Houston is a hot market, but it’s struggling with persistently low inventory and the damaging effects of oil price drops. So why are builders so confident?

There is a schism happening in Houston real estate, and oil is the separating wedge. The issue of oil prices and what impact their recent decline has and will have on Houston’s market has been the dividing line, with builders heavily crowding the side of optimism.

Approaching the debate from the side of healthy growth, recent figures from the Commerce Department suggest first-quarter residential construction – though slowing from a year prior – is still moving forward at a reasonable pace. In the first three months of 2015, residential building permits increased 2.2 percent year-over-year, compared to an 8.6 percent gain in 2014’s first-quarter. The gains aren’t as impressive as they have been in past quarters, but many Houston builders aren’t worried about the slowing pace of growth.

“It’s a little bit of a concern out into the future,” said Allan Merrill, chief executive of Beazer Homes USA, in a April 30 conference call. “But the current results and the current environment have stayed pretty robust.

Builders Stay Optimistic

Despite falling sales, builders across Houston’s construction market are touting a strong market, claiming the city has been largely unaffected by oil prices that plummeted in late 2014 and earlier this year.

In an April 23 conference call, executives from both Meritage Homes (which, in November, staked a major claim in the Imperial Sugar Land master-planned community) and PulteGroup (which saw sales decline 5 percent year-over-year) downplayed the impact falling oil prices are having.

“We have yet to experience the steep falloff in demand that many people fear with lower oil prices,” said Meritage COO Phillippe Lord.

Richard Dugas, chief executive at Pulte, admitted that demand had slowed towards the end of 2015’s first quarter, but added that “signups in the quarter were flat with the prior year.”

Also on the conference call, Larry Nicholson, CEO of Ryland Group, disregarded the company’s 11 percent decline in sales, saying, “Houston did slow down a bit, but I do feel that Houston has stabilized and we’re seeing better activity there.”

The Confidence Equation

The overtly optimistic tones from Houston builders have become something of a trend this year, as we discovered in an earlier report.

In a February article, our own Peter Thomas Ricci noted that local builder confidence eclipsed the reality of single-family home starts by a whopping 170 percent, begging the question: Why?

Unfortunately, there doesn’t seem to be a single solution to the enigma, but rather a series of factors contributing to builders’ positive outlooks.

For one, Houston, like many other metro markets, is seeing a broad shift in construction from moderate to higher priced homes – a fact highlighted by the median sales price for new homes rising 28.3 percent over the last decade, and $400,000 new home sales now being more prevalent than $200,000 and below.

The shift is the sum of stagnant incomes, low savings and increased home prices, which is something of a euphemism for one key fact – builders are following the money.

“When people get jobs, it gives them the confidence to enter into homeownership,” said Joshua Wright, director of marketing and PR at Economic Modeling Specialists International. “In the long run, job growth, and ultimately the ability to secure a job, is highly correlated with a person’s willingness to form a household. People who are interested in purchasing a new construction property need to have money. There can be pent-up demand for new construction, but until you can pay for it, it’s just not going to happen. It just doesn’t make sense.”

A Two Year Timeline

In March, Houston’s inventory inched up slightly to a 2.8-months supply. That’s still far behind the nation’s 4.6-months supply, and emphasizes the city’s desperate need for new construction.

While builders may remain confident in the face of an impending shortage, an analysis from Goldman Sachs & Co. forecasts trouble brewing in the near future. Researchers from the institution speculate that depressed oil prices and a strong U.S. dollar are going to stifle Houston’s construction growth by 24 percent and home price appreciation by 6.6 percentage points this year.

Furthermore, Goldman Sach’s forecast is in line with a separate analysis from Arch Mortgage Insurance Company, which recently increased its risk rating for the city, saying that home prices in Houston are now more likely to decrease over the next two years; and that prediction runs parallel to earlier timeline estimates of how oil-price drops were expected to affect home prices.