an improvement in our housing affordability picture."

At special risk of not getting done are housing subdivisions with homes priced more than $750,000. The problem is the tremendous decline in demand at the high end of the housing spectrum.

Of more public interest and concern, however, is the parallel but unrelated withdrawal of developers from the high-density infill housing projects that have become a staple of regional new-housing development. These projects generally have more than 30 units an acre, and often are built on land in or near Silicon Valley downtown areas. This kind of high-density housing is favored by environmentalists and city planners looking to reduce drive times and sprawl.

The homes in these developments often are intended for Silicon Valley's entry-level buyers with beginning prices of $400,000 and up.

SummerHill Homes of Palo Alto is seriously reconsidering a proposed Communications Hill development with up to 460 approved townhouses it had planned to do with Lennar Homes, says SummerHill chief executive Roger Menard. The project would have required building 25 units per acre.

"It didn't make any economic sense to us because of the densities required, the high cost of development at that site and the market conditions right now," he says.
Robert Freed, president of KB Home of Northern California, says his company also is postponing development of 233 condominiums on the site of the former Saddle Rack club near downtown San Jose. That project would require 50 units to the acre, he says.

"We at KB Home and most of our competitors are re-evaluating most of our development in light of current conditions," he says.

Construction costs in Northern California continue to be some of the highest in the country, Mr. Freed says. And building a house continues to take more time here than in other parts of the nation.

In Texas, for instance, a house can be built in 90 days, he says. A home in a project like the Saddle Rack could take as long as 15 months to build.

Market differences notwithstanding, Sam Davis, an associate dean in the College of Environmental Design at the University of California at Berkeley, wonders how large are the profit margins developers are demanding for valley projects.

(One Silicon Valley developer says no housing company he knows will accept less than 10 percent profit in the valley because the market is so risky. He declined to have his name used because the information is proprietary.)

Mr. Davis also says some developers simply don't want to embrace the kind of housing the Bay Area needs most: subdivisions with dozens of units per acre on land in the city centers -- so-called high-density, urban-infill housing.

The aversion stems partly from the fact that high-density developments are quite costly. Building up rather than out demands accommodations such as under-building garages and acoustical engineering, as well as adherence to strict seismic regulations.

Chris Twardus, a vice president at real estate brokerage Colliers International, says he has seen a rash of land sales fall through as developers rethink their plans. They often try to persuade sellers to lower their prices, he says.

Land cost -- and litigation in the case of high-density, attached housing -- is one of the most significant drivers of Silicon Valley home prices.

Some land sellers are beginning to ease up on cost, Mr. Twardus says.

But Silicon Valley land still isn't cheap. "I have one seller I'm working with that just two days ago agreed to lower the price from $4 million to $3.3 million," Mr. Twardus says. That's for a single acre of land in downtown San Jose with government approvals in place to build 62 units of high-density housing.

Steve Kalmbach, vice president of high-density housing in Northern California for Pulte Homes Inc., says all of his company's high-density projects are under review. Combined, they represent nearly 300 proposed townhouses and lofts.

Despite these companies' woes, in some way they are the lucky ones. Developers that already have begun housing projects using 2000 housing prices as guides to their cost and profit likely will find themselves deep in red ink once those homes come to market, and they must sell them at 2001 rates, their peers say.

Once a project is begun, a developer typically won't stop, because it is more expensive to stop in midstream than it is to finish.

"It's a bloodbath out there," says one such developer, who declines to have his name used.

SHARON SIMONSON covers real estate for the Business Journal.