Berkshire Hathaway 2006 Annual Meeting Audience Question # 11

The demand and outlook of the manufactured homes industry

Warren Buffett:

Number 11?

Audience Member:

My name is Jeff Bingham. I’m from Chicago, Illinois.

I have a question regarding the manufactured housing industry. What is your outlook on demand for the industry? And, correspondingly, in your opinion, will lending increase in a meaningful way over the next few years?

And are the homes priced attractively relative to competitive products, like stick-built housing and apartments, in the face of continued site rent increases at the community level and, in some cases, lenders requiring shorter maturities on mortgages?

Warren Buffett:

It’s been kind of an interesting history on manufactured housing. If you go back… you have to go back 30 or 40 years… 40 years, I think, almost, to have… find volume as low as it’s been in the last couple of years. And the houses are better than… by far better… than they were then.

There have been years when 20 percent of the housing… the new housing product in the United States… was manufactured housing. One out of every five.

Last year, leaving out FEMA demand, you know, we were bumping along for the third year, I believe, just a tiny bit over the 130,000 level, you know, which is like 6 or 7 percent… probably 7 percent… of new housing starts.

So, the percentage of the total new housing stock that has been manufactured housing in recent years has really been very low, while the houses are better… considerably better… quality than in the earlier years.

You can look at the house. We’ve got two houses out there on the exhibition floor, around $45 a square foot. You know, that’s good value.

There’s a lot of resistance, through local zoning laws and that sort of thing by the local builders, to the influx of manufactured housing. We’ve made progress on that in some areas. We’re actually developing subdivisions in that business.

The houses were mis-sold four or five years ago in huge quantity because you had manufactured housing retailers selling the properties, getting any kind of a down payment, taking the loans… selling to people that shouldn’t be buying them… taking the loans, securitizing them, so somebody in some insurance company someplace lost significant sums of money.

So you had, really, an abuse of credit in the field. And there’s a hangover from that, and it’s taken a long time for that hangover to work its way through.

I think Clayton Homes, which we own, has done a terrific job in both the financing… they should be financed on shorter terms, incidentally.

I’m… if you put them on owned land, that’s one thing, but financing them for 30 years, in my view, was a mistake.

But the terms got very lax for a while, and, you know, we’re bearing the consequences of that now.

But I think the market will get bigger, but I do not think it will get bigger this year. I see a year that, counting some FEMA demand and some hurricane-induced demand, maybe 150,000 units, 145,000 units. And by industry standards, that’s down a lot.

Now, the number of plants is down a lot and the number of retailers are down a lot.

Clayton’s position is very strong. And their record is so much better than anybody in the industry that you have to look very hard to find number two.

Charlie?

Charlie Munger:

Yeah. You asked about stick-built housing and how competitive it was. That’s been one of the troubles of the manufactured housing game is that the stick-built housing has gotten so efficient.

But there the system is aided greatly by Berkshire’s subsidiary MiTek. So… and stick-built housing is amazingly efficient when it’s done in big quantity with systems like MiTek provides.

And if it weren’t for that, there would be a lot more manufactured housing.

Personally, I think manufactured housing is going to get a lot better and take a lot more of the market. It may take a considerable period, but that is so logical that I think it will eventually happen.

Warren Buffett:

Yeah. Somewhere down the road, you would expect 200,000-plus units for the industry. But I don’t think you’ll see it in the next year or two.

The industry has to think through… and they have, they’ve made a lot of progress on this… but they have to think through what’s the logical way of financing these things, and what’s the way to make sure that the person who buys it really has an asset that’s in excess of their loan value five and ten years down the road.

And, really, very little consideration was given to that five years ago. It was just a question of put together the papers, sell it on Wall Street, and let somebody else worry about it later on.

Clayton did a way better job than other companies in that respect, but those were the industry conditions that existed then.

But I think Clayton will be… Clayton could easily be… the largest homebuilder in the United States in future years because we will be a big part of an industry that, as Charlie says, should be doing more volume.

Charlie Munger:

I also think that some of the sin that was in the manufactured housing finance a few years ago has shifted into the finance of the stick-built houses.

There is a lot of ridiculous credit being extended in America in the housing field. And it had a horrible aftermath in the manufactured housing sector, and my guess is there will be some trouble in the stick-built sector in due course.

Warren Buffett:

Well, dumb lending always has its consequences and usually on a big scale, but you don’t see it for quite a while. So, therefore, it’s like a disease that doesn’t manifest itself for, you know, a few weeks.

And you can have an epidemic of something like that, and by the time you know you have an epidemic, you’re very well into it.

Well, that’s what happens in dumb financing.

And you had that… you periodically… you certainly had it in commercial financing in the ’80s, and you had the RTC and the savings and loan crisis and all of that because, literally, one dumb project was put up after another.

A developer will develop anything he can borrow the money against. It’s that simple. And when the lending institutions pour the money out for something, it will get built.

And that happened in manufacturing housing. It happened in commercial real estate in the ’80s. I think it’s happened in conventional housing here in recent years.

And if you look at the 10-Qs that are getting filed for the first quarter of some lending institutions, and 10-Ks that were last year, and you look at the balances increasing on loans for interest that’s accrued but was not paid because people had adjustable mortgages, but they’re only adjustable so far, but the lending institutions are taking in the income as if it were paid, you’ll see some very interesting statistics.

Charlie Munger:

Yes. And some of this dumb lending is being facilitated by contemptible accounting. The accounting profession has not stopped compromising its way into terrible behavior.

Warren Buffett:

Our auditing bill just went up.

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