A Moment of Truth for Home Builders’ 2011 Starts Right About Now
The sensation today and tomorrow–on the eve of what home builders, developers, trade partners, manufacturers, Realtors, homesellers, banks, farmers, ranchers, distributors, toolmakers, earthmovers, sandwich trucks, and municipal treasurers hope somewhat against hope will be a bona fide Spring Selling Season–must be like the night before a bigtime parole hearing after a few hard years in jail.
Either you’re going to walk out of prison, and try to continue to make your way out of the shadow of the wreckage of the past, or you’re not. You’re not entitled to know based on all of the facts you can put together ahead of time.
With that feeling of suspended animation in mind, three stories we came across this morning as we assembled our Builder Pulse drill for the morning’s mailing began to weave together into a notion.
These are the three stories.
- What pent-up demand for housing looks like statistically
- Winning against tough odds and complex choices: skill or luck?
- Sellers will trade off a hit on their sale for a bigger reward on their purchase
Here’s how these stories blend, especially as we continue to listen to public home builder company management teams discuss their quarterly earnings performance and talk about how their operations are going to rationalize themselves in the months and years ahead.
The stories each have a what-you-can-control and a what-you-can’t-control element to them. Pent-up demand is a delta of potential that could be a game-changer. The skill vs. luck in winning question is totally relevant for businesses whose mantra runs along the lines of “a bad market can take down a good builder.”
The story on the couple who’d take a loss on their current home to get a bigger win on a new one ties the other two together.
Let’s put this into some context.
In home building cycles past, the plotline usually works in such a way that home builders could roll back their pricing and narrow or even temporarily invert the premium that home buyers would pay for a new home. This would re-ignite demand for new homes, which would spark both construction and consumer spending and serve as a catalyst to the broader economy.
Assuming there’s not a structural change in the way that people who reach adulthood opt to make a home for themselves, the need for home building and home builders is defined by the present and near future demand for new-home construction. The marketplace can tolerate cyclical periods of excess capacity only for so long before it begins to ratchet down the capacity and the money locked up in supporting it.
This is what has been happening now for a few years, and it will continue. We don’t think the era of casualties among home building companies is over. There are still private companies who borrowed money, and whose collateral based on the value of their land holdings has fallen, and who’ll either figure out a way to come up with more capital from somewhere or who will go into default.
Now, in broad strokes, the trickle of demand for what new-home builders do has decimated one of the few ways to gain visibility into how the money will hit the books of the companies: backlogs.
Almost everybody’s orders were down all of the second half of last year. The tide ebbed.
So, what most all of the companies did–given many institutions’ willingness last year to make a greater amount of money by agreeing to wait longer to get it back–was to shift short term debt to longer term debt and shrink their balance sheets to a best-guess at current pace of demand. If they could operated net positive exclusive of one-time charges or land write downs, they’d did the next best thing to growing. They had a water-treading plan that could get them the rest of the way across the abyss.
What public and private home building companies did during the 2000s was to become much better, or more professionally disciplined operators from a manufacturing process standpoint and a financial–debt and equity capital–management standpoint.
Which brings us to the pent-up demand story.
Here’s the graph the National Association of Home Builders’ economics brain trust of Dave Crowe, Robert Denk, and Robert Dietz put together.
Normal household growth since 1965 is 1.5% of households each year. But, between 2000 and 2007, the household growth rate averaged 1%. Looking at total households, that means that 2.1 million of them did not happen during those seven years, that if economic times weren’t so rough, may have formed.
Now, take a look at the story of the couple in Atlanta who were willing to sell their townhouse for less than they’d wanted for it because they knew that with today’s prices and today’s interest rates, they could net out a gain ultimately, because they’d get an even larger concession than they were giving, and they’d wind up with a lower interest payment.
“From a financial point of view, that could make a lot of sense,” said Karen Gibler, an associate professor who studies real estate at Georgia State University’s Robinson College of Business. “You hear people talking about how they don’t want to sell their home at a loss, but they want to move. If you wait for the market to improve to sell your home, the home you want to buy will likely go up in price, as well.”
We’re apt to think of “pent-up demand” as adult children living in the basement, or families doubled-up in apartments. But the example above is a kind of pent-up demand that’s not even counted in the 2.1 million that the NAHB economists have identified. It’s the people who have been antsy to move up or into more fitting homes, but have been waiting for the right moment to do it.
Now, just as on the negative side of the equation we see people willing to strategically default on a home loan where it looks as if the consequences of doing so will be more positive than bearing the weight of an underwater mortgage in a moribund housing market, so too, we may see a similar logic work in another way.
If people know the math of investment and return works out better to take a lesser loss on a current home for a greater gain on a next home, then all they need is the reason your company could give them to do it.
So, stepping back now to the eve of Spring Selling Season 2011, here’s what we’ve got.
In a foreclosure-dominated landscape, home builders need to do more than to motivate buyers with urgency around price as they may have done successfully in cycles past. Instead, they have to create urgency around value.
They have to reinvent value, especially in the minds of those who are among the ranks of the “missing but expected” household formers, and in the minds of those like the Atlanta couple who wanted their move-up home in spite of not getting the price they wanted on their currently owned home.
So if the 2000s were about home building’s coming of age in the disciplines of manufacturing and operations process–that balance of labor, materials, scalability, speed, and simplicity of design templates–as well as finance, the next stretch that will define successfull home builders will be their capability in marketing and selling their value. Their name, their quality, their service, their investment smarts, and their delivery of an experience.
If a rising tide lifts all ships, the home building’s next patch will be about seeing which ships can find the channel they need to navigate until the tide rises sometime hence. This is where the skill vs. luck story comes in, especially in this highly complex moment.
Increase complexity, and skill — broadly defined — takes on greater value. Luck still plays a role, but those who succeed in complex environments have talent and quickness on their feet. They can adapt. When complexity edges closer to chaos, luck may carry the day. But astute players know how to put themselves in situations where they are less at luck’s mercy and instead better positioned to affect the outcome.
Does this describe the eve of Spring Selling Season or what?
Thoughts about PulteGroup’s Plan to Close the Margin Gap
A few operational items of note jumped out of Friday’s PulteGroup earnings call in which CEO Richard Dugas addressed Wall Street’s front line of equity research analysts on how and why Pulte is “lagging its peers” on gross margin progress.
Without an almost-$1 billion NOL tax carry back benefit, Pulte faced the music on Friday, the refrain mostly being, “where are you going to find the gross margin improvement that’s been eluding you even as you’ve taken several hundred million dollars of redundant costs out of the Pulte Centex combination, and further sized down the balance sheet to reflect anemic sales velocities?”
“PulteGroup, Bloomfield Hills, Mich. (NYSE:PHM) on Friday reported a net loss of $165 million, or $0.44 per share, for the fourth quarter ended Dec. 31. The loss included $196 million in write downs, including $82 million in land-related charges and other costs associated with organizational restructuring, debt retirement and other financing amendments partly offset by a $35 million income tax benefit and a $10 million insurance reserve reversal realized in the quarter. Wall Street was expecting a loss of 9 cents per share, ex charges.”Dugas, who has become more hands on by virtue of some pretty heavy-duty management team cuts during the past eight months, says he’s personally out on a mission, convinced there are more expense opportunities in the home building operations themselves to hack away at and improve both directs and SG&A.
Still, beyond going from division to division to preach unity of purpose and pore over each of the divisions’ p&ls, Richard Dugas referred to one having to unwind a process he’d earlier been a champion of, and it has to do with the three home building platforms–Centex, Pulte, and Del Webb–that each gets its own real estate and capital resource strategy as well as its line of homes.
The reality of an agonizingly slow-absorption market, especially after the sunset of the home buyer tax credits program in mid-year last year, proved that the heavier hand of corporate control–on floor plans, operational systems, and purchasing–turned out to be a costlier alternative to forcing the nimbleness and opportunism of entrepreneurial de-centralization into its wide net of divisions.
It’s proven to be the case for many high volume builders that national purchasing contracts, beyond a few product categories, wind up costing more than buying the same items through distributors. More often than not, distributors carry more clout and get better prices than a national builder can.
So Dugas indicated that what had been a move to take more control into headquarters would move back out into the divisions, where not only real estate decisions but a whole gamut of community management executions would be turned over to the division chiefs.
This is a corporate cultural 180-degree turn, and it’s going to be interesting to see how well corporate can entrust more to divisions after spending the better part of the past two years saying, “you do what you do best, which is the real estate and home buyer segmentation analysis… we’ll take care of the rest.”
This means that division presidents won’t necessarily have to take a floorplan off the corporate shelf and make it work in his or her market. They’re going to have an opportunity to decipher more of what the particular market’s home buyer targets may be looking for and willing to pay for. Dugas hinted that base houses under the corporate control system had put costly features in that home buyers were not interested in paying for, which took its brand out of the consideration mix.
The second area of interest that came out of the call was an ongoing unsureness regarding the three-tiered brand structure that Pulte has embraced, with Centex and Del Webb flanking Pulte on the low end and the aging buyer end.
In an ideal world, Centex land positions and those of Pulte and Del Webb would each set themselves up with discrete buyer segmentation opportunities. Centex is the entry level brand now, but for many years, Centex marketed its homes not just to entry level buyers, but to first- and second-move up buyers as well. Many of the lots Pulte acquired with the Centex deal don’t nicely fit into an entry-level package, but nor do they pencil necessarily as Pulte style move-up positions.
What Pulte may be learning is that its ambitious triple-threat plan for three brands for three buyer types is one of those objectives that simply takes time, and we all know that “time and the tides wait for no man.” Reengineering up to 147,000 lots so that they’re each mapped to a brand simply can’t be easy, especially when it’s the minds of the home buyers that matter in the mapping.
We think that Pulte, just as it’s unwinding its plan for central versus divisional control, may also find that its big opportunity is to unify three into two. In other words, keep Del Webb, but make the rest just Pulte (over time) so that it doesn’t have to use the bandwidth nor resources to support three brands among three separate home buying audiences who consume different information largely through different channels.
We don’t know that Dugas will agree, as he’s a branding specialist, and he’s brought on Deborah Meyer from the Detroit auto business more than a year ago to make-over the company’s three-pronged brand strategy. Still, in this market, it may be an opportunity to capture more costs and unify its purpose around its strongest competitive position.
Lastly, we do find it encouraging that Del Webb may be gaining traction as the stock market picks back up and home buyers find that their stock assets are showing some of their bygone muscle.
It would be odd if, especially given the overwhelming atmospheric ooze of foreclosures, it’s a move-up and active adult home buyer’s needs and desires who puts the housing economy on his or her back at this point, as opposed to the traditional pick up from entry level buyers.
It looks for all the world as if federal policy won’t be planning any new creative financing ploys for first-time buyers looking to get into homeownership, at least for some time. So, the Del Webb segment may be one of the most recovery-sensitive opportunities out there, since what may be pent-up at this point is older adults moving to a lifestyle they really feel they deserve, especially after a few years of pain and patience.
Still, PulteGroup faces more challenges to its operations, particularly if the overall rebound transpires as torturously as it seems to be setting itself up to do. The big strides it seems many of Pulte’s peers have made in the past 18 months or so is the assumption that things are going to be less-than for a while now, and there’s no getting around costing one’s business around less-than assumptions.
That may be difficult given the timing of Pulte’s biggest play to become America’s largest home builder a couple of years ago. But, it may be the reality America’s No. 2 builder (in unit volume) needs to face up to now.
Will Private Home Builders Cut it in 2011? We Think the Answer is Yes.
Something funny’s happening on the way to public home builder domination of the low-pulse, anemic housing recovery.
Without question, public companies have made big strides, not only in their own operational disciplines but in the way they flex their muscles in the markets they have chosen to fight out the early stages of a new cycle competitively.
It’s Darwinian reality at this stage for the publics not just to make their numbers, but to make their less-well capitalized private brethren go out of business while they do it.
And public companies aren’t the only well-resourced menace to the well-being of private home building companies right now, either. Clearly, national political expedience favors saving the banks in favor of saving new-home building capacity, so government will sooner and more emphatically look to support the disposition of the 8 million or so properties in the foreclosure-distressed financial asset bucket than to promote the kind of economic well-being that would lead to demand for new construction.
Private home builders, in other words, have cyclical, structural, competitive, and political currents to fight upstream in; it’s no wonder so many of them have gone under in the past four years, a loss not only in capacity, but in the character and culture of home building. No one can deny that while publics have leveraged their heft, the patience of their capital, and their growth in professional disciplines to a competitive advantage, many of their home building operational innovations have come by way of private home builder acquisitions along the way.
Meanwhile, private home building companies, the incubators of much of what is “better practices” in home building–for arguably, best practices will be a phenomenon of some future stretch for the industry sector–are facing their steepest challenges yet, even after four years of cleverly surviving the teeth of the worst downturn ever since housing became its own industry sector.
Still, we talked this morning with Dan Ryan, the eponymous leader of Dan Ryan Builders, based in Frederick, Md., and operating in six states–Maryland, Virginia, West Virginia, Pennsylvania, North Carolina, and South Carolina.
There are three essential bullet points to Dan’s report on his 2010 performance:
- Settlements increased from 397 in 2009 to 502 in 2010, a 26% rise
- Although operations in Raleigh didn’t make a profit, outlier markets like Morgantown and Charlestown, West Virginia more than made up for the losses, bringing the company into the black for the year
- The market dynamics allow Ryan to “grind through” challenging land holdings to diminish the pipeline of less profitable lots
For 2011, Dan Ryan–whose father Jim Ryan founded Ryland Homes; whose Uncle Ed Ryan founded Ryan Homes of NVR; and whose cousin Bill Ryan founded and runs William Ryan Homes, a builder in the Chicago market, as well as Florida, Arizona, and Wisconsin–is pushing. He sees his company–thanks to an expected contribution of 80 homes out of the Raleigh operation, which has five decorated new models raring to go for Spring Selling Season traffic–doing another 30% quantum leap to 650 homes.
We’re hearing equally sanguine fast-growth scenarios from our friend Eric Lipar at LGI Homes in Texas, from Ken Balogh at Ashton Woods out of Atlanta, from Jay Lewis at Surrey Homes out of Orlando, and from a number of other private mini-powers.
Where do they get their moxie, especially when everybody knows bankers are essentially loathe to use the ink of their rejection stamps when it comes to lending to home builders.
Unless.
Unless what?
Well, unless there’s not only moxy but a clean, well-positioned, reliable plan to turn money into more money. That’s what some private home builders have been able to demonstrate, and that’s why they’re still in the game.
And when they’re able to shift gears from “survival” mode to “let’s kick ass” mode, they’re a force to be reckoned with.
Surrey Homes does it by careful segmentation. In both buying land and building and selling homes, Jay Lewis believes Surrey should steer clear of the fray of first-time buyer, entry level homes, a ferociously fought battle in the land of Disney magic. Instead, he’s positioning Surrey as a move-up and second move-up offer, where his rather unique twist on customer care–a five-year full warranty and a designated service and satisfaction follow up program–can actually help him move the metal.
For Ryan, it’s about keeping the fire in the belly he feels as a principal lit among his trusted associates. Word is, Ryan spent one weekend day recently going out personally to the home of one of his best sellers in the West Virginia market because he’d heard she was feeling burnt-out and frustrated. After his visit, she arrived back on the job and has been rocking the sales in the pre-selling season weeks.
Ashton Woods offers another part of the story of how privates can and will compete with publics. It’s called the land committee, and private companies don’t have them in the same sense as publics, whose land committees are a necessary part of a deal to acquire parcels opportunistically. Some times this slows them down.
In one case, recently Ashton Wood scored on a parcel that was sought-after by several publics in the Atlanta area–Madison Park, off Old Alabama Road in the Roswell area. Ashton bought it out of the banks by virtue of their ability to close, and their knowledge of the value.
Because they didn’t have to put their bid before an underwriting committee, Ken Balogh and his team landed the deal, and blasted through 45 of the 49 homes in the community in 2010. Here’s a few photos showing construction on some of the few homes left to be settled, at 3,200 square feet and ranging in the high $300s to low $400s.
We commented on what an uplifting sight all the actual home building activity on the site was, and a sales manager commented, “Yes, we’ve had folks from other home builders come over just to hear what it sounds like.”
Rumors of the death of private home building companies are premature.
We have one idea to offer that maybe they haven’t thought of as such. Why not develop a “pent up demand” home? One that intentionally recognizes that young adults and/or aging parents will be part of the household. We think there’s a future for this as a new product.
Home Builders’ Plan to Narrow the Gap Between New and Used Homes
In Orlando the week before last, we confess that we didn’t spend a whole hell of a lot of time on the exhibit hall floor. The reason is that we wanted to spend time with home builders, and, by and large, a lot of them weren’t spending time on the floor either.
It seemed to us that what a lot of the builders wanted to do was to spend time with other builders, finding out how it’s going in regions other than the ones they operate in, etc. A remark uttered in one of those informal compare-notes sessions from one of the builder executives there is haunting still.
He referred to the fact that banks were still not opening the spigot of lending to private home builders for new construction, and that Federal policy wanted it that way.
“They’ve got seven or eight million foreclosures to clear out somehow; as for us [little private home building companies], they’d like a lot of us just to go away.”
Quite a few conversations, as a matter of fact, centered on the question of whether we thought that more home builders would head into obsolescence in 2011, or having made it this far through the troubles, would see the light of day at the other side.
It’s hard to say, and we have to admit that while we’re relatively sure this Spring is not going to ignite a rebound, we’re far from sure what the “selling season” that gets formally underway in about three weekends will hold.
As for home builder casualties, we believe there will be some this year, but that they’re probably going to be more a function of the ownership or management’s age demographics and less a byproduct of an inability to find some means to stay solvent.
The sad but true statement from the home builder above reflects a common sentiment. Multiplier-effect or no on jobs, consumer spending, local tax revenue, government policy support for new construction has more than worn out its welcome. And now, if housing is going to shift from being a link in the middle of the economic train to being the engine, it’s going to have to do it on its own two feet.
So, we have what the superb housing and economics online gadfly Bill McBride refers to in his Calculated Risk Web analysis as “The Distressing Gap.” Simply, it’s the ratio of the number of existing homes sold for each new home sold.
For about the past 15 years, SAI Consulting’s Fletcher Groves points out that the “Distressing Gap” has averaged one new home sold for every six resales. In 2010, Groves notes that that ratio has morphed into a multi-headed monster– 1:16. This means 16 resales for every new home sold. The fact that many of the resales are distressed sales — either short sales, duress sales, or sales in some stage of foreclosure — is the reason for Calculated Risk’s name for the infographic, “the Distressing Gap.”
Here’s the picture of it now:
with premission from Calculated Risk
Economically, this information means one thing, which is that, under present circumstances anyway, there is an overcapacity of home building in the nation. This is the context for our friend in Orlando’s sentiment that “they’d like a lot of us just to go away.”
However, within the framework of the industry sector, the Distressing Gap is part of what benchmarks opportunity for some home builders, most likely at the expense of others.
Why is it that when you talk with the strategic management of a home building company–whether they’re small or large, private or public–they always say they want to have access to capital like a large public company but they want to work and care for customers in their markets entrepreneurially like a solid private company? In other words, if you’re a public, you find yourself emulating NVR, and if you’re a private, these days, you kind of want to take after Shea.
Neither of these two companies perfectly captures the public capital access with private entrepreneurial culture, but they’re probably as good as home building can offer.
Now, as for the Distressing Gap, the fact that it’s taking 16 resales to get sold for every new home relates to one of the anomalies of this downturn versus others. We wrote in Builder Pulse this morning:
In downturns past, foreclosures never amounted to much in the plot line of recovery. New-home builders could roll back their pricing to beat resales sellers, and that would reignite an economic daisy chain of positive effects. With estimates of as many as 8 million foreclosures to clear from this point, the government, lenders, investors,etc. don’t want to hear from added new-home capacity. Still, consumers vote with their feet, and they’ve wanted new when they can get it. The “normal” ratio of new-homes sold to resales is about 1:6. By the end of 2010, the ratio spread to 1:16. We’d peg survival for the top 200 home building companies in 2011 as reliant on getting that ratio back down to a 1:10 run-rate by the end of the year. Or else there’s just too damned much capacity.
The operational opportunity we’re talking about has to do with the stars-aligning moment that brings new, low price, low interest, lower monthly energy cost into a fleeting, don’t-miss-it instant.
Fear of losing this window of time when all of these advantages converge may be the spark of urgency buyers need.
Now, the buyers who’ll put the new-home community on their back for the next several months may not be the ones production home builders have customarily depended on, especially in the past decade.
Builders’ got competent at ushering the borderline credit-worthy aspiring home buyers across the crevice of spotty credit histories and insufficient resources.
There’ll always be buyers like that, although getting prospects from a 540 to a 640 FICO is going to elongate a lot of timelines for closings. The early-recovery buyers that home builders need to do a better job at courting are ones who have better credit, more cash, and traditionally have looked for already established communities for their families in locations with proven track records of providing what they’re after.
Some fair amount of that Distressing Gap is people finding the resale house of their dreams for a foreclosure song. Some of it is investor buyers buying up homes in bulk for another flip as the market gains a little bit of traction.
At any rate, builders need to close the gap. They won’t do that by competing on a national scale, but within submarket arenas that have eclats of opportunity to buy right and sell fast.
What we came out of Orlando with was the sense that there are builders who feel confident that although the new-home environment will be characterized by distress, there will be a one-two punch opportunity to get just the right real estate deal and offer just the right product to push the ball up the field. This is how they plan to narrow the gap.
Add This to the Flashes of Positive News: Traffic is Up
A leading indicator that’s turned solidly positive for construction is the American Institute of Architects Architecture Billings Index (ABI) for December, which hit its highest level since 2007. A lagging indicator that has turned positive, existing home sales blew through consensus estimates by a run-rate figure of 430,000 home resales in a 12-month period.
What’s more, pending home sales have cobbled together a run of positive reporting periods, initial jobless claims are tacking together a four-week moving average that is encouraging, and most of the regional economic measures of demand for goods and services reflect expanding structural demand building momentum across the board.
Now, take away from the positive tidings the fact that the European nations’ debt minefield could set off a global daisy chain of financial white light moments, and the fact that domestically, we’re seeing local governments writhe under the tyranny of past and present misguided capital planning, and closer to home, the fact that the pig in the python of foreclosure clearance seems to be stuck somewhere between the paperwork the lawyers and common sense.
Clearly, with still nearly one of every 10 employable adults out of work and both the tangible and psychic ripple effect of that phenomenon, there’s still big questions hovering over the 66% of the economy that comes from consumer spending. Don’t forget all that household debt that’s still there to be dug out of.
On the other side of it, big questions hover over the appropriate balance of for-sale versus for-rent housing, as well as the appropriate balance of government versus private sector investment in housing finance, as well as the appropriate way to securitize loans and make them safe for slicing and dicing into global structured investments.
When it comes down to it the two big question areas have to do structurally with how people can earn a living in society today and how valuable the property is that they would buy to reside in if they so choose.
Big questions.
Which brings us back to the news. The news is that amid the burgeoning signs of life in the broader economy and a feint pulse-beat in housing, we’re hearing reports that traffic numbers are up, specifically in California, post the holiday-season torrents of December.
According to our sources, traffic data is spiking normally for this part of the seasonal cycle. This is noteworthy because last year’s business was artificially stimulated, and this year, it’s working on its own two feet. Demand is simply demand.
We asked our sources two things. One is whether they thought that the 50 basis point spike in interest rates was playing a part in the motivation of potential buyers, and the answer was “probably.”
The other is does anything in the traffic in the neighborhoods suggest that people are turning to new because of any anxieties they might sense over who actually owns the title for a distressed property deal. The answer here is less clear. The broad sense is that people are tiring of the rigors of trying to purchase homes out of foreclosure. But there’s no one expressing an explicit anxiety that has arisen from the mess in the processing of foreclosures by mortgage servicers.
Still, the news is that traffic is up.
This is but a two-week moving average, and therefore not a true real estate trend. We’ll have to see how this tracks into the more formalized Spring Selling Season, should it actually evolve this year.
One thing we’re hearing many builders express is the delight they’ll have as they reach mid-year, and they can stop comp-ing their performance to months where the home buyer tax credits were playing havoc with prospects’ timing.
Who’s at the International Builders Show, and Who’s Not? And Why?
The story of the home builders show, as the National Association of Home Builders International Builders Show is known, continues this year to be who’s not attending, and why.
Last year, the show in Las Vegas perched itself amidst what in hindsight can only be regarded as the great false promise of the downturn–a buoyancy bought by taxpayers for the relief of crisis symptoms that lasted as long as the adrenaline flowed and no longer.
This year, the show in Orlando perches itself amidst what can only honestly be described as on the cusp of something–maybe good, maybe not so bad, or maybe pretty bad.
Why many home building company executives are not here this year is plain and simple. There’s too much to do back at the fort. And it’s not all good either.
For as much as January 2011 will be all about tuning the engine, and getting every part of it in fine racing form for when–32 days or so from now, the weekend after Dallas hosts Super Bowl 45–the rite of Spring Selling is to begin, some builders are back home not getting ready to ramp up but to scale back.
It’s all well enough that data points are going to edge sporadically to the positive from time to time, but solid corporate profits, record amounts of accumulated cash on the books, and a pattern of sustainable end-user demand forming in the inner core of the economy haven’t much budged either the hiring needle nor the one that moves when consumers are free-spending again.
What’s more, one of the builders we were hoping to see at the IBS in Orlando this week says he’s not coming because his very busy right now trying to get his buyers qualified for a loan. “We can work and get our buyers to a 560 or even a 580 credit score, but now the minimum score our buyers need is a 620 or even a 640 and we’re just not getting our buyers to that mark in the time we have,” this builder tells us.
What this suggests to us–especially in light of the fact that the ongoing foreclosure crisis is going to massively slow the resolution and liquidation of distressed resale inventory–is that demand for new-home construction may come strongest this year not from the usual early adopters in a housing cycle–the first time buyers.
We think it’s more likely, given the credit score demands, the down payment requirements, etc. that it’ll be buyers who can bring more of their own equity to the equation who’ll be the most ripe to court.
They’re discretionary buyers whose reason for not coming off the sidelines up until now has had more to do with the sense that the moment was not right than that a life stage or life event propelled them into the housing arena.
Because lenders are going to be saddled with their foreclosure woes for months and months to come, we don’t believe the tight credit environment is going to get much better for buyers anytime soon. Nor is it likely that the universe of potential home buyers has been expanding leaps and bounds in such a poor jobs and income stretch.
What we do see is that household formations have been suppressed for the past several years, and that builders all together have produced few enough starts to have begun to create scarcity.
So, builders can and have directly impacted the part of the supply challenge that they have any influence over, and they need to do the same thing with part of the demand challenge.
What home builders can’t do–at least in a vacuum–is hire enough people to bring the unemployment rate down, the consumer confidence index up, and household debt into balance.
However, what they can do on the demand side of the equation is to invent desire. This is part of the plotline that has run through enterprise home building for as long as it’s been around… certain kinds of home building companies can bridge the often wide gap that separates aspiration from attainment. They can do it at the entry level, and much like car companies who have made luxury features much more attainable, home builders can do the same at every other price point.
A long-winded way of saying, we completely understand why there are many home building executives who are too busy to be here in Orlando for the International Builders Show. This year, at this moment, it feels as if visibility is an impossible business notion.
Ask home building executives why they’ve gone out and spent billions on reloading their lot pipelines and are overseeing hive-like disciplines at new and retooled communities around the country right now, waiting for the last whistle to blow on Sunday night Feb. 6.
They’ll tell you, “This is what we do.” If there are no buyers they can see with their own two eyes right now, that doesn’t prove to them that they’re not out there somewhere hiding.
This is why it’s critical to thoroughly understand the “pent-up” market of double-ups, children in basements; ad hoc families who’re sharing places while one gets its feet on the proverbial ground.
Pent-up demand is real demand. It’s just hiding. It may be that 2011, apartments may get that pent-up demand. But not if the for-sale guys have anything to say about it. Which is why they’re not in Orlando, dodging the horizontal rain.
Horton Hatches a “Who’s Your Daddy?” Flourish to 2010
In a related story, D.R. Horton can claim the No. 1 ranking among home builders in our book. Horton sold almost 21,000 homes this year, a year in which the run-rate for home sales is somewhat shy of 300,000. Yes, so one home builder accounts for somewhere between 6% and 7% of the total in the nation.
Don Horton
PulteGroup, whose average selling price per home is almost 25% higher than Horton’s, booked more revenue during the period we’re talking about, so its management argues it’s still the No. 1 company in home building.
Decide for yourselves. We happen to think that Horton gets honors. You can kid yourself and say that it’s the Horton team’s ambition to be “biggest builder in the land,” but we’d say it’s more about winning.
With Horton in the game in any market, other competitors know this, that there’s a take-no-prisoners player in the arena, willing to do what it takes to sell a home at everyone else’s expense, as long as it’s good for their business. This is the way NVR competes in its more limited geographical footprint. Its people compete, literally on the same turf as everybody else, but they do everything in their power to tip the playing field in their favor when it comes to outselling everyone else.
These companies’ people arrive at work each morning knowing that they’ve got to outduel the market or they might as well not have shown up for work that day.
We’re not saying that PulteGroup people don’t come to work with that in mind, but we are saying the D.R. Horton does that more effectively with its people than any other company in the business.
Everything that’s unfair and imbalanced in the way Horton works a market–the way it builds relationships with land sources, real estate agents, trades, materials suppliers, etc.–Horton does with impunity, because culturally, its management believes that to win it must dominate, and to dominate in some cases means to demoralize its competition.
The assumptions Horton makes each day include acceptance that the universe of home buyers is smaller than its been–the pull-forward of demand, the scarcity and level of difficulty to obtain a home loan, the prevailing insecurity over employment, the paralysis in household formation–but does not include tolerance of performing at a less-than level.
This is managing adversity. Horton took its medicine like every other home builder and reduced headcount as painfully as the next guy. What Horton has not done–nor NVR–is to slack off on expectations of the people who kept their jobs.
Other public builders and private builders can say what they want about D.R. Horton but there’s an eerie correctness to what CEO Don Tomnitz promised in 2005, when he said the company would double in volume from around 50,000 units. In fact, in the context of the universe of new single-family homes sold, which has shrunk from over 2 million to under 300,000, Tomnitz’s promise that Horton would “double” more or less comes true in the sense of a percentage of the entire marketplace.
To us, Horton wins by staying true to its culture, which is to do right by its customers, help get them what they want, and also to do right by all the partners it does business with, whether that’s painful or not.
Horton–not coincidentally springing from the nature of its eponymous namesake–hard wires itself to winning. It doesn’t mind doing it the hard way either, being better at sales management, better at racing to the right deal, smarter at striking when the iron is hottest, unrelenting in understanding its potential buyers, and fearless when it comes to dominating a market.
Competition in 2011 will mean so many things as banks, desperate owners, people with job opportunities in other markets, and other new home builders crowd every potential buyer with the “once-in-a-lifetime” buying opportunity.
But anybody who needs a reminder of what competing in home building means–no matter what the market conditions are–only has to take a look at what D.R. Horton and NVR do. Writing them off as only wanting to be the “biggest builder in the land” is giving short shrift to the discipline, the financial management, the sense of timing, and the motivation of its workforce in the face of adversity. They’ve figured out how to sell the most and make a few dollars profit while they’re at it, which is more than a lot of the other builders can say right now.
Horton is as worthy a competitor as there is in home building because it puts winning right there in the middle of everything it is.
Is Today’s $30 Million Land Deal California Dreaming or A 2013 Gold Mine?
Los Angeles-based Shapell Homes paid upwards of $142,000 per acre for 211 acres of the western portion of Carlsbad, Calif.’s Robertson Ranch from long-standing landowner the Robertson family, the company announced last week.
The deal will bring Shapell–which controls 8,000 to 10,000 lots, and develops and builds in masterplans such as Porter Ranch, Gale Ranch, and Rancho Conejo in both the northern and southern parts of the state–back to the San Diego area after a several year hiatus. An already-approved “specific plan” for the tract needs grading and infrastructure work after it’s lotted out for as many as 680 homes–in both single and multifamily variety–as well as 8 to 10 acres of retail commercial.
We caught up with Erik Pfahler, vp of planning and acquisitions at Shapell Homes, who talked about the buy. Why now? Why there? What’s Shapell’s plan? etc.
The original master plan approval was secured in 2006 and the eastern portion of the property is currently under development (after an original joint venture with Corky McMillin Cos., Brookfield Homes is going ahead with building the eastern master plan).
“If this parcel came up for sale next year, we would have been interested in it,” Pfahler tells us. “It happened to be available this year, and in spite of the interest that this parcel has had from other builders, we were able to buy it on very solid fundamentals, basically the existing market.”
The plan is to do the grading, infrastructure, and land-planning work by the first or second quarter of 2012, which many analysts say will finally mark the beginning of the upturn in the cycle. The models would go in later that year, with the first home deliveries by the third quarter of 2013. Shapell, which builds both single- and multifamily units as well as retail, plans to do all the building in the masterplan itself.
The location fits Shapell’s propensity for some of the more constrained land-positions receptive to its multiple product skill set.
“The Robertson Ranch western parcel is actually where the original Robertson homestead was,” says Pfahler. “We considered this an opportunistic buy because it specifically fit the type of geography our current projects do well in–coastal areas, near jobs, with fairly up-market communities. For these locations, there are not a lot of opportunities, so we were gratified we did what we said we were going to do when we went into contract, and we got the deal closed.”
GW Realty brokered the deal.
The good news, from Shapell’s standpoint, is that the company has a two-year runway before it plans to bring the new neighborhood online. What’s more, land prices in constrained, coastal areas of California have been tended to be sticky even in light of home prices’ decline of 30% to 40% since 2006 and 2007 peaks.
The big questions for developers and builders setting up this type of pipeline is how to lot out the parcels to the densities, designs, and product types that will strike the balance between predicted demand, prospective costs, and profitability–all these assumptions in a vacuum of present-day transactions that serve as guidelines.
The nearer term market “will depend on the outcome of federal government tax policy,” Pfahler believes. “Fact is,” he says, “the people who would be most affected by changes to tax liability in the ‘upper’ earning brackets would be exactly the segment either buying or interested in buying homes in Southern California right now.”
So if there’s clarity instead of uncertainty on that front, Pfahler infers, the market could either take another blow or get a lift in the short term future.
Meanwhile, he says, it’s more likely that the housing market will put down a foundation in 2011, and hopefully do the numbers it did in 2009 versus the back half of 2010.
Pfahler’s prediction is that localities are going to need to do some major adjusting to realities when it comes to their planning, because they appear all to be pushing greater densities than the market will profitably support.
An intensified collision of interests between developer builders and municipalities is imminent, particularly as local governments struggle under the weight of their own overspending and debt obligations.
Three predictions for home builders in 2011
It fascinates us to imagine looking backward at this time next year. We think the perspective of 12 months will not necessarily begin to have restored what we have lost, but we do think the passage of one more year will confirm a few hunches, positive ones.
- (1) Here at Hanley Wood, and Housing Crisis, and Big Builder, and Builder, we’re about to shift from doing most of our stories about what has been happening to doing the majority of our stories on what people and companies are doing;
- (2) Maybe we have been looking at this notion of the home as an investment incorrectly, and if we’re going to understand true demand for homeownership in future we have to look at the first two-thirds of this past decade not as an aberration but as a direction toward which people who form households and make a “family” are going; and
- (3) central to every home builder’s strategy and agenda for 2011–irrespective of size, geography, or business model–will be one principle and one principle alone, the capacity to strike opportunistically.
Let’s take each point, one by one, and think about it.
Starting in the early 2000s, our collective defective actions as a business community, marketplace, and society led to a state of synthetic hyperactivity or euphoria. Subprime and its sudden pandemic contagion leveled the universe by the end of 2008, turning even the most powerful of global business’ giants into supplicants and spectators. In days, we’d gone from a “money for nothing” world to one in which money was in a total limbo of fantasy value, worth nothing or everything.
In the relatively short order of 36 or 48 months, home builders lost 75% of their business, like limbs lopped off with each passing quarter, each time actuals came in at variance with sequential or year earlier data points. With each V came good-byes to divisions and markets, broken promises, busted deadlines, failed deliveries, and a protracted state of triage management to stop loss.
Having made hay in the sunshine of ritalin-laced demand, firms of all sizes turned inward, focusing on survival. Action plans consisted of cuts, mitigations, random flashes, occasional inspirations, and last February 2009 through April 2010, reactions to stimulative policy.
If the tax credits did nothing else, they allowed many companies to keep a pulse in the deepest freeze any home building veteran had ever weathered.
At any rate, deep freezes don’t last forever. This one may have begun to thaw. This is what we’re seeing in a number of technical data points that have inflected positive in the past several months, including private construction spending. An important component of Residential Investment, private construction spending, may preindicate a recovery that not only means more building, but means more spending, which turns into healthier profits, more hiring, and more household formation … which means more building and more work for builders to hire workers, and so on.
So, while 2008, 2009, and 2010 have been years that we industry and community observers have been reporting on the externals of macro economics and policy exerting themselves on internally-oriented home building organizations, we think 2011 is the year that changes.
You heard it here first. By this time next year, we’ll be covering a robust roster of story-lines that have to do with home builders’ external actions to strengthen their respective opportunities. Consolidation, innovation, even escalation of initiatives will be the bread and butter of our titles, rather than what Capitol Hill scrum is going on now.
So, prediction No. 1 for 2011 is that the industry community shifts full-bore by this time next year from spectators to players.
As for the second notion, we’ve all heard often that the problem with 2002 to 2008 is that people were looking at their homes as ATMs, as speculative investment vehicles, serving a range of interests, from elevating one’s financial lot in life (no pun intended) to hedging markets, and outrunning equities, etc.
We think this is an incorrect way to look at a mega-change. The house became an investment vehicle in the 2000s because of regulatory breakdown, a global liquidity miasma, and high-finance steroids, which conspired to make money too easy to steal and pour into the economy.
The mistake would be in not understanding essential ways that households are changing. They’re changing profoundly around new values about who makes a family, what and where work takes place and how much it’s worth, and the permeability of international borders, allowing for global migration as a fluid ongoing reality.
To understand demand–not in the future, but currently–is to understand that households have changed from the married-with-children iconic economic engine, but households today are no less economic engines than the mom-dad-and-two-children households that dominated the 1950s and ’60s.
Households that had a male, a female, and young kids had needs, and 25% percent or so of 110 million households today still have those needs, because that’s the number of two parents and a young child homes there are. It’s the other 75% that is causing some of the cognitive dissonance in home building.
Even as household formations spring free of the Great Recession’s financial ball and chain, the mistake would be to assume that more than 25% of them are going to funnel into that married-with-children segment. This is something volume home builders are prone to do, which is why many of them compete head to head to head to head with one another rather than to match their skills and motivations up to where there are unmet needs.
The point is, we may momentarily conclude that people want to buy a house to live in it in contrast to 2006, when they bought a house so that they could make money on it and sell it to a greater fool. But this is temporary, we think, a function of tight credit, and low transaction volume.
In fact, we feel the more prevailing trend is that households–particularly ones who do not center their present and future values around children–will continue to see their home as part of a holistic business plan. The mega trend still unfolding is the one that put multiple earners under the same roof, working for aligned goals. Whether or not this is a husband and wife is becoming less relevant than the fact that multiple earners want a maximum return on their combined financial resources, and the house may be one part of that. So, we don’t see a retro reversion to a time where the house, and homeownership go back to a bygone day when it is not an investment.
So, prediction No. 2 for 2011, is that winners in the next 12 months will be home builders who specialize in fluency and relationship with the “unmet need” in a market. This does not only mean a home buyer who plans to spend eight or more years in the place they purchase; rather it means that “new” or “alternative” or “unconventional” or “multi-generational” households are the ones who’ll budge from the sidelines first in this kind of market.
Which brings us to point 3, the operational imperative of 2011, to strike opportunistically. You all have forgotten more about this area than we’ll ever know. However, we’ve seen in a few exceptional places breakthroughs over the past year or so, and we believe they’re bellwethers of how 2011 will work. Understanding that each home building enterprise has its own tolerance for risk, we believe it still necessary for each to exploit its own horizon of opportunism. Or simply pack it in, because it’s not going to get a lot easier for at least a couple of years.
- Niche your way to scale
- Learn to do something before the rest
- Buy land before the for-sale sign goes up on it
- Imagine your sales team–whom you may love and respect–never sold a lick of anything in their lives, and challenge them to relearn everything from a blank sheet
- Describe three buyer types you can draw from your market that Claritas never even heard of, because they’re out there–Claritas’ segmentation assumptions are 20 years old.
- Align your team around a culture of yes, of trust, and, even of mistakes, as long as they’re errors of commission rather than omission.
Another 12 months, and we’re going to be all about what you’re doing versus what’s happening to you. We look forward to that.
2011–The Year of Market Share
From what we’re hearing among a select group of home building company leaders, they’ll take “we’re doing better than the others” in 2011.
Face it, in an under 300,000-unit, single-family new-home sales environment, 200 home building companies average about 1,500 homes apiece among them. Share, as in not sharing market share, is life. Depriving others of share, including the banks that may be on pace to take back one in every five borrower’s homes in the next couple of years, is the way to keep a home building company’s lights on.
And so we hear, that the model homes are either set or in their final stages, ready for the weekend the market’s National Football League team falls totally out of contention for a playoff spot in January (which has already happened in several markets, probably accounting for higher than average traffic to new-home communities in at least the Carolinas, Dallas, and maybe Denver).
The associates are going through their paces on sales, still trying to grasp how to capture prospective buyers in the online research loop and work them through mortgage loan approvals in a moving-target credit standards environment.
All that’s left now is to sell.
To sell, just a few years ago, was a passive matter, basically completing an order form from a line of people that appeared to be longer than the number of homes that were going up. Until it wasn’t.
Now, to sell is an active, hard-nosed, creative, persistent, mine-field of buyer trepidation and lender bait-and-switch. To sell is to achieve. To sell today is to win.
And not to sell–starting with those hundreds of new communities that public and private home building companies will grand open into the teeth of a maybe-maybe not recovery–will mean to go away, at least for a while. Disappear for at least long enough for people to forget who wasn’t paid, who got left holding the bag, who went down with you, who’s still trying to dig out of the hole with you.
This is a difficult moment for the companies we call big builders. As Jamie Pirrello’s column today notes, few builders have a choice but to ante up. They can’t keep sitting out hands and expect to be in the game. That pile of chips in front of each one of them is what it is. It’s tiny in the case of many private home builders, and it’s several stacks of every denomination for a few of the publics.
More adversity isn’t an option, and unfortunately, it’s usually just before things really start to improve that they’re at their worst for the weakest of the set.
So take the next 60 days and plot the way through the following 52 weeks to around this time next year. For good measure, make it another year of assuming the lowest range range of volume, at least while companies and individuals gather their bearings in the gravitational force-field of the government’s spending vs. revenue crisis.
Remember, there’s enough health in the money math, even of housing, to heal what ails us. Four out of five home loans are not under water and not in danger of distress. Another 26% of the 75 million owner-occupied homes doesn’t even have a mortgage on it. Between 80% and 90% of workers who can earn a living are doing so.
Recovery is happening. Even a couple of those housing analysts who have sounded most bearish during the past five years, The Big Picture and Calculated Risk, have begun to reflect a litany of ways they’re tracking traction across the board. Still, they’re careful to conclude, the improvement is modest and there’s a big hole to dig out of.
Even if you call it gloom without the doom, it’s vastly better than where things got to in 2008.
What’s more, things were very bad before those Armageddon moments in the Fall of 2008. They were rotten in 2005 and 2006; it’s just that some of us failed to grasp that.
More than likely, 2010 will serve in hindsight as the beginning of the end of the worst of times for home builders, and the mind-set this time next year for Spring selling 2012 will be a great deal more positive.