Real Money Returns to Real Estate as Government Support for Housing Ebbs
Yes, believe it or not, what you’re starting to hear and see are the sound and sight in the very near distance of a phenomenon utterly absent for years–market-influenced residential real estate.
We think many in our audience will cheer the end of at least some parts of the government stimulus programs for housing. For one, it’s a significant vote of confidence that the private sector is healing. Secondly, it restores a healthier balance between fear and greed to the housing marketplace.
Compared with last year’s all-pervasive sense of doubt, this year’s sense of uncertainty has to be acceptable.
If what drove residential real estate crazy through the first half of the past decade was funny money, compliments of an unregulated Wall Street, then what has driven it nearly koo-koo in the past couple of years was even funnier money brought to you by Uncle Sam’s use of $1 trillion-plus present and future tax bounty resting on this and the next generations’ shoulders.
After midnight tomorrow (April 30), consumers, lenders, builders, investors, land holders, products manufacturers, materials suppliers, and subcontractors, will begin to learn how to behave when real money actually changes hands.
For new-home enterprises, will that mean average selling prices will have to come down even more? It could well mean that. The now-nearly-concluded federal programs that supported housing were a methadone clinic, not an addiction-free solution. They bought time to adjust that a cold turkey treatment would not have tolerated.
We don’t know how the correction will go; we only know that it will continue. Historical norms are called that for a reason–whether we’ll revert to them now, no one can say with certainty. Just as easily as you assert that prices need to go down more to reach a norm, you might also claim that they’ve already overshot a normalized benchmark, especially as real demand in the form of rising household formations, and a continued domestic migration of populations to Sun Belt states play out.
The zillion dollar question among those who are vested and invested in home building right now is this: Is what builders paid for lots in the past 12 months through the present low enough, and can their direct costs and overheads come down far enough to sustain viability even as wages stagnate, credit remains scarce, and the political, social, and business bias toward expanded homeownership remains a dirty term?
We’re seeing public home builders’ 1st and 2nd quarter numbers come in, largely illustrating operational improvement over prior quarters and in year-on-year comparisons. If new orders don’t meet expectations, then it’s to do with one home builder’s model and strategy versus another’s. In general, spec builders drove greater unit volume during the tax credit period, and order-then-build builders sought greater net profits on each unit.
Imagine, housing economics with real skin in the game, and hard-earned money getting put to work for gain or loss. It’s the closest we’ll come to this notion for a generation, and we may wind up finding that we like it.
An exageration? Probably, a bit of one. But to some great extent, we need a post-policy cushioned world to tell us all what we’re working with. Without artificial government support and without Fabulous Fab and his silk-tied ilk’s mischievous play in some global game of financial chicken , the house price, both new and used, will find its level.
Estimates from solid sources are that national house prices still need to and will decline something on the order of 5% to 10% from their current level–down some 45% from their 2007 peak–to reach equilibrium. Equilibrium would be defined in part historically, and in part by virtual of home prices’ ratio relationship to household incomes, or cost-to-rent, or on a more macro basis, as a percentage of GDP.
As much as there are forces and sources of great anxiety in the global economic pool, the unmistakable signs of economic recovery have pronounced themselves as real and present.
Here, Barry Ritholz’s The Big Picture blog outlines the, well, big picture, which the thesaurus apparently told him translates into “macro overview.” Here’s his take on real estate.
Real Estate (Commercial and Residential): We do not believe that residential real estate has found its natural price level yet. It remains over-valued. This is due to artificially low mortgage rates, foreclosure abatements and mortgage mod programs. We are probably 10-15% over valued, when measured by Median Sales price to median Income, Rent vs Ownership Costs, and Home Value as a Percentage of GDP.
Stable home prices are destabilizing for those who either paid for their homes (or building lots) at bubble levels or who have borrowed too heavily against existing homes at over-appreciated bubble levels.
Housing finance–the Government Sponsored Enterprises and the Federal Housing Administration–umbilically relies on the federal government, and is enormously susceptible to politicization. So, while we’d like to think that market forces can finally do their thing to correct real estate, our elected officials have their hands in the soup to a greater degree than we might like.
Still, now that the federal tax credits for home buyers and the suppression of mortgage interest rates have run their course, private sector liquidity–which many believe is substantial–can go to work, and home buyers themselves can go to work to arbitrage what they can really pay for what they still dream they want.
Home Building Focus Post Policy Punchbowl–Land and People
We’re going to go (not too far) out on a limb today and suggest that, from this past Saturday to this coming Friday at midnight, home building companies collectively will write more new-home sales than they have in any single week for the past 48 months.
As a stimulus program, we believe the $8,000 and $6,500 tax credits for home buyers operated largely as designed, especially when you blend in the way that human nature works. Human nature–not so different than the Deep Blue IBM computer that used to match chess-playing skills and wits against one grand master or another of the human variety–learns by getting it wrong to get it less wrong next time, and eventually getting it right.
When it comes to home price corrections, combined with low low interest rates, combined with a tax credit bump, it certainly didn’t hurt a buyer under most circumstances to wait until the very end of the program. Providing a buyer could be assured of arranging financing to close by June 30, many of them would do better on price or other concessions if they could make builders wait ’til the 11th hour for a deal.
What should be debunked, after all however, is the myth that there is no demand. What should be affirmed is that demand is psychosomatically pre-disposed; it has been suppressed by turmoil in mortgage financing and job losses; it can be stimulated by policy incentives; and it is keenly sensitized to the felicitous and precise alignment of house prices, interest rates, and broader consumer confidence.
What also should be debunked after this week, and after this six-month push since Congress extended and expanded home buyer tax credits through the end of this month, is the myth of home building companies as nothing but oversized general contractor-order takers.
What the extension and expansion of the credit may not have done was to put new-home sales volumes on steroids, although it has brought the months’ supply of new-home inventory within a whisper of a normalized six months on a national basis.
What it likely did was to allow ever more discerning home buyers time to measure carefully what they’re getting for their money, giving “new” a chance to show its value amidst a tsunami of distressed, short-, court-house steps, and other foreclosure sales. New’s value shows up strong in manageable monthly payments, in predictable household maintenance costs, and in a tendency for savings on energy costs.
Even with the prospect of six million foreclosures more to work themselves through housing’s correction, new homes have gained ground among buyers who plan to dwell in their homes rather than lever them toward grandiosity.
What the extension from last November through April also no-doubt did was to improve the tenor of the national psyche through what might otherwise have been one of the longest and darkest winters anyone alive could remember.
Closer to home though, what has occurred in the past 12 to 18 months or so among home building organizations themselves essentially set up the possibility of having a record week in home sales maybe not seen since the bubble days.
This time though, discipline and risk kept close track of each other, and design, production, and sales have worked as they never have before. Most home building companies today are 25% to 30% the size they were in 2006, and they’ve done some amazing things to reengineer their business structures to the market. How? Fewer people are causing more value.
After a week like this one, managements may get the best glimpse they’ve gotten for years at who the real talents are in their companies.
Clearly, we’re seeing in public company earnings announcements and in private company results that home building firms must reinvest if they want to drive recovery their way. That reinvestment comes in two key flavors, land and people.
The May issue of Harvard Business Review takes out a special report on “How to Keep Your Star Talent,” noting that, among 100 companies surveyed:
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- One in four intends to leave your employ within the year.
- One in three admits to not putting all his effort into his job.
- One in five believes her personal aspirations are quite different from what the organization has planned for her.
- Four out of 10 have little confidence in their co-workers and even less confidence in the senior team.
One of the big mistakes companies make with “high potential” performers, the article says, is shielding talent from tests were they could fail and another is keeping your young leaders in the dark.
Share future strategies with them–and emphasize their role in making them real.
This is exactly what we had in mind as we developed this year’s new high production home building management event, The Housing Leadership Summit, taking place in two weeks, May 10-12, at the Four Seasons in Chicago. We want both company leadership and “high potential” leaders there because our program addresses the information, networking, and management challenge needs of both groups.
With help from our friends Clark Ellis and John Doherty at FMI Inc., we’ve created specific workshop tracks that focus on development of your team, not just for the next year, but for a future that will demand more and different skills than they’re equipped with right now.
Here’s how we phrase one of the drills our workshop peer groups will go through on Tuesday, May 11, in an all-day, roll-up-your-sleeves work session:
Assume that your divisional staff is dealing with a set of typical circumstances. Those who remain have probably been forced to accept pay cuts, have certainly not had bonuses in several years, are wearing multiple hats, are working long hours, still are not sure that they will be retained and/or that their company/division will remain solvent and have seen friends and colleagues lose their jobs, homes and life savings over the last few years.
Challenges:
- Morale is hard to gauge, it’s a combination of “survivor euphoria”, “survivor guilt” and fear.
- The market is at its bottom and should improve from here, which is a positive thing for your company. However, it also means that other builders, service companies and others will be looking for talent. Your remaining staff will begin to have employment options again for the first time in several years. Your best and brightest will be most at risk for leaving quickly and unexpectedly.
- How do you motivate and inspire your team to act as a team? People focus on their own self interest during the best of times. During times like we have seen in our industry since 2006, people become obsessed with their own self interest.
- How do you get your team to think “long term”? Define “long term” in today’s market environment. This could mean getting the team to at least think through the impact of their decisions and actions through the month or quarter.
Assignment:
In your table groups, develop at least three specific strategies, initiatives or actions that your team will implement to galvanize your team. Be prepared to discuss how you plan to engage and activate the creativity, energy, experience and brain power of your “survivors”. Think about and be prepared to discuss at least one significant risk to your plans.
We’ve already got a stellar roster of executives from public companies D.R. Horton, Hovnanian Enterprises, KB Home, Lennar, Meritage, M/I Homes, M.D.C. Holdings, NVR, Pulte, Standard Pacific, Taylor Morrison, Toll Brothers, and from private builders like Bloomfield Homes, Caviness and Cates, Centerline, Charter, Cityview, Corey Barton, Dan Ryan Builders, David Weekley, Drees Homes, Fischer Homes, FourSquare Builders, Gehan, Holiday Builders, Joseph Carl, LGI, Mattamy, McBride and Son, Ole South, Providence, Rausch Coleman, Shea, Sivage, Surrey, Vicinato, Wade Jurney, and Westport Homes.
We still have some room, and we want you and your “high potential” talent there. What better time and circumstances to share your strategy with an up-and-comer.
What we’d like to do is to host you to a beverage in celebration of your best week in selling new homes in a while.
And we can work on how you’re going to do it again, and again, and again.
Price Vice Grips Lumber and Building Materials Suppliers as Commodity Costs Surge
As Q1 earnings season progresses, we note home builders crow about improved gross margins they’ve achieved. They’re cutting SG&A, land base costs, and directs, but not without pushback on a couple of those fronts.
Competitive bidding for lots, particularly in markets where publics need to restock lot supply to justify their operational footprints, exerts margin-eroding pressure on the land-base expense. Commodity price increases we see starting to flow through the pipeline have not quite hit home builders’ directs yet, but that’s because they lag expiration of contracts in place.
Lumber and building supply distribution expert Craig Webb, who edits ProSales and prosalesmagazine.com theorizes that upward pressure on materials will hit home builders before too long.
Here he reports on the impact 60- and 90-day contracts to hold prices for home builders had on Builders FirstSource first-quarter financial performance, a loss of $31.4 million.
His take on the vice-grip suppliers find themselves in as commodity prices go up while builders continue to enjoy contracts for their end-user prices to stay low: something’s got to give. Here Webb comments.
This is the first case I’ve seen in which a dealer has said it’s been squeezed between, on one side, the recent run-up in prices for lumber and other construction commodities, and on the other side, the guarantees it has given to builders to hold prices for up to 90 days.The issue of holding prices has generated a lot of comments recently in the LBM community. My guess is that BFS’ experience is going to inspire other dealers to be even more cautious about guaranteeing prices and/or to set extremely high prices if they’re asked to provide long-term guarantees.
We’ll likely see the effect of this pricing squeeze play out as other lumber and building materials supply organizations report their Q1 earnings, or lack thereof.
New Home Sales–Surprise, Surprise, Especially for the Tax Credit Naysayers
New home sales for March blew away consensus expectations among Wall Street analysts. Their models were broken before and they still are. But if you’re listening to us, you already knew that, and you’re busy not paying attention to the media noise about what it means.
You’ve declared a six month moratorium on mainstream media coverage and daily Wall Street mumbo-jumbo, and your focus is operational. Like ours is.
We heard Tom Lee, chief equity strategist at JP Morgan, respond recently to a question about why his 2010 forecast on the equity markets is much more optimistic than that of most of his peers. In so many words, he’s predicting continued strong recovery in equities because that’s what his analysis tells him. “It sounds smarter to be a bear,” he added.
This is what we believe to be the case right now in housing. We know builders who’ve said the soon-to-expire tax credits for home buyers did not create the surge in demand they’d expected. Both public builders and private ones–underwhelmed by the impact of the Uncle Sam inducement–say the first wave of the tax credit from February to November of 2009, had a much bigger impact and that it pulled buyers forward from the home buyer pool of the future.
But it’s hard to compare the two programs. One started last February 2009, and ran through the entire Spring selling season into the Fall. The surge had nine months to build. The one that’s about to expire straddled the seasonal low-ebb for home buying–the months of December, January, and February.
Many a home builder would have had to roll the dice on spec home building practically the moment in early November 2009 that the ink was dry on the legislation to extend and expand the tax credit.
What’s more, bad weather in the mid-West and Atlantic coast in February may have restrained activity builders may have expected, which pent up traffic until later.
What’s clearer to us is this point, and it’s precisely here that we must again disagree with the consensus on the post-expiration effect: Home buyers are smarter. Waiting–in this case, to the last possible moment before the expiration of the tax credit punch bowl–has been smarter than not waiting. Why? Well, in many instances, they’re getting a better deal than if they bought earlier in the program window.
Now, $8,000 is $8,000, and $6,500 is $6,500. So, if Uncle Sam takes that punch bowl away, will smart home buyers believe for a second they’ve forfeited their opportunity to make June or July or August the best moment in a generation to buy a new house? No.
What the credit extension and expansion succeeded in doing, as M.D.C. Holdings CEO Larry Mizel has pointed out, is to draw the focus on home buying over to new vs. used.
The likelihood that home buyers believe they’re making a smart choice to buy new now is higher because home finance has corrected, and valuations have begun to solidify.
Now, even optimistic JP Morgan strategist Tom Lee posits that home prices have another 6% or 7% to fall on a national basis before the bottom sets in (he’s predicting it’ll be 2022 before we see them regain their 2007 peak pricing levels).
But we’re not recommending home building companies pay any more attention to analysts now than we were a month ago. They just don’t know. If you focus on building smart, and building “finance-able” homes, the analysts’ forecasts can get to be a source of amusement rather than the cause of an ulcer.
Laddering out the Debt: It a Public Builder Bet the Cycle Rules
Anyone who wonders how many days are left in April only need to check out a home building company’s Web site these days.
Meanwhile, while the debt window is open on Wall Street, we’ve seen a flurry of public home building companies jump through it, and the likelihood is we’re going to witness several more ladder out their borrowings, preserving as much of their stockpiles of cash as they can.
It’s a tactic that makes too much sense not to do; but it’s also one that causes some headshaking among critics who point out that public home builders’ debt structure to this day traces to when these companies were two to three times larger than they are.
Still, it’s widely believed that interest rates are headed up sometime, money will get more expensive, the banks won’t be ones to turn to for available capital, and the need to build will be abundantly clear.
Their strategy here is pretty simple. The cost of capital in the public markets is currently inexpensive. The premium they’d have to pay–using those treasure troves of cash they’ve amassed–to delever is a disincentive.
And most importantly, we’ve got a dozen or more public home building companies whose financial conviction, faith, and wager is the permanance and infallibility of the cycle.
Moving some daunting debt maturities from sooner to later, home builders are essentially saying they’re willing to pay more for the borrowing because they believe their business is going to grow stronger in the years ahead. They want the cash now so they can strike and pay for a lower land cost base to accelerate their capacity to beat it out of the doldrums.
We’ve got land deal pounces, swaps, club deals, etc. going on at a frenzied pace, but what’s not clear yet is how end demand for what’s being bought now will work out. The knife could still be falling, or it may have hit the ground. Some have their hands around the blade, but haven’t closed their grip, while others have.
We’ve seen Meritage, Ryland, and Standard Pacific in recent debt maneuvers, following earlier ones by Beazer, Hovnanian, and Toll Brothers.
Right now, analysts who follow the publics stress that debt and interest payments as a percentage of sales is too high, but management at these companies points to the wisdom of the cycle.
Here, we’re of a mind to believe that some of those who are making the claim that they’ll again be two- to three-times larger than they are when the new maturity dates come due will be right. But not everybody.
Even if the business normalizes at 900,000 to 1 million single family starts in the next few years, we’re not going to need capacity and debt structures to support the level we’re seeing it emerge while the debt window is open.
Pressure on Public Home Builders from Shareholder Groups Increases
Amid a host of recently-past and upcoming annual shareholder meetings, management and the boards of directors of the 15-or-so publicly traded home building companies face growing pressure from shareowners on two issues: executive compensation and climate change.
While attention among activist stakeholders gravitates mostly to “named executive” pay and bonus packages, a number of home builders, namely Lennar, Ryland, Standard Pacific, and Toll Brothers are the target of the Investor Network on Climate Risk, a group that’s pushing companies to make reducing greenhouse gas emission a more transparent strategic priority.
Shareholders of both Toll Brothers and Lennar, whose annual meetings took place on March 17, and April 14, respectively, voted down shareholder proposals that called for “quantitative goals, based on available technologies, for reducing total greenhouse gas from the Company’s products and operations.”
Ryland shareholders meet next week, on April 28, and Standard Pacific’s annual meeting is set for May 12, at company headquarters in Irvine, Calif. The INCR, whose interests in home building companies are represented by shareholder groups such as the Nathan Cummings Foundation, and the Officer of the Comptroller of New York City, have submitted shareholder proposals that aim to get home building companies to set measurable goals and account for performance on those goals to shareholders each year.
Here’s a statement from a March 5, 2010 Memorandum from The Nathan Cummings Foundation’s director of shareholder activities, Laura Shaffer.
“Over the last two years, there has been substantial movement among some companies in the homebuilding industry towards both increased disclosure and concrete action to reduce GHG emissions…. NVR is building all new homes to Energy Star standards, KB Home is building all new homes in new communities to Energy Star standards, and Pulte is focusing on increasing the energy efficiency of the homes it builds while simultaneously looking to reduce operational GHG emissions. Meanwhile, companies like Lennar, Ryland, Standard Pacific and Toll Brothers are falling even farther behind. None of these companies appear to be anywhere near the completion of a GHG emissions assessment, let along the establishment of a GHG emissions baseline covering operations, electricity usage and products as recommended.”
Each of the four companies asserts that its building and corporate operations are already making strides in efforts to reduce their carbon footprint. However, nonetheless, they are recommending that shareholders vote down these proposals because complying with them would take away their ability to compete in a ferociously competitive arena with other home builders.
“We are pro-green, and we do everything we can in our homes, communities, and our company to reduce greenhouse gas emissions,” says Toll Brothers executive vice president and CFO Joel Rassman. “Fact is, our customers tell us a lot of what they want in their homes, and while we encourage them toward greener choices, we can not comply with what we can’t control.”
Rassman notes that Toll Brothers shareholders defeated the proposal, with 56% of the vote going against, 23% in favor, and 21% an abstaining vote.
The Nathan Cummings Foundation’s Shaffer says that support for such proposals is growing each year. “We introduced the first shareholder proposal for greenhouse gas emission reduction goals at Ryland in 2005, and got 7.9% shareholder support. In 2009, support was up to 29.9% of shareholders.”
According to Shaffer, the Foundation owns, 200 shares of Lennar, 103 shares of Ryland, and 170 shares of Standard Pacific, not a lot of weight in and of itself, but enough to raise the issue.
What’s clear is that the executive management and boards of directors of home building companies will have an increasing number of shareholder proposals calling for changes to both strategy and operations of their companies. Pulte, whose annual meeting takes place, May 12, will vote on six shareholder proposals, mostly having to do with executive compensation.
Another Texas Two-Step: MHI Inks $50 million Land Venture Deal with Wheelock Street Capital
Houston-based, McGuyer Homebuilders, aka MHI, notched the third in a recent series of private home builder-private equity joint ventures aimed at gaining control of homesite assets, this one clocking in at $50 million.
On the heels of last month’s LGI-GoldenTree InSite Partners agreement to venture on a lot acquisition initiative, and David Weekley Homes’ similar $25 million land venture fund with Midway Cos., MHI is teaming up with Wheelock Street Capital, and has closed on an initial $15 million purchase of 3,000 homesites in the Austin, Dallas, and Houston markets.
Per an MHI press announcement, “The diversified portfolio will include product for buyers ranging from first time buyers to second time move up buyers. MHI will manage the land development responsibilities. Both firms will work to market the homesites for sale to homebuilders.”
Frank McGuyer, CEO of MHI, is quoted in the press release, saying, “We are excited about the relationship with Wheelock. Their experienced team understands our business, and we’ve learned that we share similar acquisition and development philosophies. The formation of this venture will allow us to take advantage of some of the great opportunities we are seeing in our markets right now, leveraging our knowledge of the Texas markets with the capital backing of Wheelock.”
Lacking access to conventional bank lines to reload on lots that have market-corrected prices, private home builders are turning to investment funds that have got some urgency to deploy capital sooner than later, and which have begun to bet that the residential real estate market has bottomed.
This way, on a selective and more targeted basis, the remaining private builders with strong balance sheets and a visible track record of unit volume can position themselves to ramp up earlier in the recovery cycle and plan to grow faster.
MHI, which builds under the brand names Pioneer, Plantation, and Coventry Homes, and Carmel Builders, ranks in the top 30 of Builder magazine’s Builder 100.
Attempts to reach principals at MHI and Wheelock Street Capital by telephone were not answered as of our deadline.
Pride of the Private Home Builders Heads to Chicago in May
To hear Larry Webb talk about private home builders, you’d almost think he uses the term as a way to describe a personality type, and you wouldn’t be far wrong.
Larry, who’s working on getting his own new company, The New Home Company, up and running in California, says of his fellow private builders, “When times are really bad, we think they’re never, ever, going to be good again. And when they’re going good, we think they can’t ever get bad.”
Larry Webb and The New Home Company team.
Fewer than 20 publicly traded enterprises operate in the US, but in a housing economy that overcorrected dramatically to below-normal demand for new homes, it’s those 15 to 20 firms with access to public equity and debt markets who can eat up a greater share of the shrunken market. When—not if—demand normalizes to 900,000 or a million starts a year up from barely half of that, the publics’ dominance may recede. Private companies will find niches; those niches will grow; and before too long, privates will go toe-to-toe again in high-demand markets with the publics. That’s the way the story seems to go when a housing cycle restores equilibrium, … even if it’s only temporarily.
It takes a rare strength of character to deal with a business cycle that works the way home building and real estate does, at least that’s what you’d infer from people who talk about the difference between private and public home building. Supply and demand play a constant cat and mouse.
Webb says, “in how many other businesses, do people still put their own name on the company?” It might come across as ego, and there’s probably some of that, but every local and regional home builder knows it’s more.
When Carl Mulac, whose Phoenix-based upstart Joseph Carl Homes is on pace to hit its year-one plan of closing 60 homes, says, “I am a home builder,” he says it with reverence and regard to a culture and class of business people who behave and believe a shade or two differently than those who ply their trade in other fields or professions. It’s said with pride, passion, humility, defiance, a sense of comic irony, but never with regret or remorse.
A delicate balance underpins the truism that all real estate is local. Start with the relationships a business man or woman has with land-sellers, which in many ways continues to be the black box of success or failure for home builders. Continue with the reputation with people who buy homes; the management staff and associates on the payroll; the trades who work on the sites; and yes, the dirtiest word of the moment, lenders who finance the projects, the land purchases, and the horizontal development.
When credibility and trust serve their normal level of importance in each of those interactions, private home builders thrive. When euphoria or panic dislocates or diminishes the role that relationship plays; when people en masse fantasize that they can get “something for nothing;” or when institutions press the “delete” key on their institutional memory–that’s when private residential real estate companies have a hard time, which is now.
Here are a few of Big Builder editor Sarah Yaussi’s words for private home builders’ current plight: “as much as private builder executives are business managers, many of them are also business owners who’ve poured their hearts, souls, and savings into growing their business in the best of times and keeping them alive in the worst of times—of which the past three years most definitely qualify.”
Big Builder senior editor Teresa Burney captures quintessential private home builder David Weekley’s thoughts on how he adapts to doing business in a cyclical industry: “I think what happens to anyone who goes through these very severe contractions, when they have layoffs and impairments and you go through all the distress, I think these things kind of scar you, mark you, mold your thinking for what’s the smart way to do business.”
In private home builders’ own words, we find eloquence, resolve, humor, and ultimately, success.
We’ll have David Weekley, Larry Webb, Carl Mulac, Shea Homes’ Bert Selva, David Drees, Corey Barton, Dan Ryan, Fischer Homes’ Bob Hawksley, McBride’s John Eilermann, Holiday Builders’ Bruce Assam, Timothy Gehan, Jamie Bigelow, Charter Homes’ Robert Bowman, Wade Jurney, LGI’s Eric Lipar, Bruno Pasquinelli, Center Line Homes’ Craig Perry, Sivage’s Jamie Pirrello, and a host of other private home building business and thought leader luminaries with us as we host the Housing Leadership Summit, May 10-12, in Chicago at the Four Seasons.
What a delight it’ll be to have all of those personalities cut of the cloth of that one personality type crowding the room, working through issues and toward solutions for themselves and their peers! While some of these fellows believe in their hearts there’s no contest when you compare a private home building company with a public builder, they’ve also had too much fun carrying on the debate over the years to let it go.
So come have a beer, roll up your sleeves, explore a few, new ways you can get access to highly sought after capital, and tell some of the war stories yourself. See you there, we hope.
Private Home Builder Notes from the Road
We’ve been on the road for a while, and had occasion to talk with a lot of folks about how they’re managing their private home building firms. Three stories from private home builder land help chart where we see the business for this group. It’s not all dire, but it is all challenging. The stories illustrate the way this part of the home building sector has come a long way from a year ago, but still has a stretch–a tough one–ahead. At best, private home builders have clawed from the realm of doubt to a fragile place full of uncertainty.
Call one of them, “snatching survival out of the jaws of death.” We hear of a privately capitalized home builder who operates in two regions who started 60 homes last November more starts in a single month than any other month for the past three years. Why this was what a number of home builders did–if they could–in response to the renewal and expansion of the home buyer tax credit.
If they were going to experience a windfall from the credit expansion, they’d have to start going vertical in November to make the April sale and June 30 close deadlines.
As of April 15, this builder has sales on about 25 of the 60 homes he started, and he’s out more than $8 million in his own reserves to get construction going so all of them would be done. He thinks the tax credit maybe got him an incremental bump of about 12 sales, but his best guess five months ago was that it would pump about 35 more than that into the equation.
“We definitely pulled buyers forward last fall, which left us fewer buyers in the universe to draw on this time around,” says this principal executive of a top 100 private company.
This will not put his firm in a better position with providers of his credit lines for projects, operational capital, not to mention acquisition and development money. But that doesn’t much matter to him.
“The banks can shut me down, and they’ll lose a lot more than if they extend me and allow me to keep making payments, even if they’re a little less and a little later than they’re supposed to be,” he says. “They’re figuring their best way of getting made whole on their loans is to let me keep paying it down slowly. I’m not going to pay anything off completely because they’ll take the money and shut me down, and then everybody loses,” he says.
So defiance in the face of dealing with below par performing loans may be a tactic that will allow a private home builder to live to fight another day.
Another builder, MBK Homes of Irvine, has a predicament of another nature. As with a few other private firms whose diversified parent companies act as fairy-god-parents through the downturn, MBK draws on its Japan-based parent, Mitsui for capital sustenance.
MBK has manage to grow in volume each of the past several years, and plans more of the same, according to its CEO Tim Kane. With a fiscal year that begins April 1, Kane reports that the home builder, with seven active communities in Northern and Southern California, has recorded a sales backlog of 116 homes only two weeks into its fiscal.
This means MBK has reached 78% of its 2010 plan for sales in the first 15 days of its fiscal year. What could be the problem with that?
The problem is that those 116 sales will effectively sell out five of the seven neighborhoods MBK has to sell in, which means the builder is officially desparate for land.
Since MBK has Mitsui behind it, it’s not subject to the same constraints–i.e. bank loans–to plunk down the money necessary for the deals. It’s just that what MBK is finding is that the much reported shortage in vacant developed lots that would allow it to open new stores affects not only large greenfield tracts, but increasingly the boutiquey small count parcels that only a private could love.
Not any more.
“The publics are moving in on us,” says Kane. “We can’t get anything, not even a seven- or 10-lot parcel without having to bid against several of the publics on the dirt.”
This thoroughly busts the notion that privates will have an edge in competing for land that publics can’t scale themselves down to. Another private home building executive based out of Atlanta confirms that publics can port their lean-and-mean operations into smaller and smaller community opportunities and still make a profitable go, particularly if they want to justify that market’s overhead structure.
What this means is that private home builders can counter program to zero in on customers only they can serve well, but that doesn’t give them a free ride in competing for land that bigger, better-capitalized companies don’t want. In other words, land is going to be bid up, even for some of the smaller tracts.
The last case we’re going to mention is one that’s had our attention before, and will get it again. Carl Mulac’s start-up, Joseph Carl Homes.
Not too many private home builders can talk about having advantages in this market, but Mulac can, and none of it has to do either with favorable environmental conditions nor luck.
Mulac reports that as of April 15, he’s closed five homes across the four active communities he’s building in, and he has 26 homes in his sales backlog, with a goal of 60 for his first year of operations. He’s pulled his first building permits on his new active adult community of CantaMia, and, most importantly of all, he’s sent his first check to his flegling company’s guardian angel, JEN Partners.
Mulac plans to expand his operations, and has already got a staffer on the ground checking out opportunities in Las Vegas, but, for now, he thinks reasonable finished “A” and “B” lot business in the Phoenix-Vegas neck of the is over.
What he is convinced of is that if anything new does arise, he’ll know about it. “Thanks to having been here for years and built up the relationships, I’m pretty sure I’m going to get to get a look at anything that might come available.”
Quotes from Private Home Building’s Trenches
We caught up with Mick Pattinson late last week, who says this of the banks, “we’re not gonna let the bastards beat us.” Mick takes this banks business personally. He says he and the principals in Barratt American Homes, a Builder 100 casualty of the Great Recession that went out of business in a Chapter 7 liquidation last August, lost $100 million in equity as the company’s lender consortium shut down their lines, discontinued project lending, called in their loans.
He speaks for many in the business who are struggling with a fatal error reading that came of builders who took out short term debt on long term assets, land.
What remains missing as people speculate about the timing of a recovery are two factors critical to a restoration of lending, both for home mortgages and for commercial AC&D loans: absorptions and price stability. While both of these factors are erratic, the cost of money that could be put to work to navigate through and out of trouble will continue to be asphyxiatingly high.
Mick and a few trusted cohorts ex- of the now-defunct Barratt American Homes have rekindled the fire in the entrepreneurial belly, and reincorporated under a new aegis, The Barratt Group. The Barratt Group is an avowed shadow of the company it succeeds, but it is a home builder nontheless, and it has begun to hire back some of the staff who had the rug pulled out from under them as Barratt American failed last Spring.
“We’re out there on the court house steps picking up foreclosures, distressed assets, and broken development deals,” says Pattinson. It’s a plan, and it keeps the fledgling company’s destiny in its own hands. No lending, no ulcers over whether the debt deadlines will arrive without demand for the homes ahead of that time.
Pattinson’s defiance inspires. “We’re drawing on private capital. We’ve got a track record, and a good name with our customers, and we’re going to keep fighting this through. It’s small potatos, but it’s what we can do for now.”
There are Mick Pattinsons, larger and smaller, across the country. Speculation among Wall Street real estate investment analysts and home building company executives is that 80% to 90% of private home builders who competed as recently as 2007 will have “exited” their markets by the end of the downturn in the next 12 to 18 months.
This means that the companies they built under the trustmarks of their family names and their brand names will either go away or morph. This also means that the skin they’d put in to secure lots to build on will be a mere memory. This also means that many of them have creditors calling them to make good on personal guarantees that are now haunting them at home as well as at work.
And this is the way the cycle designs the housing economy to work. All the events in the narrative have occurred repeatedly before, but never before with such widespread destructive force at such high-stakes from an absolute dollar value.
We also heard back from Rich Ohmann of Raleigh, N.C.-based St. Lawrence Homes, founded and run by Rich’s brother Bob Ohmann. St. Lawrence filed for protection under Chapter 11 in February 2008, and is close to substantial completion of its plan for reorganization to come out in the weeks ahead.
Rich reports that the company is doing “just okay,” selling inventory, pre-sales, and building with a line from local lender Capital Bank. Having had to downsize its entire in-house selling team, St. Lawrence is getting a heartening lift from New Home Star, an outsourced sales force.
“It’s like we’ve managed to get off life support, and now we’re wobbling weakly down the hospital corridor with the hospital gown flopping in front,” Ohmann says.
You want short term debt to cover short term assets, but you don’t see that combination when home buyer sales demand is still a big X Factor tied to jobs and consumer confidence.