Homebuilders have experienced major whiplash over the last few years. The pandemic originally caused them to slam the brakes on new development. Then the housing boom happened and they raced to catch up and build — but then they ran into supply-chain constraints. Then in 2022, the interest rate shock put the market into a freeze. But before that building can begin, how do developers find completely unused land and turn it into new homes? Who takes on that risk? Who buys and brokers that land? On this episode of the podcast, we speak with Chase Emmerson, the co-CEO of Emmerson Enterprises, an Arizona-based boutique land investor and brokerage. He explains the process of securing land, getting it permitted for development, obtaining water rights, and more. He also walks us through what he's seeing in the housing market right now. This transcript has been lightly edited for clarity.
Key insights in the pod:
What does a land acquisition company do? — 3:24
How does a buyer find suitable land for development? — 4:07
How homebuilders have changed how they buy land — 5:35
How does Arizona handle water rights? — 12:50
How water rights determine what gets built? — 15:04
Why Arizona still has plenty of water — 18:09
What's happening now in housing — 21:14
How landbuyers compete against each other — 27:19
How do publicly traded homebuilders differ from private ones? — 34:01
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Joe Weisenthal: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:15)
And I'm Tracy Alloway.
Joe: (00:16)
Tracy, you know, we've talked a lot about the home builders and the factors that go into building a home, the supply chain crunch, the effect of rates. We've seen this big collapse in a single family home construction over the last year since ratehikes, but there's a pretty big component of housing that that I don't think we've really hit yet.
Tracy: (00:38)
Yeah, that's right. We talk a lot about building the houses, but we don't actually talk about securing the land that those houses are going to be built on.
Joe: (00:48)
Right. And if you read the transcripts of some of the big publicly traded home builders, a lot of the questions they have are like ‘What's your strategy with land acquisition right now?’ because you can't build if you don't have more land. But on the other hand, that's a big capital cost. You're bringing that onto your balance sheet, etc. I doubt they want to just have like tons of land sitting around. So the question of like, thinking about acquiring land for housing is a pretty big dimension of the adequate housing story.
Tracy: (01:21)
Totally. And it also taps into a lot of other big picture questions like ‘what are the best markets to actually build in? Do people take into account maybe climate change considerations? Places that are popular now, you know, you think of some of the Sunbelt states, are those going to be viable markets in the future?’
Joe: (01:39)
All kinds of questions like that. So I want to talk about the land decision because, you know, again, we talked about the rate hikes. So one of the things that we've seen with the rate hikes is that actual physical building of supply, it seems to be pretty sensitive. And we've seen this big drop in the amount of new homes built, but I don't know anything about how sensitive land decisions are to rate hikes and how fast that they can respond and how fast new land could be acquired, because that seems like a pretty big process.
Tracy: (02:12)
The other thing I would say is, this is just an interesting business, the business of securing land that you then sell onto home builders for a development. And I was not aware that this was a business model that existed. I kind of assumed that the developers themselves would go out and buy the land. And then just build it and do everything themselves. But that is not the case.
Joe: (02:31)
That is apparently not the case. I didn't even think about it that way. I just assumed, ‘oh, there's plenty of land out there. You just put up a home.’
Tracy: (02:39)
No, there's all these permits and regulatory red tape that you have to jump through...
Joe: (02:43)
Just to get the land itself. Okay. Well, we are going to be speaking to someone on the land specific side of the question, in studio with us. We're gonna be speaking with Chase Emmerson. He is the co-CEO of Emmerson Holdings, a boutique land investment group and broker based in Arizona, which as we know is one of the hottest, I guess, in...
Tracy: (03:05)
Many ways.
Joe: (03:05)
In multiple ways, one of the hottest real estate markets in the country. So Chase, thank you so much for coming on Odd Lots.
Chase Emmerson: (03:13)
Great to be here.
Joe: (03:14)
Thank you so much. So why don't you just explain big picture, what is Emmerson Holdings? Why don't you just sort of give us the top line view of like where you sit within the housing industry?
Chase: (03:24)
Big picture. With our funds and with investor funds, we buy land right on the edge of existing development. We then master plan and design a community, obtain all of the engineering approvals and permits, and then sell to top 25 national home builders.
Tracy: (03:43)
So my big question is, and I alluded to it in the intro, but why does this business model exist? Why doesn't a big institutional housing developer just by the land themselves and then build on it?
Chase: (03:55)
It's a really difficult industry for institutional investors. So much of it depends on local knowledge and relationships. And so while many institutions have tried buying land and having land funds, for example, few have had success at that. Looking at the home builders also, home builders have typically started to just buy land that has all of the final approvals in place.
Tracy: (04:19)
So randomly, this is something I was talking about with farmers in rural Connecticut about a week ago, which is how do you go about identifying land that's for sale? And there are all these secret ways that they were telling me about looking up on local hunting registries to see who owns the land because you can contact people and say, “’can I hunt on your land?’ And so that's a way of getting in touch with people. So when you say you need local knowledge for the market, is that the kind of thing that you're thinking of?
Chase: (04:47)
Yeah, exactly. When someone goes to sell, oftentimes they'll look at who a large landowner is in the area or a broker will have a lead on who may be interested in selling, and you want to be the first person that they call with that opportunity.
Joe: (05:03)
Talk to us a little bit more about the perspective of the home builders themselves. I guess my question is what business, I guess modern capitalism is all about finding the specific business that you're in, and then outsourcing as many sort of like peripheral businesses to third parties. And so in their view, land acquisition/land development is not the business that they're in. Obtaining permits from the local authority, this is not the business that they're in. Talk to us a little bit more about that relationship and what service you provide them?
Chase: (05:35)
Yeah. There's been an evolution in the way that home builders buy land. Before the great financial crisis, builders would go on the periphery and purchase large tracks of land, often without the approvals in place. And many of them got burned. For example, we just purchased a property that a home builder paid $100 million dollars for — Centex Homes — before the downturn. We purchased it for just over $10 million, just to give you a feel for some of the mistakes that the builders had made. But today, builders just trying to buy land that has all their approvals in place.
Tracy: (6:04)
Oh my gosh.
Joe: (06:10)
Sorry. Wait. Just to be clear, this was a hundred million land track purchase that was made in what? 2007?
Chase: (06:16)
2006.
Joe: (06:17)
2006. And today, after all of this and the housing recovery and [everything], you were able to get it for $10 million? Man, 2006 was crazy.
Tracy: (06:27)
So, you know, you mentioned the permits and regulation. Walk us through what does the process actually look like? Say you identify, you know, it's currently farmland. It's being used to grow alfalfa and you buy it. How do you go through the next steps and what do those steps look like?
Joe: (06:44)
And how long does it take?
Chase: (06:45)
Yeah. So the first step is rezoning. So oftentimes there'll be a holding category for the land. It may have one acre zoning, and so typically it's upzoning it for more density. So the first step is rezoning. The next step is what's called preliminary plat, and that is the early engineering, rough engineering for roads for infrastructure.
Joe: (07:04)
What does plat mean?
Chase: (07:06)
A plat is a document that gets recorded on the land showing lots in infrastructure. And then the final step is the final engineering, which is called Final Plat.
Joe: (07:16)
And what does that entail? How long is this whole process?
Chase: (07:18)
So the rezoning process can take 12 to 18 months. If it's political, it can take longer. The preliminary platting and final platting process can also take 18 to 24 months. So there's a long lead time before land can be converted from agricultural land to land that has final approvals.
Tracy: (07:38)
So it sounds like you do some of the urban planning, almost, for a lot of these developments. Like you decide where the roads are gonna be and the basic look of the development?
Chase: (07:48)
Correct. Depending upon the municipalities, sometimes you're even setting exact park details, amenities, you're definitely setting lot sizes community design, and that happens very early in the process.
Joe: (08:01)
But why don't the home builders want to be in that? Because you'd think that's something like, well, ‘What is the design of our community that we're building? What's it going to look like? What kind of amenities, parks, etc.?” Intuitively, I would think that would be the kind of thing home builders would want. You work closely with them. Do they tell you generally that sort of trends that are like going on in that direction?
Chase: (08:20)
Yeah, we have close relationships with home builders and get their feedback early in the process with preferred builder buyers, but we maintain control of that process typically. Sometimes a home builder will enter into escrow with a land seller and then they will control that process.
Joe: (08:34)
So I want to go back, you know, I'm still blown away that there is a piece of land that's sold for a hundred million in 2006 that's just sold for $10 million. Obviously one of the biggest themes of this podcast is scars from downturns and how they affect behavior for years and years and years.
So if you have these home builders that in 2006 spent egregious amounts of money on land that they were underwater on for 15 years, maybe forever, talk to us a little bit more about how that informs still today or up until recently, home builder decisions about land purchases?
Chase: (09:12)
Yeah, it really has impacted the home builders’ outlook on how much supply they should keep at any given time. And I think that we're setting up for a shortage of developable lots given their narrower outlook. For example, Meritage Homes said that they have four and a half years of supply, but that's based on current levels of demand. And so if home sales increase that supply drops from four and a half years to perhaps three years.
Tracy: (09:59)
You know, you mentioned political tension, and I have to ask, NIMBYism must be a big part of your business, I would expect, like dealing with people who don't necessarily wanna see large scale residential developments next door.
Chase: (10:13)
Absolutely. Yeah. Cities and towns go through evolutions of being pro-growth. And then once a certain amount of residents live there, the mentality can shift. And so sometimes you get city leadership that will push for what's called executive housing or larger lots and that can really hurt housing affordability.
Joe: (10:34)
Has there been a change over time? So you mentioned Meritage. Right now they say, ‘okay, we have four and a half years of spare capacity to build more homes at current demand levels. We don't know, demand might go up, demand might go down, etc.’ Do those trends change over time? And do home builders generally have targets? Do they try to match each other? Do they all want to be within some range? Is there a number that investors like to hear that's optimal?
Chase: (11:02)
Yeah, the home builders are typically very conservative in their underwriting. They plan for two to three homes per subdivision per month. And so if you consider that builders plan for just two to three months of housing, sometimes they can be caught flatfooted.
Joe: (11:24)
Sorry, can you explain that? I didn't quite get, when you say they plan for two or three months per subdivision, can you, sorry, I didn't quite understand what that means.
Chase: (11:31)
Yeah. So two to three homes per subdivision per month is typically what a builder will underwrite a new land acquisition at. So they assume a certain sales level. But if they only have a few years of supply, they can often be caught without existing supply. And then you have a land grab where builders try to acquire new property and start competing again for land parcels. And we're seeing that now in today's market.
Tracy: (11:57)
So just on that note, how do you yourself identify potential purchases? What are all the different factors that go into it? I assume you're looking at the market overall, the exact location of the plot, who you're able to sell it to, and maybe the amount of liquidity or financing available for those purchases?
Chase: (12:19)
Yeah. First, all of our acquisitions are cash. But the main thing we look for is water. In Arizona, it's critical to have an assured water supply. And while 18% of the land in Arizona is private, only a small fraction of that actually has a hundred year water supply.
Joe: (12:38)
Talk to us more about that. So if you want to get the go through all of the permitting process, what do you have to demonstrate to local authorities about water?
Chase: (12:50)
So there's two different jurisdictions in Arizona,. There are areas that are known as “certificate of assured water supply” areas. And in these areas, each individual developer has to demonstrate that they have a hundred year assured water supply for their community.
Other areas have what's called a “designated provider” and that might be a city, it might be a private water company. And that entity basically gives the landowner their hundred year designation. It's very interesting because it creates different incentives within those areas. So for example, a designated provider area, all demand counts towards that allocation. So if it's industrial, if it's multi-family, there's a fixed amount of water and everything counts towards that total capacity. Within a certificate of assured water supply area, only single family residential is counted. So it's a loophole, essentially, where multi-family and industrial can take capacity without any allocation for that.
Tracy: (13:55)
That's really interesting. So you mentioned how that creates sort of different incentives. Just give us a little bit more color on what you mean?
Chase: (14:04)
So for example, there's a city called Casa Grande, which is just outside of Phoenix. You might be familiar with Lucid Motors, one of the large EV manufacturing companies. Casa Grande is a certificate of assured water supply area. And so it's very difficult now, Casa Grande's essentially out of water, so it's very difficult to start a new subdivision in a place like Casa Grande. But you can start a multi-family development and oftentimes it will look just like a single family subdivision.
Joe: (14:39)
So you can have something called a multi-family that looks like normal subdivisions. But what I don't get is, if you say they're running out of water, are they going to run out of water?
Tracy: (14:49)
Where's the water coming from?
Joe: (14:50)
Yeah I get that it's like a regulatory loophole, but people still need to drink, or more importantly, and you know, I know there's a lot of semiconductor factories being opened up, that is an extremely water intensive process to like wash the wafers of the silica.
Chase: (15:04)
Yeah. For the semiconductor industry, it is a ton of water. For example, Taiwan Semiconductors uses 20,000 acre feet of water per year. And just to put that into context, that is roughly 80,000 new homes.
But it's a lot of water, but at the same time, it's not a lot of water if you consider agriculture. So agriculture is in Arizona, there's a lot of cotton production, for example. And 5,000 acres of cotton production is equivalent to all of Taiwan Semiconductor’s water capacity.
Tracy: (15:42)
Wow.
Joe: (15:43)
So from a sort of GDP value add, my guess is maybe let's have less cotton production in Arizona and more chips?
Chase: (15:53)
Exactly.
Tracy: (15:55)
You mentioned that water rights are top of mind for you in selecting real estate and locations. Has that changed over the years? Has it become more difficult to source water to the extent that, you know, maybe 10 or 20 years ago this wasn't as pressing an issue?
Chase: (16:14)
It's become very difficult to secure water. You have to really look at who stands in line to get the water and what your legal rights are. And that's the very first thing that we look at when buying land.
Joe: (16:25)
And this has been going on in Arizona since the very beginning right? I mean, it's the desert. The entire west is, there's no water there. So talk to us just like generally about where's that water coming from? Is it piped in from elsewhere? Is it underground aquifers that are depleting, etc.? And I mean, this is like the history of the American West is fights over water.
Chase: (16:46)
So Arizona has two main sources of water. The first is the Central Arizona project which takes water from the Colorado River. The second is we have abundant groundwater. Depending upon which part of the Phoenix area you're in, there's more abundant water than others. And so with the Colorado River, we're dependent upon allocation from the Colorado River Basin states. And that is more at risk of being cut back. Whereas with groundwater, it's very abundant and they're ancient deposits of groundwater.
Joe: (17:22)
I read an article recently, and I know all of these states that sort of depend on Colorado water or Colorado River water, are always in these negotiations. And I have to imagine that developers in Arizona want to see more allocated to Arizona and developers in Nevada wanna see more in Nevada etc.
Can you talk a little bit, is there tension between the states and how it affects you and how it affects your thinking in terms of who is going to get these allocations and more importantly, you know, I know that the Southwest is in a two decade drought, and this is like, what if there are cutbacks or if there are say, look, we really need to conserve. What is that going to do to the ability for these rapidly growing population states to keep growing at the pace that they are?
Chase: (18:09)
We still have plenty of water for growth, but much of the land in Arizona is not going to be developable with water. So that's the first thing that we look at. We think that areas that have ground water versus Colorado River water are going to become more and more valuable. For example, the city of Maricopa is the eighth fastest growing city in the US right now. And that water is entirely from groundwater. And not only, it's also replenished, which is a key thing.
Joe: (18:41)
Oh, I thought it was just gonna empty one day.
Chase: (18:43)
Yeah. So basically there's affluent produced by subdivisions, and this affluent is often recharged back into the aquifer or used for irrigation.
Tracy: (18:54)
Maricopa is where they have that big Rio Verde controversy at the moment, right?
Chase: (18:59)
Yes. Rio Verde foothills is just outside of the city of Scottsdale.
Joe: (19:04)
What is that? I don't know about this controversy.
Tracy: (19:05)
This is where, it's two communities basically fighting over water rights.
Chase: (19:08)
So Rio Verde foothills is an area just outside of the city of Scottsdale. And residents have drilled wells, built homes and others who are unable to hit groundwater by drilling a well have relied on hauled water. And so basically a truck will fill up water from the city of Scottsdale, drive it out to these homes and fill up their tank, whether it's once every couple weeks or once a month.
Joe: (19:32)
That sounds insanely costly.
Chase: (19:34)
But the city of Scottsdale is now turning off the tap for those residents.
Tracy: (19:38)
Yeah. So everyone is either going to have to drill a private well or find water from elsewhere. I mean, people are talking about this as the start of the water wars or a sort of preview of the water wars to come. I guess big picture existential question, but you develop land exclusively in Arizona, is that business model gonna be viable, you know, 40 years from now?
Chase: (20:05)
Yeah, I think it will be. If you look at the water use in Arizona today, 72% is used by agriculture. And so when you convert agricultural use to residential use, you actually create a lot of savings in terms of net water usage.
Joe: (20:19)
So basically and I think, isn't one of like the huge alfalfa farms, it's owned by Saudi Arabia, which is their prerogative to like buy land, etc. But it does seem like you could probably grow alfalfa somewhere else, right?
Chase: (20:36)
Yeah. We're leasing roughly 10,000 acres to the Saudi government.
Joe: (20:40)
You know, we should have had an alfalfa firmer in Arizona as the other guest and we debate what should Arizona's water be used for? Housing development...
Tracy: (20:54)
… or alfalfa?
Joe: (20:54)
I would've liked that.
Tracy: (20:55)
Well, why don't we talk a little bit about what you're seeing now. And Joe kind of alluded to it in the intro, but we have seen a lot of the home builders affected by higher interest rates. Is that something that you are feeling on your own business model, or does it not matter so much because people are still buying up land for future development?
Chase: (21:14)
So, stepping back to when interest rates went up back in June and July, pretty much all of the home builders either extended escrows on land transactions or canceled escrows. And so they stopped their land buying entirely. They also often stopped their land development spending. So parcels they had purchased, they stopped finishing some of those lots. We are just starting to see builders approve feasibility on deals and move to closing. This is based on strong sales in January.
Joe: (21:48)
Right. So housing is picking up. Did you yourself have buyers walk away at some point in 2022?
Chase: (21:55)
We had several buyers walk away. Most of them asked for extensions and we said no, because we know that land is in tight supply.
Tracy: (22:05)
Is that just a function? I mean, how are they making the decision to walk away from these properties? Do you notice any patterns?
Chase: (22:13)
Yeah, I think it's a knee-jerk reaction. And there's a difference of opinion between the local land acquisition teams and their corporate view of the market. The local teams recognize the land is in short supply and that they're going to have to start buying land again. Whereas corporate is often issuing decisions to shut down land spend altogether.
Joe: (22:36)
I was doing a little bit of prep, I was reading the recent earnings call from Pulte Homes Group,
Tracy: (22:43)
As one does...
Joe: (22:44)
As one does. And they said in the fourth quarter we walked away from 21,000 auction plots and associated$ 900 million in future land acquisition spend. And as a result of these actions, ‘we incur a pre-tax charge of $31 million for the write-off.’ So they post, when they make entering these deals with you, they post some sort of escrow. If they walk away, they lose it. Correct?
Chase: (23:03)
Correct.
Joe: (23:04)
Is part of your business, I mean that's obviously not great for you, but is part of why there's a business margin or opportunity is essentially warehousing this risk, so to speak? So it's like, okay, in 2022 you take a hit from these home builders that want to walk away, and it's like, okay, they can do that because they put some escrow, but then they're really going to pay up in 2023 and pay a premium. And the idea is that over time you make more by warehousing this risk, you make more in the good years when they're like we need more land suddenly.
Chase: (23:38)
That's exactly right. A lot of home builders were looking for big price reductions based on the drop in demand. And land sellers just aren't giving the price reductions because they know that demand will return. There's not more land to build on and the builders will have to pay if they want to keep home building.
Tracy: (23:52)
Hmm. Well just on that note, I mean you mentioned the pickup that we've seen in housing activity in January. And I think that's surprising some people who thought that after interest rates went up to, I think 8%, late last year...
Joe: (24:09)
I think they got around 7%. Oh, did they hit eight?
Tracy: (24:12)
Okay. 7% or 8%, or higher than they happen for many, many years. [People] thought that would at least knock the market for more than a few months. Talk to us about how you're viewing that portion of the housing market at the moment. What accounts for the rebound and the strong activity?
Chase: (24:29)
Yeah. I think builders were surprised by the strong activity in January. We've heard several of the top builders actually exceeded their January sales from the prior year. And so builders have dropped pricing in the range of 15% for entry level homes. But you have to consider they had 35% gross margins at the peak. And now that might be in the lower mid twenties, but it's still a healthy margin.
Joe: (24:56)
I mean, I know you're not a builder, but since you talked to them, maybe you can answer that. Is your impression that their supply chain issues, setting aside land, lumber, windows, garage doors, we did a million, you know, there were a million stories up. Have they eased?
Chase: (25:10)
They have, I think builders have seen roughly $15,000 in cost reductions for entry level new homes. And so that's helped their margins as well.
Tracy: (25:18)
What's the catalyst for another leg up in the housing market in your opinion? Is it simply interest rates starting to fall back or mortgage rates starting to fall back?
Chase: (25:27)
I think there's a structural shortage of lots in the Phoenix market and in many other markets. John Burns Consulting came out with a report that said Phoenix is the fourth most undersupplied housing market. And we only have 20,000 finished lots available, which is compared to about 25,000 permits for new homes in a year.
Joe: (25:52)
I want to go back to one short question, did you slow down or put a pause on the pursuit of new land for your business in 2022?
Chase: (26:02)
We didn’t, we buy through cycles. We focus on making good buys and we did find some opportunities where sellers were impatient and didn't want to wait for the recovery. And so for example, that hundred million transaction that dropped to $10 million was an institutional seller that just wanted to get out.
Joe: (26:19)
And then can you describe a little bit further your financing? I mean, I think you said you bought them in cash, do you borrow, or can you describe your financial arrangements?
Chase: (26:30)
Yeah. We use our internal capital plus we have a close network of investors but by buying for cash, we can be patient and wait for the market to return.
Tracy: (26:39)
Is that unusual in this business to purchase through cash only? Or is that sort of the norm?
Chase: (26:44)
Since the great financial crisis, it's been very difficult to get debt financing for land. And it also can put pressure on ownership. So we find that buying cash gives us the most flexibility.
Tracy: (26:56)
And just on that note, but this type of business — land acquisition — I know you mentioned local knowledge and expertise earlier, but how do you compete against other land purchasers? Is it through making sure that you're very good at acquiring all the needed permits expeditiously? Is it simply offering good value to a developer and competing on price?
Chase: (27:19)
Yeah, I think there's a few components to that. The first is competing on buys. So through relationships with landowners, with brokers, you try to be the person to get the first phone call when an opportunity comes up. The second is on your community design. You try to design as closely as possible to what builders will want, often 2, 3, 4 years out. And the third is by being easy to work with.
Joe: (27:47)
Since we're talking about how everything in the modern economy is like outsourced and everyone specializes, do you yourself as a company go through the permitting process? Or are there other companies whose specialty is helping the land developers walk through all that process?
Chase: (28:02)
There's a big land development industry that we use. So we have teams of attorneys who are focused on water law, for example, attorneys focused on rezoning. We have engineers who are specialists in floodplain.
Joe: (28:18)
And these are outside your company? So the home builders have an outside company that deals with land acquisition. The land acquisition companies have outside parties deal with like the water law.
Chase: (28:32)
The home builders have land acquisition teams that are internal. But they also rely on water law experts and engineers and oftentimes of the same people that we are using.
Joe: (28:41)
On the turning land into land that can build a house, whose responsibility and who does the, like, paving the roads, actually putting in the pipes so that water rights can be turned into usable water? Where does that happen in the process? And does that happen before or after it's sold to the home builder?
Chase: (29:04)
So going back b before the financial crisis, builders would buy land and take it from raw land all the way through the improvements. Just after the financial crisis, builders were still very risk averse. And so they would typically just purchase finished lots, which means all of the water, sewer, and roads are complete. Now we're starting to see builders close at final approvals and sometimes do those improvements themselves or sometimes they'll share that risk with the land seller.
Tracy: (29:49)
You know, we mentioned a number of times that parts of Arizona have seen a big boom since the pandemic. Everyone moving to these Sunbelt states, everyone wants to enjoy, you know, lower taxes, warmer weather...
Joe: (30:02)
I want all that.
Tracy: (30:02)
We all want that. Do you see that continuing? Or do you see that some of the pandemic era migration is starting to tail off?
Chase: (30:14)
We see it continuing for a few reasons. The first is this reshoring trend that you spoke to, I think on your recent podcast with Steve Eisman. So we're definitely seeing reassuring in the Phoenix market. Major manufacturing companies are coming to Phoenix. We created more than 80,000 jobs in the prior year. And so there's a robust employment market. It's not just speculation driven.
Joe: (30:41)
I do think we're going to have to do an alfalfa episode. Chips, EVs etc. that's all great but...
Tracy: (30:49)
We'll get all the water stakeholders of Arizona together in one room.
Joe: (30:53)
Well, the Saudi cattle companies that need alfalfa to feed their cows. Who's going to replace that? I don't know if totally obvious. So are there any other sort of like interesting dynamics that we've missed so far? Or things that you're thinking about right now?
Chase: (31:12)
Yeah, I think the big thing is unexpected demand increases or drops coupled with a delayed supply response for these finished lots is really setting up for a structural shortage of lots.
Joe: (31:27)
So actually this is the question that I wanted to delve further into, which is we talk all the time about scars from the great financial crisis, particularly as they relate to housing and then all the other inputs. But then we had this shock and 2022 is the fastest rate hike cycle in like decades, it probably caught a lot of people by surprise. It’s weird because it's at a time of like low unemployment, a lot of demand for housing. Talk about the knock on effects that we'll see just from the rate shock of 2022.
Chase: (31:58)
So stepping back first to Covid, you had builders kind of hit the brakes on development and then they got flatfooted when demand returned with a vengeance. And then next we have this increase in rates, which has led the builders to pause yet again. And so we're really setting up for the builders to be in a position where their lead time on finishing land and lots is going to be so tight that they're not going to be able to meet coming demand if and when rates return to more normal levels.
Tracy: (32:33)
So we've had a bunch of episodes by now about the hangovers left by these sort of extreme cycles. And what, in your view, when it comes to the real estate market, would help to smooth out some of that volatility or to change developer's behavior in the sense that maybe they feel like they don't have to hit the brakes so hard on construction? Or, you know, they don't have to wait so long to start new projects?
Chase: (33:00)
I think the growing importance of water in the Arizona market particularly is leading builders to take larger positions where they know that they have water.
Tracy: (33:10)
Oh, interesting.
Chase: (33:10)
And so, I think that is driving builders to get away from this ‘just in time’ mindset. And so especially the private builders have taken the lead on this in acquiring larger parcels with maybe four or five, six or seven years of supply. Whereas some of the public builders have been focused on just two or three years of supply.
Joe: (33:33)
This is such an interesting dynamic that public-private that we probably... And I think you see something in oil too, where it's like when the oil prices boomed in 2021 and parts of 2022, you had the sort of quarterly obsessed public companies, they’re like, ‘oh we're maintaining capital discipline.’ I think a lot of the new production in oil actually came from private companies that didn't feel those constraints. So it's interesting to hear a similar dynamic pop up on the builder side.
Chase: (34:01)
Yeah, they're definitely more aggressive in the land market. Some of the public, some of the public builders just will not close on property unless all the final approvals are in place. Whereas a private builder sometimes is able to close even without the zoning in place. So that gives them an advantage because they're able to acquire the land for a more attractive price.
Tracy: (34:22)
I’ve got to say though, when you talk about water supply for five or seven years, that still doesn't seem that long to me. What happens after those five or seven years?
Chase: (34:32)
Well to be clear, these properties have a hundred year assured water supply.
Tracy: (34:36)
Oh, I see. Okay.
Chase: (34:36)
The builders are buying, so Arizona actually has some of the most conservative groundwater management laws in the whole country. We have a hundred year planning window. And so these properties have an assured supply for decades.
Joe: (34:50)
Actually, can you clarify that point about how, so you mentioned that industrial uses, they can get away with certain things. What's the difference in multi-family development? I think you said multi-family is characterized more like industrial. So what does that result in, in terms of what gets constructed?
Chase: (35:07)
So, a big boom in the Phoenix market has been the build-for-rent product.
Joe: (35:13)
So these are single family homes?
Chase: (35:14)
These are single family homes with small yards and they build roughly 12 units per the acre. So you have much greater density than maybe single family at three or four units to the acre. And the loophole is they're able to lease these for 364 days a year. And so if it's 365 days a year more, you have to get a hundred year assured water supply.
Joe: (35:37)
Oh. And, if you have 364, then what?
Chase: (35:41)
If you have 364, you do not have to demonstrate.
Tracy: (35:44)
Why that loophole exists. Was that created on purpose in order to encourage more housing density or?
Chase: (35:51)
I think it stems from consumer protections and people buying single family homes. I think the impetus of that law was designed to protect the homeowner, whereas the owner of a maybe 120, 200 unit multi-family development is a bit more sophisticated.
Joe: (36:09)
So 364, you can renew your rent or do you have to like go sleep at a hotel one day a year?
Chase: (36:15)
You can renew your rent.
Joe: (36:15)
Okay.
Tracy: (36:17)
So what are you looking out for? You know, we talked a little bit about how unusual this period of time is. We still have the post pandemic hangover, but housing activity may be picking up a little bit. But on the other hand, the Fed says that rates aren't going to come down anytime soon. What are you looking out for this year? What's the big catalyst on the horizon?
Chase: (36:37)
I'm looking for mortgage rates to come down and for buyers to get off the sidelines. I think part of the shock has not just been affordability, it's also been psychological. I think some buyers have a fear of buying at the top. With rates coming down, with pent up demand for housing, the builders are doing a similar thing as well. They're kind of all looking at each other. When are we going to get back into the market and start buying land again? And I think home buyers are doing just exactly the same thing.
Joe: (37:08)
Do you think, you know, you mentioned they walked away from agreements to buy land. Do you think they walk away from agreements to buy garage doors and windows and we might actually see some constraints emerge because of that 2022 shock on the supply chain?
Chase: (37:23)
That's an interesting question. I know they have paused development trying to wait for pricing to adjust downwards. But I think that if all the buyers return at the same time the home builder demand, that might cause another problem.
Tracy: (37:37)
Maybe they've been stockpiling kitchen sinks. That's the best case scenario.
Joe: (37:43)
Do you have any kitchen sinks in the basement of your home?
Tracy: (37:48)
I have but one kitchen sink. One. I do have an extra coal stove though, randomly.
Joe: (37:52)
Oh, quick question. Speaking of stoves. Most of the homes that get built in Arizona, electric or gas ovens?
Chase: (38:01)
Mostly electric. On the high-end, gas stoves.
Joe: (38:04)
Gas stoves. That's what I meant. Okay.
Tracy: (38:05)
This isn't a politics show.
Joe: (38:06)
Yeah. We're not going to get into, only in the last month did gas stoves become a political question, but I was curious about that. All right. Chase Emerson. So great to have you on the podcast. This is totally new for us. You know, the other thing that I'm glad you brought it up, the whole build for rent market is something we, I think we talked about it the other day, but’ve got to do more on.
Tracy: (38:28)
This is yet another episode that has sprung forth like three other episodes that we need to do, including one, obviously, diving in even more on water rights, I think.
Joe: (38:37)
Absolutely. All right. Chase, thank you so much. That was so cool.
You know, Tracy, there are so many interesting things in that conversation, but I also, I am like just sort of generally fascinated by the degree to which all companies want to eliminate every single risk outside of their one narrow expertise, which I guess on some levels is very obvious. And we know outsourcing and third party consultants is big, but this is a very interesting example of it for me.
Tracy: (39:16)
I guess it's the natural tendency towards specialization. But it is strange that I had never considered that the housing developers would not be buying the land themselves. I always just assumed that was the way it worked.
Joe: (39:30)
I'm still blown away by that one stat, where tracks of land that were selling for a hundred million dollars 15 years ago, or I guess, no, that's longer. 2006. That's like 17 years ago, whatever. Maybe I did not appreciate how crazy that bubble was.
Tracy: (39:46)
That is a true bath on a financial asset, I gotta say — not even a financial asset, actual land. All right. Shall we leave it there?
Joe: (40:01)
Let's leave it there.
You can follow Chase Emmerson on Twitter at @azlandinvestor.